China’s USD 7 trillion domestic market is the second largest in the world. It makes up around 10% of the world’s stock market capitalization. On June 1 2017, Robeco launched its Chinese A-share Equities strategy, offering investors direct access to this increasingly important market, which provides a broad and representative multi-sector exposure to China.
There are several different ways of gaining exposure to the Chinese market. The offshore market, mainly H-shares (the Hong Kong-listed shares of Chinese companies), makes up about 26% of the total Chinese market (as shown below). The Chinese domestic or onshore market – the A-shares – trade on two exchanges in Shanghai and Shenzhen and make up the remaining 74%.
Retail investors hold over 50% of the A-share market’s total free-float market cap, but account for more than 80% of the total trading volume. The A-share market has one of the lowest correlations with other markets worldwide, making it a useful tool for portfolio and risk diversification.
China’s equity market opened to domestic investors in 1990. Since then the markets have gradually become more accessible to foreigners via, for example, quota schemes such as the Qualified Foreign Institutional Investor (QFII). The more recent Shanghai- and Shenzhen-Hong Kong Stock Connect schemes have made it much easier for investors to trade shares on each other’s markets using their local brokers and clearing houses.
The A-share market offers investors access to themes that are not so well-represented in the offshore universe, and the proportion of the total A-share market cap made up of ‘new economy’ stocks is also increasing, nearing 40% in 2016. Seven of the 15 key sectors have over 80% of their market cap listed in China A-shares only.
The MSCI Emerging Markets Index already actually includes quite a lot of China exposure. But the stocks are either H-shares or shares of Chinese companies listed on US exchanges. None of them are A-shares trading on a mainland China exchange – these stocks are currently not reflected in any of the major indices.
MSCI has focused on issues that have prevented inclusion in the past – two of the most important stumbling blocks have been accessibility and trading suspensions. In this year’s proposal, there are fewer eligible shares; 169 compared to 448 in the 2016 proposal. These are the stocks of large cap companies that are accessible via the Connect program and which have not been suspended for long periods (50 days or more) in the last 12 months.
If this draft concept is implemented, the estimated weight of China A-shares in the MSCI EM Index will be approximately 0.5%. The roadmap above shows the phases that could follow initial inclusion this year, providing further market liberalization occurs. Based on the current criteria, China A-shares will make up 8.6% of the MSCI EM after full inclusion, but this weight could also increase significantly as the selection of eligible stocks expands.
We are positive on the outlook for China’s A-shares. They posted strong earnings for 2016 and in the first quarter of 2017, earnings grew 21.5% as compared with last year, registering the second-highest single quarter growth since the end of 2010. Estimates for 2017 earnings growth are also very strong with 19% and 38% growth compared with 2016 expected for Shanghai and Shenzhen stocks, respectively.
Themes reflect transition to service-driven economy
For the rest of 2017, we see investment opportunities in the A-share market. Robeco Chinese A-Shares Equities applies a thematic overlay that focuses on specific macro investment themes, relating to political, demographic, economic and social developments in China. These reflect China’s transition to a consumption and service-driven economy and include consumption upgrade, industrial recovery, supply-side reform, ‘Made in China 2025’– an effort to upgrade China from a manufacturer of quantity to one of quality, technology and innovation and SOE Reform. MSCI A-share inclusion will also attract inflows and help boost sentiment, while valuations are becoming attractive and are below their long-term historical average.
This strategy gives investors direct access to the potential of the Chinese capital markets by selecting stocks on the Shanghai and Shenzhen A-share markets. It combines disciplined and fundamental research with Robeco’s proprietary quantitative models. This quantitative overlay enables the portfolio manager to also analyze earnings and price momentum.
High conviction portfolio of 30-50 stocks
It follows a high conviction philosophy which leads to a concentrated portfolio of 30-50 stocks. Robeco Chinese A-shares Equities is benchmark agnostic and uses the MSCI China A International as its reference index. The strategy is managed by China CIO, Victoria Mio in Hong Kong, while head of China Research, Jie Lu and his team of analysts based in Shanghai, advise on the portfolio.
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