In March 2019, MSCI confirmed its plan to raise China A-shares’ inclusion factor in its global indices from 5% to 20%.
These are shares of domestic Chinese companies traded on the Shanghai or the Shenzhen stock exchanges as opposed to those listed in Hong Kong (H-shares).
The process involved three phases of implementation, and since the beginning of November, China A-shares' weighting in the MSCI Emerging Markets index has risen from 0.7% to 3.3%.
There is an element of inevitability to the increasing recognition of China's equity market in global indices. This is a market with almost 5,000 companies with a market capitalisation of $8.5trn, and that is only going to become more relevant over time.
Barriers to foreign ownership have largely been removed and important changes in regulation have made investors such as us more comfortable about investing in domestic Chinese equities.
Stock Connect has proved to be robust and there has been a visible reduction in the trading suspensions that plagued the market in the summer of 2015.
Stock Connect is the system allowing foreign investors to invest in eligible China A-shares listed in Shanghai and Shenzhen. Prior to its introduction, A-shares were predominantly traded by domestic Chinese investors, with foreign investors having only restricted access.
We believe that China's A-share market presents an interesting opportunity for a number of reasons. For example, factors affecting other global stockmarkets are less influential on China's A-share market. It also provides access to a large field of private companies and sectors less well represented on other exchanges.
For example, consumer staples and healthcare are better represented in the domestic stock exchanges and communications services less so.
It remains a largely retail-driven market and as such tends to be influenced more by sentiment than fundamentals. This is a good hunting ground for disciplined and patient stock pickers, as share prices can be meaningfully out of sync with what we would consider a company's true worth.
For example, in December 2018 we introduced Huayu Automotive Systems to the Invesco Asian Fund (UK). Huayu is the biggest auto parts supplier in China, which was trading at what we considered to be attractive valuations, had a good dividend yield, and exhibited what we believe to be many positive attributes that had not been recognised by the market.
In February of this year, we also introduced to the fund Jiangsu Yanghe, a liquour/spirits maker that had seen its share price weaken given concerns over a slowdown in China consumption growth after two years of rapid growth.
However, the share price appeared to be reflecting an overly pessimistic outlook, with management proactively seeking to expand into new regions outside its home market supported by product upgrades and leveraging on its strong in-house distribution network.
As Asian equity investors, our investment strategy towards the A-share market is the same as that adopted in other markets. We seek to invest in shares trading at a significant discount to our estimate of fair value.
The Chinese A-share market is broad and liquid, where assets can be quickly converted to cash, and as a largely retail-driven market the short-term views of 'people-on-the-street' leads to greater volatility.
It is under these conditions that significant discounts emerge.
William Lam is co-head of Asian and emerging market equities at Invesco