Gree Electric, Zhejiang Supor Cookware, Fuyao Glass. If you know much about any of these three companies, I take my hat off to you. Gree is the market leader in air conditioning in China. Zhejiang is the country’s largest manufacturer of pressure cookers, blenders and other small kitchen appliances. Fuyao is the world’s only pure automotive glass company. I must confess, I’d never heard of any of them.
All three are listed on China’s domestic A-share markets in Shanghai and Shenzhen. All three have been contributors to my colleague Jing Ning’s China Focus Fund. And all three are pretty much unknown in the outside world. Why am I telling you this? Because I suspect that quite quickly the black box that is China’s onshore sharemarket could become a whole lot more transparent. It may be a while before these companies roll off the tongue like Apple, Siemens and Samsung, but the days when China’s best-known stocks elicit blank stares are numbered.
Last week, MSCI, a New York-based company that creates the indices that investors use to measure the performance of markets, lifted the lid just a fraction on the hidden world of China’s A-shares. Three years after first toying with the idea of adding Shanghai and Shenzhen-listed shares to its widely followed emerging market index, MSCI finally took the plunge. Foreign investors who track the performance of this benchmark will find it difficult to continue pretending that the world’s second-biggest sharemarket doesn’t exist.
The A-Share market in China is valued at about $7 trillion and lists more than 3000 companies, yet big Western investment houses have been more than happy to ignore it, accessing the world’s second-biggest economy via the far smaller number of mainland Chinese companies that have taken the trouble to get their shares listed in either Hong Kong or New York.
It’s not hard to see why. Many overseas investors who have ventured into the Wild West of the Chinese market have discovered, to their cost, that different levels of due diligence apply. Corporate governance in China is, shall we say, less developed than they are used to at home. The regulation of sharemarkets is less rigorous. The ease with which Chinese companies suspended trading in their shares at the first whiff of a market meltdown during the 2015 correction confirmed the old emerging market adage: they’re hard to emerge from in an emergency.
What changed this year? A key change in the Chinese sharemarket over the last couple of years has been the creation of the so-called Stock Connect link between the two big mainland Chinese markets and the foreigner-friendly bourse in Hong Kong. With up to $2 billion in trades allowed to pass in either direction every day, investors are more reassured today that not only can they put their clients’ money into Chinese shares they can also take it out again. The support of big institutional investors (the principal users of MSCI’s indices) has been crucial.
Don’t think, however, that a new investment El Dorado has suddenly been opened up to overseas investors. MSCI has opened the door just a crack. These are baby steps. First, only 222 A-shares have been deemed large and liquid enough to be included in the emerging market index. Furthermore, because only 5 per cent of their actual market value is used in MSCI’s calculations, they will have just a 0.7 per cent weighting in the benchmark. MSCI is coy about the conditions under which that might move closer to a more representative exposure.
The index maker is right to be cautious. More than two-thirds of the 222 companies are, in effect, run by the Chinese state. Government control of the banking system means the supply of credit to companies is driven by bureaucratic fiat. China remains a uniquely policy-driven economy; it’s hard for outside investors to navigate and has a regulatory framework that evolves rapidly.
The A-share market is also dominated by retail investors, who are influenced by short-term swings in sentiment and have a tendency to overpay for apparent growth levels that are not sustainable over an economic cycle.
That’s the bad news. The flip side of all this is a market full of opportunity, with sketchy research coverage of stocks giving investors on the ground a genuine information advantage that is much harder to achieve in more developed markets. Including A-shares in MSCI’s indices will bring new capital into the market, reduce volatility and help create a better-regulated, smoother investment environment.
The enthusiasm of Chinese retail investors for get-rich-quick growth stories makes the A-share market a happy hunting ground for value-focused investors with a longer time frame. There are many domestically focused shares listed only on the A-share markets that are well-placed to benefit from the ongoing shift towards a more consumption-driven Chinese economy. There are plenty of companies with steady growth prospects, undemanding valuations compared with global peers and even attractive dividend yields. Many of the home appliance manufacturers, like Zhejiang Supor, can be accessed only through the mainland markets.
One final lesson investors might take from MSCI’s adjustment to its emerging markets index is the fact that passive investing is much less mechanical and systematic than they might have thought. The fact that a small index provider in New York can effectively decide how much global investment giants should be directing towards the Chinese sharemarket suggests index tracking is more arbitrary than its proponents might claim.
In the meantime, what can you tell me about China Vanke, Baidu or Nexteer Automotive?
