China’s enormous stock market, long off-limits to international investors, is now part of many a mom and pop investor’s portfolio outside the country. That’s because the world’s major equity index compilers began including Chinese equities in their gauges last year. As a result, funds that track those indexes -- for instance, the $60 billion Vanguard FTSE Emerging Markets exchange-traded fund -- have loaded up on so-called A shares that trade in Shanghai and Shenzhen. Now, U.S. President Donald Trump’s administration is examining whether to place limits on government pension funds investing in Chinese equities.

1. How much do international investors own?

About $207 billion. That’s according to data on foreign ownership of A shares compiled by Bloomberg and the People’s Bank of China, and it’s only trending higher. Cash has poured into the $6.7 trillion market over the last few years as China moves to open up its capital markets, with overseas accounts now holding almost as big a stake as China’s own mutual funds. One big driver: Passively managed investment strategies, which have become some of the most popular ways to get exposure to global stocks and bonds. Funds that seek to replicate an index now oversee about $8 trillion in the U.S., ceding control over where they put this money to work to the companies behind their benchmarks. The Big Three indexers -- MSCI Inc., S&P Dow Jones Indices and FTSE Russell -- are all adding A shares to their flagship benchmarks, giving many investors their first exposure to China.

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2. Why was China for so long a pariah?

New York-based MSCI rejected China’s bid for inclusion in its emerging-markets index for three straight years though 2016, citing investor concerns. Those included the government’s control over financial markets (including heavy interventions during turmoil), accessibility, tax treatment and worries about the ability to move funds in and out of a country that controls capital flows.

3. What changed?

In granting approval in June 2017, MSCI said China had adequately improved market access for global asset managers by letting foreigners buy shares on the Shenzhen stock exchange, its version of the Nasdaq stock market. FTSE Russell and S&P have since added China to their gauges, with all three boosting the nation’s share within their indexes in stages to minimize market impact. MSCI said in February it would quadruple the weighting of A shares in its indexes by November, yet that will still mean only 3.3% of its emerging-markets index is allocated to China.

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4. Why was this such a big deal?

MSCI is one of the world’s biggest index compilers, with roughly $12 trillion in assets benchmarked to its products. Its embrace of China is expected, over time, to send billions of dollars flowing into the world’s second-biggest equity market. For China, there were the kudos of taking another step into the mainstream global financial community. Investment from international fund managers also helps China balance its capital account and reduces the market’s reliance on unpredictable retail investors.

5. And for investors?

Global money managers had long invested in Chinese stocks listed in New York and Hong Kong -- such as Alibaba Group Holding Ltd. and Tencent Holdings Ltd. -- but China’s domestic market offers exposure to a wider group of companies that benefit from an increasingly consumer-led economy.

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6. How many Chinese companies are involved?

On completion of MSCI’s upgrade in November, there will be 253 large-cap and 168 mid-cap A shares in the MSCI Emerging Markets Index. Heavyweights including Kweichow Moutai Co., China’s biggest liquor maker, and surveillance camera maker Hangzhou Hikvision Digital Technology Co. -- which was blacklisted by the U.S. in October -- were added to that gauge as well as the MSCI China Index and the MSCI All Country World Index. Meanwhile, FTSE Russell added more than 1,000 Chinese firms to its global equity indexes in June, while S&P said it would add more than 1,200 A shares to its global benchmarks starting in September.

7. Which funds are big China buyers?

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Indexed funds that track emerging markets are among the biggest. For example, Vanguard Group’s emerging-markets ETF -- the largest tracking developing economies -- owns more than 1,800 onshore companies, data compiled by Bloomberg show. Those firms accounted for about 4.7% of the fund’s allocation as of July 31, a company spokesman said.

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8. So why the political attention?

With the U.S. embroiled in a tariff war with China, officials in Washington are looking for new tools to pressure those in Beijing. The Trump administration is considering ways to prevent U.S. government retirement funds from investing in China, Bloomberg reported, citing people familiar with the matter. In August two senators criticized the Federal Retirement Thrift Investment Board, which runs a $546 billion plan, over a 2017 decision to switch the benchmark of one of its funds to a gauge that includes China. Preventing or reducing the flow of international money into the world’s second-largest economy would hurt a stock market that’s already seen two straight quarters of declines. It would also pose a major headache for providers of indexes and the funds that track them.

--With assistance from Grant Clark.

To contact the reporters on this story: Sam Mamudi in Hong Kong at smamudi@bloomberg.net;Rachel Evans in New York at revans43@bloomberg.net

To contact the editors responsible for this story: Richard Frost at rfrost4@bloomberg.net, Laurence Arnold

©2019 Bloomberg L.P.

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