MSCI A shares delay disappointing but short-lived

The decision by MSCI to delay the inclusion of Chinese A shares into their benchmarks is, naturally, mildly disappointing for us and for other investors in the Chinese stock market.

It is likely to have a short term negative impact on some A shares, especially those at the more speculative end of the spectrum, as some investors may have put on an ‘event-driven’ trade ahead of the decision, which they will now presumably exit.

These trades were no doubt encouraged by the reasonable expectation among most commentators that this time around at least some proportion, perhaps 5%, of A shares would be included.

There are a number of reasons why we believe any such disappointment will be relatively mild and short-lived:

1. Although delayed, eventual inclusion is still clearly a question of ‘when’, rather than ‘if’. Whether this happens in 2017, 2018, or even 2019, should not make that much difference to the long term investor in China.

2. A 5% inclusion, which is what many had expected, would have resulted in foreign inflows representing less than 1% of the nearly $3 trillion A share market free float. There is, in fact, an argument that when MSCI’s lingering concerns are finally addressed, it would be preferable for inclusion to begin with a more meaningful percentage of perhaps 10%, or even 20%.

3. Even without A share inclusion, China’s weighting in global indices continues to grow inexorably; from 0% as comparatively recently as 1989, to around 25% in the Emerging Markets benchmark today. The most recent increase comes from the significant inclusion of Chinese ADRs.

4. MSCI’s decision to delay should encourage further financial reform in China and the implementation of other measures to protect the interests of foreign investors.

5. While A shares will remain out of benchmark for the time being, key points for the global investor include that there are a number of attractive companies among them trading at reasonable valuations, and that the domestic share market has increased its accessibility in recent years and will continue to do so.  Therefore, we view any correction based on MSCI’s decision as a buying opportunity, especially in our favoured “New China“ sectors, such as environment, healthcare, education, internet, leisure and travel.

Anthony Cragg, senior portfolio manager at Wells Fargo China Equity Fund, Wells Fargo Asset Management.

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