Morningstar's "Perspectives" series features investment insights from third-party contributors. We hear from Matthew Sutherland, Investment Director, Fidelity International.
China’s equity markets have been relatively quiet in recent months; a welcome change from the volatility seen at the beginning of the year when a weakening yuan hit markets not just in China but around the world.
The Shenzhen connect would broaden the range of stocks to which foreign investors would have access
There are a number of factors that could support sentiment for Chinese equities as we head into the second half of the year.
First off, at the end of May the Shanghai and Shenzhen stock exchanges announced stock halt and resumption rules aimed at avoiding a situation like last year when half the market was suspended in a rapidly falling A-share market. Key measures include better disclosure of reasons for suspension and maximum suspension times for different corporate activities.
Next, an announcement on the launch of the Hong Kong-Shenzhen Stock Connect scheme could be announced this month. This follows on from the launch of the Hong Kong –Shanghai Stock Connect last year. The scheme allows mainland investors to invest in Hong Kong listed stocks and vice-versa.
China has two domestic stock markets, in Shanghai and Shenzhen. Most listed firms on the Shanghai Stock Exchange are state-owned and/or from traditional sectors such as financials, industrials, energy and utilities. Companies listed in Shenzhen represent more of the private sector of the Chinese economy, such as technology, telecoms, consumer discretionary and pharmaceuticals. The Shenzhen connect would broaden the range of stocks to which foreign investors would have access and would thus be a positive move, especially as many sit in the areas of China’s new economy that is experiencing significant policy support.
If announced, the earliest possible launch date would be in September this year.
China A-Share Inclusion
These two measures are part of a push by China to have its A-shares included in MSCI indices. MSCI could announce any such inclusion in mid-June. Despite the size of China’s economy and capital markets, A-shares are not currently represented in MSCI indices that international funds typically track or benchmark themselves against, and access to the market remains restricted.
Whilst any inclusion would likely be only partial – perhaps a 5% inclusion, meaning that for each A-share that is included, its index market capitalisation would be capped at 5% of its free-float adjusted market capitalisation, the long-term view is that A-shares will be fully included at some point.
Finally, on May 31st we saw the second phase of the inclusion of China American Depositary Receipts (ADRs) into the MSCI China benchmark. ADRs are stocks that trade in the US and represent a specified amount of shares in a foreign company. They can be an easy and cost effective way for investors to shares in a foreign company, especially so in the case of Chinese equites where access can be restrictive.
Chinese Internet giants Alibaba, Baidu and JD.com will all see their weighting in MSCI China increased, and passive funds that track the index will need to adjust to their new weightings.
So we have four catalysts, each of which could produce some positive boost to sentiment for stocks, especially those in Hong Kong and China financial services. Fundamentally, we don’t expect these catalysts to have much direct earnings impact as they are more sentiment than fundamentals driven.
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