The case for China ‘A’ shares – but beware of a bubble


Hexavest, the top-down global manager which is part of the Eaton Vance stable, has come out strongly in favour of investors giving consideration to changing their mix of exposures, if they have a mix, to the broad China market. While there are risks, ‘A’ shares look the best bet compared with the alternatives.

In a paper published this month which analyses the likely impact of ‘A’ shares due to relaxing restrictions, by both the Chinese and the big index provider MSCI, the firm says that the pace of foreign institutional flows is intensifying. ‘A’ shares represent the second-largest market in the world, by market cap, and therefore “too big to ignore”.

Written by Jean-Christophe Lermusiaux, a Hexavest portfolio manager, for emerging markets, the paper ‘A-shares: The Long March (to full inclusion)’, says: “So far, most of the largest Chinese technology-related companies (Tencent, Alibaba, Baidu) have raised funds abroad and are listed offshore. This does not fit the Chinese authorities’ goals, as they would like to create a buoyant technology sector in mainland China, capable of raising funds locally (and therefore benefiting local investors). In our view, there will be a strong push to list start-ups and so-called unicorns on either ChiNext (China’s closest equivalent to the NASDAQ) or on the newly announced Shanghai tech board. This will likely be a driver for the Chinese market over the next few years.

“Moreover, these shares are much more representative of China’s real economy than the H-shares, which are currently included in global equity market indices (MSCI World and MSCI ACWI). On the other hand, despite significant improvements made over the last few years, Chinese equities are still plagued by opaque disclosure practices, high stock price volatility for no apparent reason, frequent quotation suspensions, and difficult access for foreign investors.”

Morgan Stanley estimates that the 2019 ‘A’ shares index inclusions by MSCI and FTSE Russell should bring substantial foreign inflows, ranging from US$70-125 billion this year alone.

The paper argues that inflows could maintain the pace for years to come. But there could be significant outflows from other emerging countries as their weight gets crowded out by China in the index.

The Hexavest paper says: “We remain mindful of the changing dynamics in the marketplace and their impact on valuation and investor sentiment. Yet, in the short term, as we already have an overweight position, we would avoid increasing it further given the rally that occurred over the last three months. However, we note that further market consolidation would likely provide an investment opportunity.”

– G.B.