The index provider is boosting the profile of mainland Chinese equities in its main emerging markets benchmark, with big implications for the weight of money flowing into the asset class.

The global markets index provider MSCI, or Morgan Stanley Capital International, has completed its plans to boost the weighting of mainland Chinese stocks in its flagship emerging market index, as well as other benchmarks. As a result, investors tracking such indices will by default increase their holdings of such assets. 

The index rebalancing took place on 27 November, affecting China A-shares. This year, the inclusion factor rose to 20 per cent from 5 per cent through three stages, starting in May this year. Following the rebalance, Chinese A-share securities now make up about 4.2 per cent of the MSCI Emerging Markets Index, an increase from 0.72 per cent, and China exposure including A-shares now makes up approximately 33.6 per cent.

Greater weighting and access to mainland Chinese equities in such indices is all part of China’s attempts to attract more capital and foreign investment, as seen in the liberalisation of investment quotas, the Hong Kong/Shenzhen and Hong Kong/Shanghai stock market links, and the wider use of the renminbi as a global currency. 

“China is primarily driven by a desire to draw institutional assets into its domestic market, according to our MSCI source. While many developed equity markets are 80 per cent-plus institutionally owned, China remains the inverse with only 20 per cent institutional ownership. That has led to higher volatility as annual turnover in the A-share market in 2017 was 222 per cent versus 116 per cent for the US.

Access to a larger pool of institutional capital, which tends to be more stable and long term in nature, would help reduce volatility in the market,” Matthews Asia portfolio strategist Jeremy Murden said of the change. 

“The current Chinese exposure within the MSCI Emerging Markets Index and other indices is heavily weighted to mega-cap internet companies and large Chinese banks. This and future  increases in A-shares exposure, and a further broadening of the universe to include small-cap stocks, will allow the indices to better reflect the opportunity set within Chinese equities,” Murden said.

Murden said there was an estimated $1.9 trillion in assets that track the MSCI EM Index as of March 2019. He said the growth of the benchmark weight is likely to translate to inflows to the space and larger exposure from active managers who track the index.

While there has been pressure from US policymakers, led by Florida Senator Marco Rubio, to remove Chinese stocks from indices, MSCI remains focused on the needs of global investors, Murden continued. He noted that MSCI said it will not change existing indices or delay a planned allocation due to political pressure, only to changes in market access.

“We continue to be attracted by the fundamentally sound merits of many local companies listed in China. We realise that many quality A-share companies in growing industries can be priced at rich valuation multiples, however, which makes our experience of carefully vetting them critical. We believe long-term investors can benefit from exposure to A-shares,” Murden said.