Currencies, Emerging Markets, Funds / ETFs, Stocks

Ahead Of MSCI’s Decision On Including China’s A Shares, Vanguard And FTSE Gear Up

111228_chinese_yuan_mao-800x500_cAhead of the highly awaited decision by global equity index provider MSCI on whether to include shares from mainland China’s multi-trillion stock market — or A shares — to its emerging markets index, Vanguard Group — the largest U.S. mutual fund firm — has decided that it will add mainland Chinese shares to its $69 billion emerging-market fund.

The endorsement of China’s domestic equity market by Vanguard comes as MSCI weighs whether to include China’s A shares — listed in Shanghai and Shenzhen — in its global emerging markets index (which is tracked by $1.7 trillion of funds) from May 2016.

MSCI’s decision is closely being watched by investors as it could bring billions of dollars of investment flowing into China’s markets.

25-Year Evolution of the MSCI Emerging Markets Index

Chart courtesy of MSCI

China A shares will represent 5.6 percent of the benchmark index tracked by the Vanguard Emerging Markets Stock Index Fund (VEIEX), according to a statement published on Tuesday. The exchange-traded fund (ETF) version of the fund — the Vanguard FTSE Emerging Markets ETF  (VWO), the largest emerging market ETF— will also include mainland equities.

“Global markets have evolved to become more accessible, presenting an opportune time to provide investors with exposure to more markets,” Vanguard Chief Executive Officer Bill McNabb said in the statement. “The fund will benefit investors with more diversification, deeper emerging markets exposure, and greater access to the growth potential of Chinese equities.”

Last week a rival to MSCI, index provider FTSE announced that it will include China’s A shares in two new transitional emerging market indexes called the FTSE Emerging Markets China A Inclusion Indexes, with one Index that will track all-cap stocks and the other index to track large and mid-cap stocks.

The new transitional indexes are said to have a staggered approach, which will bring China’s A shares into its emerging markets benchmark in two to three years.

The initial weighting in the FTSE Emerging Markets China A Inclusion Indexes will be around 5 percent and is planned to be increased to 32 percent “over time”, according to a statement.

“The China domestic market is opening up to international investors but it will take several years for all of these investors to gain access to China’s capital markets,” Mark Makepeace, Chief Executive of FTSE Russell, said in the statement. “The transition to include A shares in global portfolios is now beginning and we will support this transition while ensuring that all users of our global benchmarks have sufficient time to manage the change.”

FTSE is set to make a decision on whether yuan-denominated shares will be added to its global indexes during a September review.

Illustrative Index Inclusion Roadmap of China A Shares

Chart courtesy of MSCI

Shanghai’s Composite Index has rocketed 141 percent since last year, and a new exchange link with Hong Kong that opened up in November has provided a new avenue for foreign investors to buy mainland equities.

Shanghai Composite Index

Chart courtesy of StockCharts.com

So, if China’s A shares were included into the MSCI EM index, what could we expect?

The Financial Times weighs in:

Passive global funds would have to buy shares right away to match the new index, while active managers would probably add them over time to reposition against the altered benchmark. The initial estimate is that around $20bn of foreign money would go into Chinese stocks to meet the MSCI target of a 1 per cent weighting in the EM index. That compares to the $23.8bn that has gone into China via the Stock Connect since November, and a current daily trading volume in Shanghai of up to $200bn.

Mark Mobius, the Executive Chairman of Templeton Emerging Markets Group who oversees about $40 billion in investment and has over 40 years of experience investing in emerging markets, was against the inclusion of China’s A shares as recently as March, however he changed his tune in May after he said his funds are now buying yuan-denominated shares.

“Every time MSCI came around, I said ‘Forget it. We can’t invest,’” Mobius said. “Now we can, and I have no objection.”

MSCI began consulting with the market about the potential inclusion of China’s A shares in March 2014, however opted not to include them in its June 2014 review after pushback from investors.

The decision on inclusion of China’s A shares by MSCI is due on June 9.

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