It has been a very long awaited move indeed, but the MSCI finally confirmed that it would be adding Chinese A shares to the index (in a weight of 0.73%) and stocks reached an 18-month high in anticipation of greater flows. China has the second largest equity market in the world, but it is thinly held by foreigners due to onerous restrictions. These restrictions were loosened when the Hong Kong/Shanghai Connect improved access to A shares, and the trend has been more permissive in recent years.
Previously most exposure to China had been via offshore proxies – companies listed in Hong Kong or elsewhere, with well-known names such as Alibaba and Tencent but now, investors who seek to hold the index will be forced to purchase direct exposure in order to maintain index exposure.
This opens up a delicate yet vital issue regarding the automated, rules based nature of index investing, which has seen a surge in inflows recently as investors shift from active to passive management in droves. Some investors may still feel that the A share market is immature – with corporate governance unproven and the potential for governmental intervention legendary. But blind index following will build exposure nonetheless, resulting in a sizable transfer of wealth from millions of global investors to the current holders of Chinese A shares – mostly Chinese institutions and retail investors.
But maybe China has had a larger role in recent markets than we would think – there is a line of thinking that suggests that the so-called Trump “reflation” trade coincided almost exactly with more positive Chinese data and that the market strength was just as much attributable to the ebbing of Chinese concerns as it was to the surprise Trump victory. Now, with oil prices officially in a bear market (mainly due to supply rather than demand concerns) it remains to be seen whether they will be the tail that wags the China (and by extension, Emerging Markets) dog and act as a deflationary force that dampens spirits globally.