Cautious Excitement over China's A-Shares Market Opening
March 8, 2019 1:13 p.m. ET
Chinese stocks are hot again. Very hot.
The KraneShares Bosera MSCI China A Share exchange-traded fund (ticker: KBA), which tracks domestically-listed A-shares, rose 22% year to date. The iShares MSCI China ETF (MCHI), invested in offshore H-shares, is up 15%.
Rumors of trade peace with the U.S. are the primary driver. Beijing authorities have also done their bit by tilting away from deleveraging and toward economic stimulus. The index gurus at MSCI further bolstered the bull case on Feb. 28, more than quadrupling the weight of A-shares in their global emerging markets basket by the end of 2019. “This is definitely a game-changer,” enthuses Brendan Ahern, KraneShares’ chief investment officer.
Less-biased investors urge more caution. The market is already assuming middling success in the trade talks: a truce that leaves key intellectual property and technology transfer issues unsettled, and allows President Donald Trump to revert to China-bashing during next year’s re-election campaign. “The middle-of-the-road, muddle-through trade solution is priced in,” says Louis Lau, director of investments at Brandes Investment Partners.
The A-shares inclusion bump still leaves their share of global emerging markets at an underwhelming 3.3%. The burgeoning Shanghai and Shenzhen exchanges will remain dominated by Chinese mom-and-pop investors, who account for at least 80% of trading, and are prone to roller-coaster volatility—such as the 4% plunge in mainland stocks on Friday, in response to disappointing trade data.
Would-be A-shares investors face other obstacles, from financial reports that are typically published only in Mandarin, to state pressure to pad even private companies’ payrolls. “Chinese corporates do not by and large look at profitability as a priority,” says James Donald, head of emerging markets at Lazard Asset Management. “The priority is employment.”
But the MSCI move is exciting in the longer term. The index authorities nearly doubled the number of onshore companies deemed investible, to 448. That gives investors an implicit green light to delve deep into China’s dynamic mid-cap tier, and explosive growth industries like pharmaceuticals and health care. Foreign capitalists can start choosing between Chinese sectors, rather than taking their chances on a country index dominated by internet giantsTencent Holdings (700.Hong Kong) and Alibaba Group Holding (BABA), and the big state banks. “A lot of people are pretty naive on how they approach China, considering it’s the No. 2 equity market in the world,” says Jay Jacobs, head of research at upstart ETF provider GlobalX.
As it happens, GlobalX offers a dozen different China sector funds, from information technology, which has galloped ahead 30% this year, to utilities, lagging at 6%. KraneShares offers ETFs focused on health care, electric cars and “future mobility,” and infrastructure firms tied to the One Belt, One Road initiative. For fans of closed-end mutual funds, Morgan Stanley is offering its China A Share fund (CAF) at an 11% discount to net asset value.
Beyond the politics, China’s rebound stems from a realization that its miraculous growth story is maturing, not disintegrating, and investors ignore it at their peril. “Twenty years ago China was 1% of emerging market indices, now it may be on its way to 40%,” Lazard’s Donald reflects. “That’s a very big change.”
Governance is improving since the trading halts and other blunders authorities committed during the 2015 bear market, and valuations still look sober after their pummeling last year. “Prices are just back to June 2015 levels, and I know a lot of positive stuff has happened since then,” says Andrew Mattock, lead manager of the Matthews China fund (MCHFX). Just don’t bet on more double-digit gains over the next two months.