The Chinese A share market is the second largest in the world. It is also the most under-owned equity market.
This is set to change with MSCI including Chinese A shares in its flagship MSCI Emerging Markets Index. We estimate that $1.2T will get invested in Chinese A shares over the next few years. This wave of foreign flow into Chinese A shares will further propel the market, which is already cheap compared to historical levels.
This market represents huge untapped potential for active managers. The market is relatively inefficient, stock level dispersion is high and valuation spreads are wide.
MSCI is in the process of adding Chinese A shares to the MSCI Emerging Markets Index (EM) at 5% inclusion factor in 2018. MSCI projects that at full 100% inclusion, Chinese A shares would represent 17% of the Index.
We believe that the 17% weighting is significantly underestimated and that Chinese A shares could represent as much as 28% of MSCI EM and all China could represent 8.5% of MSCI All Country World Index (ACWI) over the next few years.
In light of this, institutional investors need to revisit their policy allocations to Emerging Markets and China, and determine how to best implement this allocation.
Using a set of simple assumptions, we demonstrate that an optimal allocation to Chinese A shares within an Emerging Markets portfolio currently is between 20-30%.
Broad based Emerging Market managers most likely lack the China specific insights required to be successful in this market. We believe that the best way to implement this China allocation is through a China specialist manager. To read more about the nuances of the Chinese equity markets, read our paper China A: Right Here, Right Now