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Asia Markets
China Investors Look to Index Rejig for Next Rally
From the Wall Street Journal of Fri, 19 Dec 2014 06:24:25 EST
An investor reads stock information at a trading hall of a securities firm in Hangzhou, China.
An investor reads stock information at a trading hall of a securities firm in Hangzhou, China. Zuma Press

As China’s stock markets rocket higher, the next breakthrough being closely watched is whether Chinese shares will be included in global equity indexes that influence trillions of dollars of fund flows.

MSCI Inc. and FTSE Inc. will decide in the first half of next year whether to include China in their global benchmarks, potentially fueling the next leg of a rally as mutual funds and exchange-traded funds would need to buy Chinese stocks to rebalance their portfolios and track the index. A rally in Chinese shares this year has already made them the world’s top-performing major index, mostly driven by domestic investors.

China has taken large steps to inclusion with a trading link between Hong Kong and Shanghai that launched last month and allows investors to make bets on domestically-listed equities of mainland Chinese companies, also known as A-shares.

FTSE will review the constituents of its FTSE Emerging Markets Index in March 2015, which will be the first indication of whether the new channels to invest in China are sufficiently robust.

That will be followed in June by the MSCI, which oversees the $3.9 trillion MSCI Emerging Markets Index, the most widely followed benchmark of developing markets.

Because of their importance to the financial system, index providers rarely take decisions in a hurry: It took the United Arab Emirates and Qatar five years to gain access to the MSCI Emerging Markets Index last year, while South Korea had been attempting since 2008 to secure an upgrade to “developed market” status before MSCI determined it hadn’t made enough progress in June this year.

But banks and asset managers say the Stock Connect program, which gives global investors easy access to China, has upped the chances of inclusion. The link expands an existing licensing regime beyond investors given express approval from Beijing. Until now, this had made it difficult to use Chinese mainland indexes as a benchmark.

“The fact that A-shares are becoming more and more tradable thanks to Shanghai-Hong Kong Stock Connect increases the probability of having A-shares entering the major indexes,” said Klaus Baader, chief Asia-Pacific economist at Société Générale.

Fund managers are likely to load up on Chinese stocks if they sense an inclusion is likely, he added. “I don’t think investors would be terribly well advised to wait until inclusion is announced before you increase your exposure,” he said.

Inclusions in global benchmarks can divert huge sums of capital in exchange-traded funds and other passive investments into stocks. Deutsche Bank estimates that the inclusion of Chinese domestic equities in the MSCI Emerging Markets Index could bring $8 billion of inflows, eventually diverting as much as $140 billion into A-shares as its weighting in the index changes to reflect the size of China’s economy.

That said, Deutsche notes that further changes to Stock Connect’s trading rules will be required for it to make the grade with MSCI. The earliest the bank sees Chinese stocks being added to the index is in May 2016.

Another factor that could have a big impact in 2015 is whether MSCI chooses to include companies listed outside of their country of domicile in its major benchmarks. At present, MSCI bars companies whose primary listing is overseas from being included in its home country’s benchmark.

Of the stocks currently excluded from MSCI’s indexes that would be affected by a change in policy, the biggest group are Chinese companies. These include Internet stocks such as Baidu Inc. and Alibaba Group Holding Ltd. , which listed on the New York Stock Exchange in September in the world’s biggest ever initial public offering.

The current MSCI policy leaves some of the biggest companies in China unrepresented in the biggest global benchmarks and they should be added “as soon as possible,” said Arnout van Rijn, chief investment officer at Robeco Hong Kong, which has $300 billion in assets under management.

“It’s quite silly that they don’t have them in there,” he said. “They’re not represented in any other of the mainstream indexes.”

MSCI conducted a consultation on the issue that ended in late November and is preparing to release its recommendations.

Beijing’s plans for economic rebalancing are likely to favor up-and-coming sectors like e-commerce, new energy and health care, which will lead investors to U.S.-listed Chinese equities regardless of MSCI’s decision, said Fan Cheuk Wan, chief investment officer for private banking and wealth management, Asia-Pacific, at Credit Suisse .

“Inclusion of the Chinese ADRs in the broader China indexes would shift investors’ focus even more towards ‘New Economy’ sectors,” she said. “This dynamic is going to be a recurring theme for 2015.”

Write to Gregor Stuart Hunter at

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