MSCI and China’s A shares

A few days ago, MSCI, the premiere authority on the structuring of stock market indices around the world, declared that it had been carefully considering adding Chinese A shares to its Emerging Market indices–and concluded that it would not yet do so.

What is this all about?

MSCI

MSCI (Morgan Stanley Capital International) creates indices that investment management companies use to construct their products–both index and actively managed– and to benchmark their performance.

Having a certain stock, or a set of stocks, in an index is a big deal.   For passive investors, it means that they must hold either the stocks themselves or an appropriate derivative.  Either way, client money flows into the issues.

For active investors, they’re forced to at least research the names and keep them on their radar.  If they don’t hold a certain stock or group, they’re at least tacitly betting that the names in question will underperform.

 

If we measure economic size using Purchasing Power Parity, China is the largest in the world.  It seems odd that the country not be fully represented in at least Emerging Markets indices.

 

China

Beijing, in the final analysis, would like to have international investors studying A shares deeply and buying and selling them freely.

How so?

In many ways, the story of the growth of the Chinese economy over the past three decades has been one of slow replacement of the central planning attitude of large, stodgy state-owned enterprises with the dynamism of more market based rivals.  The heavy lifting has been done by constant political struggle against powerful entrenched, backward-facing, political interests that even today control some state-owned enterprises.  It would be nice for a change to have the market do some of the work–by bidding up the stocks of firms that increase profits and punishing those that simply waste national resources.

 

In addition, Beijing now seems to believe that freer flow of investment capital in and out of China can act as a safety valve to counteract the extreme boom/bust tendency that the country’s domestic stock markets have exhibited in the past.

 

the burning issue?

Foreign access to the A share market is still too limited.

Fir some years, China has had a cumbersome apparatus that allows large foreign institutions to deposit specified (large) sums of money inside China and use the funds to buy and sell stocks.  But becoming a so-called qualified foreign institutional investor and operating within government-set constraints is a pain in the neck.  It’s never been a popular route.

Recently, Beijing has begun to allow investment money to flow more freely between Hong Kong and Shanghai.  A HK-Shenzen link is apparently also in the offing.

In MSCI’s view, this isn’t enough free flow yet.  I think that’s the right conclusion.  Nevertheless, weaving A shares into MSCI indices is only a question of time.

my thoughts

As professional securities analysts from the US and elsewhere turn their minds to A shares, there stand to be both big winning stocks and equally large losers.  The big stumbling block will be getting reliable information to use in sorting the market out.

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