Inclusion of China A-shares in the MSCI EM Index

Starting in May 2018, effective with the RAM Emerging Markets Equities Fund’s May rebalancing, MSCI will include 222 large-cap, China A-shares in the MSCI Emerging Markets (EM) Index.

What is the weighting of the planned inclusion factor of the A-Shares?

Although the initial weighting of Chinese A-shares in the MSCI EM Index is relatively small (c.0.73%), the full impact (potentially 100% inclusion over the next decade) will be substantial. In our view, the inefficient nature of the A-Shares will, we believe, present an excellent opportunity for our stock-picking strategies (which look to capitalise on inefficiencies on a global basis). Our research suggests that further inclusion of A-Shares could represent a significant risk for the benchmark overall. Our Fund’s strategy here would be to invest via our counterparties in CFDs (should access not be possible via cash).

Allocation to China & HK in the RAM EME Fund average over the last quarter (by strategy): 

In terms of our Strategy’s allocation to China & HK over the previous quarter*, all three maintain an underweight relative to the benchmark (30%). While our Momentum engine maintaining the largest weighting (26.2%), we have seen a general reduction in size over the quarter (peak of 26.2%, to a low of 22.9%). Our Value engine has a 25.8% allocation to China & HK, below the benchmark. Lastly our Defensive engine has the lowest relative allocation (22.8%). Again the reduction theme was evident here (peak of 25.8% to a low of 19.5%).

Potential Risks and Challenges

Market Valuation:

A consequence of the historically limited access to offshore investments here is the potential risk of overvaluation of the China A-Share market. As the integration of A-Shares increases over time, shorting and arbitrage opportunities could arise, leading to divergence in the valuations of the A- and H-Share markets. The market appears largely in favour of H-shares (trading at 23% discount, while also being cheaper to trade) versus A-shares listings for dual-listed stocks (see chart below).

As of March 2018, the valuation of the MSCI China A-Share Index was roughly double the valuation of the MSCI China H-Share Index: 

Source: Bloomberg from 3rd May 2013 to 23rd April 2018.

Lack of Shorting Availability:

Given the high levels of valuation, our research indicates that we would rather identify short rather than long opportunities in the A-Shares universe. However, it is very difficult to capture these shorts and build a significant short position in the market, as borrowing availability in A-Shares is scarce given very low borrowable stock inventory.

Rising Costs:

In addition to the above, we can expect higher exchange fees and higher taxes, as well as higher commissions amounting to around 25bps of trading costs in A-shares, which could prove to be a costly exposure for our Strategies.

Disclaimer

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