Don't Want to Touch Volatile Chinese Stocks? Soon You Might Have To

TAIPEI, Taiwan -- China has done what it can to make foreign funds want to invest in volatile "A" shares, but many still don't. Someday soon they may be forced to.

China-traded shares are being considered for inclusion in the influential MSCI index of emerging market stocks, possibly in the first half of this year, analysts and media reports say. Inclusion would prompt ETFs tracking that index to rebalance by shifting money to China. Mutual funds that use the index as a benchmark may also feel compelled to reallocate.

No one would be happier than China. The government has gone on buying sprees, tweaked its rules and liberalized the yuan currency to control volatility in "A" shares since a 40% slide in mid-2015. But prices keep falling, including a 13% decline this year on the benchmark Shanghai Composite Index. Gradual inflows of foreign investment, including some of the $1.7 trillion now benchmarked to the index, would lift the market.

"They're looking at (MSCI) as a way to gain a global standard for 'A' shares, and there would obviously be more flows into A shares over the long term," said Charles Salvador, investment solutions director with Z-Ben Advisors in Shanghai.

MSCI is reviewing "A" shares for inclusion again after declining to add them in June due to concerns about liquidity and ownership, CNBC reported in November. The index of 23 countries now covers 837 companies, including Chinese firms that are listed offshore. MSCI, one of the world's most influential builders of indexes, covers multiple markets.

But cheers from China would not drown out fears among foreign institutional investors forced to take positions in the "A" shares that MSCI picked. Individual foreign investors are barred from direct trades in China but can buy into funds offered by institutions.

Among the funds affected would be BlackRock's (BLK) iShares MSCI Emerging Markets ETF, a 13-year-old fund with assets of about $18.1 billion. BlackRock supports MSCI's "process on the inclusion of China 'A' shares into its global indexes," a spokesperson for the giant American asset management firm said Friday.

"China is an important investment destination for our clients globally, and the opening of its markets is a hugely significant event, giving access to its vast markets," the spokesperson said.

Multinational investment banks Amundi, HSBC (HSBC) , Lyxor,  (SCGLY) and UBS (UBS) also offer funds that track the same index, according to Internet database justETF.com.

The $662 million Van Eck Emerging Markets Fund (GBFAX) would also stand to be affected. The New York-based investor believes it's "inevitable" that MSCI will add "A" shares, portfolio manager David Semple said.

"China will become a bigger part of the global equities universe," he said.

Some of China's moves over the past year to make "A" shares more attractive to foreign funds may also be aimed at impressing MSCI before the next review. The government is considering new links between domestic markets and more freely traded counterparts offshore. It also eased rules on foreign institutional investors this month.

Beijing looks to its stock market to capitalize smaller local firms that could lead China's transition from a manufacturing economy to one driven by private investment and consumption.

But China-listed stocks could turn out to be too restrictive, for now, to include in the index. Only 279 qualified foreign institutions have been granted quotas to invest in Chinese equities, meaning other institutions that track the emerging markets index could not legally add "A" shares.

China is expected to stick to market reforms until it qualifies for the index.

"I don't see how they could include 'A' shares in the MSCI until every institution -- small and large, those with QFII quotas and those who don't have them -- can invest," said Jack Perkowski, managing partner of merchant bank JFP Holdings in Beijing. "I think we are a ways off from the inclusion of 'A' shares in popular indices."

 

 

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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