20160425-高盛-The_great_China_debates__II__China_A_inclusion_to_MSCI_-_should,_will,_when__28页_1013kb

Summary: The Great China Debates (II) - China A Inclusion to MSCI

Core Content

This document discusses the potential inclusion of China A shares in MSCI global benchmarks, focusing on the likelihood, timing, and implications for global investors. The MSCI decision is expected in June 2016, with a 50% probability of inclusion, and the implementation is likely to occur in June 2017. The inclusion is seen as a long-term process that could significantly increase China's representation in emerging market (EM) and Asia-Pacific ex-Japan (APJ) benchmarks, potentially reaching 30% of EM and 25% of APJ by the end of 2017.

Main Arguments for Inclusion

• Market Size: China A shares are the second largest equity market globally by market cap (10%) and cash turnover (26%), yet they represent only 2.4% of the global equity universe (ACWI).
• Macro Influence: China's contribution to global GDP, trade, and consumption in 2014 was 13%, 12%, and 9%, respectively, but its representation in global benchmarks is disproportionately low.
• Market Access Improvements: Chinese regulators have made strides in improving accessibility, including linking QFII quotas to fund size, relaxing capital flow restrictions, and simplifying the application process.
• Holistic Benchmark Creation: Adding A shares would complete a unified Chinese equity benchmark, encompassing A shares, H shares, Red Chips, P Chips, ADRs, and other listings.
• Historical Precedents: Korea and Taiwan were included in EM benchmarks after similar market access improvements, suggesting that China's conditions are now aligned with global standards.

Main Arguments Against Inclusion

• Market Microstructure Issues:
  • Voluntary Suspension: A significant number of A-share companies suspend trading, reducing liquidity and causing replication concerns.
  • QFII Repatriation Limits: Only 20% of QFII funds' NAV can be repatriated monthly, which restricts portfolio flows.
  • Anti-competitive Clauses: A-share underliers require pre-approval from Chinese exchanges, limiting investment and hedging options for international investors.
• Lack of Hedging Tools: Limited availability of equity and FX hedging instruments constrains risk management for global investors.
• High Volatility and Valuations: A shares experienced high volatility and valuations in early 2015 due to margin financing and leverage, though these concerns have eased.

Key Concerns and Roadmap

• The inclusion is contingent on resolving key issues such as voluntary suspension practices, QFII repatriation rules, and the implementation of Shenzhen-Hong Kong Connect (SZ-HK Connect).
• MSCI may apply a 5% inclusion factor (IF) to the market cap eligible for inclusion, translating to an estimated 1.1% additional weight in the EM index and US$16bn in potential flows.
• The initial impact is expected to be modest due to the low IF, but the long-term effect could be substantial, with China potentially representing 30% of EM and 25% of APJ by end-2017.

Investment Strategies for A Share Inclusion

1. Inclusion Beneficiaries: 13 A-share index heavyweights with sensible valuations.
2. GARP (Growth at a Reasonable Price): Stocks that have historically delivered 72% alpha over the past five years and align with international investment criteria.
3. Northbound Alpha Opportunities: 21 stocks with GS/GH Buy ratings or classified as 'New China' stocks listed in Shenzhen, offering exposure to growth sectors.

Conclusion

The inclusion of China A shares in MSCI benchmarks is a probable event in June 2016, with the implementation likely to follow in June 2017. While there are still concerns regarding market microstructure, the progress made by Chinese regulators and the historical precedent of other markets suggest that the inclusion is increasingly likely. Investors should consider the long-term implications and position themselves through strategic and tactical approaches, including inclusion beneficiaries, GARP stocks, and Northbound alpha opportunities.

Key Figures

• China's GDP contribution: 13% (2014)
• China A market cap: 10% of global total
• China A cash turnover: 26% of global total
• China's current weight in MSCI ACWI: 2.4%
• Potential inclusion factor (IF): 5%
• Estimated additional weight in EM index: 1.1%
• Potential initial flows: US$16bn
• Projected China's EM weight by end-2017: 30%
• Projected China's APJ weight by end-2017: 25%

Analysts

• Kinger Lau, CFA: +852-2978-1224 | kinger.lau@gs.com
• Timothy Moe, CFA: +852-2978-1328 | timothy.moe@gs.com
• Jack Wang: +852-2978-1220 | jack.wang@gs.com
• Si Fu, Ph.D.: +852-2978-0200 | si.fu@gs.com
• Alvin So: +852-2978-1585 | alvin.so@gs.com

Disclosure

Goldman Sachs does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification and other important disclosures, see the Disclosure Appendix, or go to www.gs.com/research/hedge.html.