MSCI Inc. (MSCI:US)’s proposal to include mainland Chinese equities in its global indexes is getting a cold reception from investors.
Fidelity Worldwide Investment calls it crazy. Schroder Investment Management Ltd. says it’s terrible. Societe Generale SA’s private-banking unit dubs it unfair.
While China is opening up its capital markets as part of the most sweeping economic overhaul in two decades, the reaction to MSCI’s plan shows how much more President Xi Jinping needs to do before the country can be integrated into global markets. International investors who measure their returns against MSCI indexes say the proposal is unworkable unless China removes the capital controls that limit access to local securities.
“To put them in an index when most of the investors can’t buy those shares, because of the various restrictions that the Chinese have, doesn’t make sense,” Mark Mobius, who oversees about $50 billion as executive chairman of Templeton Emerging Markets, said in an April 7 interview on Bloomberg Television.
MSCI, whose gauges are used by money managers with an estimated $8 trillion of assets, has been consulting with banks and funds on whether to include yuan-denominated A shares in its benchmark Chinese and developing-nation indexes starting next year.
MSCI plans to include the proposal in its 2014 review of market classifications, to be announced in June. The index provider would probably contact between 2,000 and 3,000 global investors before deciding whether to include A shares, Chia Chin-ping, a Hong Kong-based managing director at MSCI, said in an interview last month.
Chia said in a separate interview April 17 that no decision has been made and MSCI “fully expects” investors to express different views on the “complex” issue.
The MSCI China Index, largely composed of mainland companies listed in Hong Kong, has lost 6.7 percent in the past four years, compared with a 31 percent drop for the benchmark Shanghai Composite Index. The MSCI gauge added 0.2 percent at the close today, while the Shanghai measure slid 0.5 percent to its lowest level in three weeks.
Under China’s existing rules, only overseas institutions that have been awarded licenses and quotas by two different regulatory bodies can invest in A shares. The combined approved quota of about $86 billion is less than 3 percent of the $3.3 trillion market value of locally-listed companies.
It’s a “terrible idea because you haven’t got the liquidity or the accessibility,” Allan Conway, head of emerging-market equities at Schroder, said in an April 9 interview in London. “There’s only a certain percentage of those shares that foreigners can buy. There’s a quota. You have to buy a quota to even get the exposure to begin with, so you’ve got very limited accessibility.”
Quotas issued under the Qualified Foreign Institutional Investor program, known as QFII, total about $54 billion, while 201 billion yuan ($32 billion) of quotas have been doled out under the Renminbi Qualified Foreign Institutional Investor program, or RQFII, according to the State Administration of Foreign Exchange.
QFII allows dollars to be used for stock and bond investments in the local currency, while RQFII enables offshore yuan to be invested in China.
“If the A-share market does well and foreigners can’t take part in this, then it would be unfair,” David Poh, the Singapore-based regional head of portfolio-management solutions at the private-banking unit of Societe Generale, which had about $116 billion under management as of December, said on April 4.
Adding China’s domestic shares to MSCI indexes would expose investors to a wider range of companies in the world’s fifth-biggest equity market. The MSCI China index has 140 stocks, data compiled by Bloomberg show. That compares with about 1,000 in the Shanghai Composite and more than 1,600 in the Shenzhen Composite Index. The move may lure about $12 billion to the indexes, MSCI’s Chia said.
“I am in favor of including A shares to the MSCI indices,” Robbert Van Batenburg, a director of market strategy at Newedge Group SA in New York, wrote in an e-mailed response to questions on April 2. “It will however be a very gradual inclusion and presumably contingent upon further liberalization of the A-shares market.”
The number of members in the MSCI China index would increase to 385, with 221 A-share companies being added, according to MSCI’s March statement. The weighting of A shares would initially be 2.9 percent due to the difficulty of investors obtaining quotas, MSCI said.
The proposal comes after China took further steps to open its markets, including the doubling of the cap for QFII and RQFII aggregate quotas, as well as letting more institutional investors buy A shares, MSCI said.
Since the consultation was announced, China unveiled a plan to allow overseas investors to buy Shanghai equities through the Hong Kong exchange. Success in opening up financial markets is the linchpin to Xi’s efforts to shore up an economy mired in its deepest slowdown since 1990.
Overseas institutions and investors will be able to trade shares on the SSE 180 Index and SSE 380 Index, as well as dual-listed stocks, via Hong Kong brokerages, Hong Kong’s government said April 10. There will be a daily cap of 13 billion yuan and a total quota of 300 billion yuan under the pilot program due to start in about six months.
The agreement, which also allows mainland investors to buy Hong Kong equities on the Shanghai exchange, furthers China’s push to reduce capital controls after policy makers pledged the biggest expansion of economic freedom since the 1990s and widened the yuan’s trading band. Xiao Gang, chairman of the China Securities Regulatory Commission, said April 10 that regulators will expand QFII quotas, while the Hong Kong-Shanghai tie-up may replace the program to some extent.
Conway, Poh and Sutherland didn’t reply to two emails asking whether they had changed their views on MSCI’s plan after the cross-border investment deal was announced. Mobius said he had no further comment to make.
China’s push to allow greater foreign access to shares comes as local investors pull out of the slumping stock market. The number of equity accounts containing funds has fallen by 3.6 million from the June 2011 peak to 53.7 million as of April 18, data compiled by Bloomberg show. The Shanghai Composite trades 66 percent below its 2007 peak, while its 200-day moving average touched the lowest level in seven years this month.
The cross-border trading agreement doesn’t change the fact that A shares aren’t fully accessible, Peter Elston, the Singapore-based head of Asia-Pacific strategy at Aberdeen Asset Management Plc, said April 15. Elston said in an interview on April 4 that including mainland shares in MSCI indexes would be “silly.”
“We stand very firmly on the side that it doesn’t make sense because it’s asymmetric,” said Matthew Sutherland, Fidelity Worldwide’s investment director for equities in Hong Kong. “It seems to me crazy to have an international benchmark that’s got a share class in it that the world can’t invest in.”
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