MSCI, Unlike FTSE, Forgoes China A-Shares

MSCI will not include China A-Shares in its global and emerging market indexes for now. The decision came less than a month after competing index provider FTSE said it would start introducing A-Shares in some of its benchmarks.

In the world of ETFs, that means funds that track MSCI indexes such as the $31 billion iShares MSCI Emerging Markets ETF (EEM | B-94) will remain A-shares-free for the time being. Meanwhile, the $47 billion Vanguard FTSE Emerging Market ETF (VWO | C-86) plans to own mainland Chinese stocks.  

“This makes the distinction between FTSE and MSCI even more clear here—MSCI is the more stable. FTSE gets smaller and riskier on the margins,” Dave Nadig, director of ETFs for FactSet, said.

Behind MSCI’s decision was a notion that while Chinese regulators have done a lot to open up market access and improve transparency, it has to do more, Remy Briand, MSCI managing director and global head of research, said in a conference call late Tuesday. MSCI’s announcement came as part of its annual classification review.

“Chinese regulatory authorities made substantial progress in opening the market to institutional investors,” Briand said. “But there are three issues of particular concern to investors with regard to the quota allocation process, capital mobility restrictions and beneficial ownership of investments.”

Improvements Needed

Yes, investors are “eager” to invest in China, but they are still calling for improvements in market accessibility, he says. For example, the process of allocating quota—the program known as RQFII for qualified institutional investors—has to be more transparent, reliable and predictable, he notes. Liquidity also needs to be available as concerns about capital mobility are very real.

The inclusion of China’s A-shares into MSCI’s global benchmarks is important to the extent that MSCI is the index of choice for many institutions around the globe, and an allocation to mainland Chinese stocks would certainly equate to massive flows of assets into China. Consider that the MSCI Emerging Market Index, for instance, would suddenly have an allocation to China of nearly 44 percent, according to MSCI. Today China represents about 17 of the benchmark, and Hong Kong 6 percent.

“There would be a ridiculous change in composition of global equity markets and way beyond in emerging markets,” Briand said. “We would anticipate that investment process would have to adapt. Allocation decisions will have to look at China with more prominence.”

MSCI will reconsider and include China A-shares in its global benchmarks “as soon as accessibility issues are resolved,” Briand added, noting that a decision could very well come before the next annual review in June 2016.

“It’s hard to say when the timing of the resolution will be, but I suspect the Chinese regulators will figure it out quickly,” said Brendan Ahern, whose firm, KraneShares, focused exclusively on China ETFs. “Ultimately, this is going to happen and likely sooner than many anticipate, as MSCI won’t wait for the 2016 annual review for inclusion.”

The KraneShares Bosera MSCI China A Share ETF (KBA | D-55) tracks a cap-weighted index of China A-shares expected for inclusion into the broader MSCI Global Equity indexes if and when MSCI deems A-shares eligible for inclusion.

In the past year, KBA’s A-shares-focused strategy has rallied sharply higher in stark contrast to broader emerging market funds such as EEM and VWO, as the chart below shows. 

Chart courtesy of StockCharts.com