MSCI is to add Chinese A shares to its Emerging Markets index in June 2018 following efforts by China to make its domestic market more transparent and accessible. However, the index company will only add 222 China A large-cap stocks to its MSCI Emerging Markets Index, so only about 5 per cent of the roughly $7 trillion (£5.52 trillion) market will be included. These A shares will be added to the index in two phases in May and August next year.
MSCI has no immediate plans to increase the A share proportion from 5 per cent to 100 per cent of the market, as was originally considered in 2014, although it will consult on increasing the number of A shares in the future. This means A shares will only account for about 0.73 per cent of MSCI Emerging Markets index next year.
Although China A shares will only have a small weighting in MSCI Emerging Markets index, this will have a significant effect on passive funds tracking this index (with about $1.6 trillion in assets), as they will have to buy these shares. These include London-listed exchange traded funds (ETFs) iShares MSCI Emerging Markets UCITS ETF (IEEM), Source MSCI Emerging Markets UCITS ETF (MXFP) and db x-trackers MSCI Emerging Markets Index UCITS ETF (XMMD)
MSCI had refrained from including China A shares in its Emerging Markets index in its annual review of its indices in the past three years due to concerns about corporate governance issues and a lack of transparency in the domestic Chinese market. A particular sticking point for MSCI was that investors were trapped in suspended stocks during the Chinese stock market correction in 2016.
MSCI said the Stock Connect programme, which links the Hong Kong stock exchange with the Shanghai and Shenzhen exchanges, had been a "game changer" in opening China's markets. The 222 China A shares being added to MSCI Emerging Markets index next year are large-caps accessible via the Connect programme.
Currently, China accounts for 28.9 per cent of MSCI Emerging Markets index, but the stocks included are offshore-listed H Shares traded in Hong Kong. With the addition of the A shares next year, China will account for just under 30 per cent of MSCI Emerging Markets index.
That is still a fairly small chunk compared with the size of China's total stock market. As of January 2017, China was the second-largest equity market with a value of $6.6 trillion, and third-largest bond market globally. The total capitalisation of the A shares market has grown by more than 480 per cent over the past decade, so it is a notable omission from emerging markets indices.
Asset manager Matthews Asia said: "China's A share market has simply been too big to be overlooked by global investors. It is the second-largest equity market in the world, both in terms of market capitalisation and turnover. The structure of MSCI indices has been lacking in their representation of China's overall markets."
The A Share market, which features a significant number of high-growth technology companies, has been highly volatile due to its restricted nature and because it is mostly traded by Chinese private investors. However, many commentators say increased access to domestic shares, including some of China's most exciting new technology companies, will benefit international investors.
The forthcoming inclusion of China A shares in MSCI Emerging Markets index is also relevant to active funds benchmarked against this index. This is because their managers may feel compelled to own A shares in a similar quantity to the index if they think they are going to do well.
Dale Nicholls, manager of Fidelity China Special Situations (FCSS) investment trust which has MSCI China as its benchmark, adds: "The breadth and depth of China's onshore market is huge, but still relatively under-researched, which means there are many interesting stockpicking opportunities. I would expect that over time the onshore A share market grows in importance not just in Asia, but globally too."
Fidelity China Special Situations already has about a third of its assets in China A shares.
MSCI will also start to include China A shares in the MSCI China Index, where they will have a weight of about 2.5 per cent, and MSCI AC World Index where they will account for about 0.1 per cent.
