Investors, even at the best of times, have a habit of running after bright shiny objects and latching on just like a fish to some lure. However in a sideways market, where everyone is chasing after any little nibble of growth, this natural inclination towards hype is amplified.
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China’s mainland stock market has been red hot over the past year and could get another big lift soon. But Chinese H-shares traded in Hong Kong could be the best long-run bet
This habit usually appears when it comes to initial public offerings (IPOs), where opening-day enthusiasm soon gives method to the sober light of losses, and it is usually retail investors who wind up paying simply because they get in the sport too late.
This week, the standard thing appeared as if it might happen half a global away, as expectation grew that MSCI Inc. C the earth\’s largest indexer C might finally include China A-shares in the Emerging Markets Index.
The speculation ended up being something of the non-story, because MSCI ultimately decided to hold off for now. But it left the doorway open to include A-shares – stocks in mainland China companies, traded on mainland exchanges for example Shanghai and Shenzhen – within the influential index, that is tracked by greater than a trillion dollars\’ worth of funds around the globe.
The impact on China and other international markets could be huge. By some estimates, foreign inflows into Chinese markets because of full inclusion could total US$330 billion.
If, or rather when, it takes place, this theoretical liquidity pump could further inflate the super-hot mainland exchanges. The Shanghai and Shenzhen indexes\’ one-year returns are 156% and 189%, respectively.
It may also displace billions of dollars from other emerging markets for example India and Korea. It is no surprise, then, that Shanghai was up and India was down as speculation within the potential inclusion ramped up the 2009 week.
Should you care? Well, no. And yes.
With the affected Chinese indexes on the tear, who wouldn\’t would like to get a piece of that action? Full inclusion would offer at least a brief boost to waning emerging-market funds that track the MSCI. Lord knows they might use some help.
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Yet the devil is incorporated in the details. And the details of the potential index rebalancing and also the state of international access to A-shares would confuse a Byzantine courtier.
Under strict foreign investment rules, A-shares are mainly available for trading only by citizens of China, although a relatively small quota is allowed for foreign purchase with the country\’s Qualified Foreign Institutional Investor (QFII) system.
A-shares can also be accessed through the Shanghai – Hong Kong Stock Connect program announced by China this past year. It lets Hong Kong and qualified Chinese investors buy stocks on those two exchanges, but there are daily quotas.
There really are a bunch of other complications, too. A-shares exchange renminbi, and the Chinese currency is still not fully convertible. As well, MSCI cited remaining issues over quotas for institutional investors and restrictions on beneficial ownership as causes of its decision to stall.
It\’s clear, too, that any inclusion within the index would be gradual, and the impact on prices along with other markets would likely be incremental as well. Finally, even with inclusion, investors wouldn\’t gain any more ability to hold A-shares directly.
Beyond all of the barriers to ownership and capital flows, Chinese markets are plagued by an identity for a lack of transparency. Chinese stock markets also have a reputation for – how to put this delicately? – a high level of enthusiasm for risk.
There is unquestionably nothing in China\’s recent lacklustre economic performance to warrant the mainland rally, which is being driven by low interest rates, government stimulus and tight liquidity.
Inclusion in the MSCI index could pump up the China stock bubble even further, and so some long-term emerging-market investors should maybe breathe a sigh of relief.
All having said that, even the proven fact that MSCI is seriously considering A-shares inclusion – it\’s setting up a working group tasked with Chinese regulators to sort out the issues – talks to how far Chinese exchanges have come in liberalizing and rationalizing, despite continuing controls.
For instance, regulators recently began allowing short selling of shares on the Connect Exchange, and are said to be contemplating the removal of a ban on rollover margins.
Trying to get into MSCI\’s Emerging Markets Index could provide momentum for more reform, and there\’s good reason for China to want to make changes.
Chinese companies are saddled with huge debt loads, and the government continues to be trying to discourage credit expansion. More foreign equity investment could be good for corporate balance sheets. Obviously, that might not be good for investors.
Index inclusion or otherwise, cracks are developing in the Chinese wall that keeps foreign investors out. However in the long term, whether or not to take advantage comes down to the health of China\’s companies.
If further liberalization of China\’s markets means greater corporate transparency, as surely it ought to, investors may wish to take a critical look under the hood.