How to invest in Chinese equities?23/12/2020 | Article
Today, international investors can access the Chinese equity market, which is one of the largest and most dynamic in the world, via China A-Share class equities. Investors should be aware however that although this market has many advantages, it is best suited to active qualified investors.
For many years, western investors had only limited access to Chinese capital markets, as Beijing prevented Chinese companies from falling into foreign ownership.
The original share class system allowed non-Chinese investors to buy only Hong Kong listed equities issues mainly by mainland Chinese public or private companies. These included China Mobile, China Construction Bank, Tencent and Xiaomi, which were regrouped under the H-share class legal category. Alternatively, investors could buy American Depositary Receipts (ADR), which act as “mirror shares” listed in the US, enabling indirect investments into around 170 Chinese companies such as Alibaba and JD.com.
Today however, Beijing also allows international investors to buy China A-Shares issued by companies based in mainland China, which are listed in yuan (RMB) on the Shanghai (SSE) and Shenzhen (SZSE) stock markets.
In other words, this system opens the door to investing in the third-largest global equity market in terms of market capitalisation, after the New York Stock Exchange and the Nasdaq. China A-Shares provide access to almost 3,800 companies ranging from large caps to mid & small caps1 in one of the most dynamic economies in the world.
To complete the picture, the local Chinese markets also enable investments in B-Share class equities, which are less actively traded and listed on the Shanghai (SSE) and Shenzhen (SZSE) stock markets in US dollars (USD) or in Hong Kong dollars (HKD).
What are the advantages to buying China A-Shares?
What are the advantages to investors in buying China A-Shares? Firstly, these investments provide a significant advantage in terms of diversification. This market provides access to a broad range of Chinese companies with more domestic profiles, which do not therefore depend on revenues generated abroad for their financial health.
Over the past few years, China A-Shares have been opened to western institutional investors. Their average trading volume has increased by a factor of fourteen or more over just under 3 years. Meanwhile, the reciprocal agreement in June 2019 between the Shanghai market (SSE) and the London Stock Exchange (LES) could attract further foreign capital inflow into Chinese equity markets.
The global MSCI and FTSE indices also started including China A-Shares in 2017. In August 2020, they represented 5.1% of the MSCI Emerging Markets index (chart 2). Their weighting is projected to increase further (chart 3).
Although Chinese equities weigh only 5.6% of the MSCI All Cap World index which represents global equity markets, this percentage does not reflect China’s real weighting in the global economy. According to data from the World Bank, China’s GDP represented 16.3% of total global GDP in 2019.
Furthermore, foreign investors own only around 2.5% of the total China A-Shares market, compared to 22% and 40% of the US and UK markets respectively. The weight of China in global equity markets should therefore ultimately increase.
A market for actively-managed funds
Although global indices have begun to include China A-Shares, it should be noted that mainland Chinese companies are not obliged to respect the same strict standards as their competitors listed on the Hong Kong stock market. In the light of these governance issues, combined with the fact that fewer analysts cover these companies, this market is better suited to actively-managed funds and less appropriate for index-based investment approaches, for investors seeking gains through exposure to this segment.
Judicious investment choices and active management are therefore essential. China A-Shares provide a deep selection pool for stock pickers within a dynamic market, characterised by above-average price swings. This volatility enables investors to identify and capitalise upon investment opportunities.
The Chinese state owns approximately one quarter of domestic industries, exercising control and influence over many aspects of the economy. However, compared to the China H-Shares listed in Hong Kong, the A-Shares market provides access to a wider range of private IT and tech stocks and other consumer goods sector companies which currently harbour numerous investment opportunities.
According to an article published recently by the World Economic Forum, “the combination of numbers 60/70/80/90 are frequently used to describe the private sector's contribution to the Chinese economy: they contribute 60% of China’s GDP, and are responsible for 70% of innovation, 80% of urban employment and provide 90% of new jobs. Private wealth is also responsible for 70% of investment and 90% of exports”.2
Finally, as pioneers in ESG investing, we are glad to see that environmental, social & governance factors are becoming increasingly important for Chinese companies. Although the major leading groups have expressed the greatest interest in ESG within their sectors, which benefit from the highest level of foreign investments, there is still considerable room for overall improvement among companies and within the regulations. The increasing importance of ESG factors is directly linked to the carbon neutrality objective for 2060 set out in the Paris Agreement and also due to the subsequent development of clean energy and electric vehicles. It also stems from the recent announcement of antitrust measures impacting the internet and e-commerce sectors.
We are therefore confident in the future of China A-Shares, which should continue to develop and offer international investors a key growing market and a source of diversification with quality undoubtedly improving.
1 Source: World Federation of Exchanges, as at May 2020. ↑ Back to the text