The opening of the China A-share market to foreign investors – and the subsequent growing inclusion of a much larger number of Chinese companies in widely used equity indices – is poised to be, in our view, one of the most transformative events in the financial markets over the next decade.
The opening up of the China A-share market
could be a transformative event, giving
investors a unique opportunity to optimise
global equity portfolios
Stock Connect programmes have lowered
the cost of accessing domestic Chinese
stocks and, as MCSI adds China A-shares
into emerging-market indices, China’s
growing importance will increasingly
be reflected in global equity indices
China A-shares add meaningful portfolio
diversification, given their low historic
correlation with major equity markets
globally, and can help investors access
a broader investment universe reflecting
the faster-growing sectors of China’s
China’s importance is not reflected in
the MSCI EM Index, which has a China
A-share weighting of just 4.1%* and
a mega/large-cap bias. “Buying the
index” is not ideal for investors to
gain appropriate exposure to China
The asset class has risks relative to
developed markets, but we expect such
risks to normalise as the market matures
On balance, we believe investors should
consider a dedicated allocation to
China A-shares. Our analysis suggests
that a 10% to 30% direct allocation,
coming from existing emerging-market
portfolios, could improve returns and
may diminish risk
The opening up of the China A-share market to foreign
investors – and the subsequent growing inclusion
of a much larger number of Chinese companies
in widely used equity indices – is poised to be,
in our view, one of the most transformative events
in the financial markets over the next decade.
The implications for investors are numerous,
complex and, above all, inevitable, making the
maintenance of the status quo, in our view, an
Investors considering an investment in the domestic
China A-share market are now able to tap into the
full China equity pool, with a significantly larger
market capitalisation than Europe, for example.
The A-share market alone encompasses more than
3,700 listed companies worth nearly USD 8.8 trillion
across the entire market-capitalization spectrum
(Exhibit 1). That’s comparable to the USD 9.3 trillion
market capitalization of equities in the euro area.1
In this paper, we argue that an allocation to
China A-shares presents a unique opportunity for
investors to optimise their global equity portfolios.
Our analysis shows that the Chinese domestic market
exhibits low correlation with other widely held asset
classes (such as Hong Kong-listed H-shares as well
as US and European equities), a trait that stems
from the fact that a) the Chinese domestic market
is influenced by unique economic, political, and
monetary policy considerations, and b) it has very
different market participants than elsewhere. In
addition, because these companies generate the
vast majority of their revenues domestically, the
effects of ongoing trade tensions with the US are
less pronounced than may be commonly assumed.
Exhibit 1: China A-shares give foreign investors broad access to a significant opportunity
listed in HK
Market cap (USD tn)
Number of stocks
As of 31 January 2020.
Only the market cap of the listed share class is included. Offshore China stocks are defined based on companies with ultimate parent domiciled in China. Suspended stocks are excluded.
Source: Nasdaq, Shanghai Stock Exchange, Shenzhen Stock Exchange, Bloomberg, Allianz Global Investors
Also, we explain why we believe that – given China’s long-term
economic growth prospects as well as the still-abundant
inefficiencies seen in the country’s domestic equity market – an investment in China A-shares exhibits superior alpha-generating
Lastly, we present our views on the future evolution of the
market – as well as its growing representation in equity
benchmarks – and weave our thoughts on how investors
should consider tapping this market as well as what potential
impact an allocation to China A-shares may have on
All in all, we see this as an evolving story, for both the China
A-share market itself – which, we expect, should continue
to grow and modernise – and Western investors – who, we
believe, should take a progressive approach to allocating
to this momentous asset class.
A long path to access, but a potentially rewarding one nonetheless
Before 2003, foreign investors could only trade some Chinese
firms listed on the Hong Kong Stock Exchange (H-shares),
which is dominated by state-owned enterprises, such as banks
and energy firms, or American Depositary Receipts (ADRs)
traded in the United States. Together, H-shares and ADRs are
known as “offshore China”.
Access improved in 2003, with the launch of the Qualified
Foreign Institutional Investor (QFII) programme, which offered foreign investors access via quotas to China A-shares – listed
in the Shenzhen and Shanghai bourses (known as “onshore
China”) and traded in renminbi. The RMB Qualified Foreign
Institutional Investor (RQFII) scheme, launched in late 2011,
further expanded access by allowing Chinese financial firms
to establish renminbi-denominated funds in Hong Kong
for investment in the mainland.
Subsequently, the launches of the Shanghai-Hong Kong
Stock Connect programme in 2014 and the Shenzhen Connect programme in 2016 gave foreigners access to Shanghai- and
Shenzhen-listed stocks, without quotas or the need for a
licence. Importantly, these Stock Connect programmes also
significantly lowered the costs of accessing the Chinese
onshore market. Finally, on 1 June 2018, MSCI added China
A-shares into its emerging market indices for the first time.
Although it was a long road until foreign investors gained
access to China’s domestic stock market, we believe that
investors will come to realise that it might have been worth
the wait given the size and scope of the opportunity.
Now the second-largest economy globally, China is forecast
to overtake the United States as the world’s largest economy
by 2030. That growing economic importance will increasingly
be reflected in global equity indices and in portfolios.
Further, adding China A-shares to portfolios adds meaningful
diversification, as evidenced by China A-shares’ low historic
correlation with major equity markets globally (Exhibit 2).
Two main reasons are behind this low correlation.
Exhibit 2: Because of domestic revenues and distinct economic and monetary policy, China A-shares have a low correlation with major equity markets
As of 31 January 2020.
Correlation data is calculated based on historical return of respective MSCI indices for the past 10 years, using weekly USD return. See full names of all specific benchmarks at the end of this paper.
Source: Bloomberg, Allianz Global Investors
First, the Chinese domestic equity market is, by many
measures, still in its infancy. Trading is still dominated by
retail investors (more on that later) and the regulatory
environment – albeit evolving quickly – remains volatile
and susceptible to the vicissitudes and trends of the Chinese
domestic political environment.
Second, the companies trading in this market sell primarily
to local consumers. In fact, China A-share companies yield
90% of their revenue domestically, in many cases leaving
them well placed to avoid significant negative impacts
associated with ongoing trade tensions with the US. This
local revenue base makes them less sensitive to global
macroeconomic trends, and more sensitive to the directions
set by both the Chinese government as well as the People’s
Bank of China, the country’s central bank. Traditionally,
Chinese fiscal and monetary policies have “marched
to their own beat”, and have not been highly correlated
to the policies adopted by the US and other Western
China A-shares and the promise of the “new economy”
In addition to the low-correlation factor, the China A-share
market provides an entry door for investors to more deeply
benefit from China’s ongoing shift from an export-driven
economy into the so-called “new economy”, characterised
by an increased role of domestic consumption and higher-value-added sectors, such as tourism, entertainment,
healthcare equipment, industrial automation, new energy
vehicles, biotech, software and new materials.
As shown in Exhibit 3, investing in China A-shares gives investors
greater access to the small- and mid-cap companies set to be the future drivers of China’s economic growth – technology,
innovation and the rapidly expanding Chinese middle class.
Exhibit 3: China A-shares better reflect faster-growing sectors of the “new economy”
MSCI China All Shares Index, index breakdown by listing location
As of 31 January 2020
Data analysis based on the MSCI All China Index (broken down by sector and stock exchange).
Source: Bloomberg, Allianz Global Investors
In fact, more than half of China’s economic output comes from
the services sector, and the country is a major investor in, and
adopter of, digital technologies. So, China A-shares – especially
when accessed through non-passive instruments – better reflect
the promise of the country’s digital future than emerging-market
benchmarks such as the MSCI Emerging Markets Index, which is
highly biased towards Chinese mega- and large-cap stocks.
Buying the MSCI EM Index alone is not the ideal way to boost China exposure
Today, most investors benchmark their exposure to China to
international equity (ie., MSCI ACWI ex-US) and/or global
emerging market (ie., MCSI EM) indices. But simply increasing
allocations to those indices may not be an ideal
way to broaden China exposure.
Here’s why: although China A-shares are now included in
MSCI indices, their weighting within the MSCI EM Index
and MSCI ACWI Index are, as of this writing, just 4.1% and
0.5%, respectively. To put that into context, the market cap
of China A-shares as a percentage of global equities was
9% (at the end of 2019) and the overall Chinese economy
accounted for 15.8% of global economic output in 2018.2
As the numbers show, China A-shares are considerably
under-represented in one of the benchmarks most widely
used by investors.
The current Chinese exposure within the MSCI EM Index
is weighted heavily toward low-growth companies and
concentrated in a few mega-cap technology firms, such as Alibaba and Tencent.3 This extra “mega/large-cap bias”
creates further imbalances for investors seeking to establish
an exposure to Chinese equities that is concomitant to the
current growth opportunity for that market.
In this context, we argue that a direct allocation to China
A-shares – especially when done through non-passive
instruments – can provide investors a more well-adjusted
exposure to the Chinese market. For example, investing
in A-shares gives investors greater access to a plethora of
opportunities among small- and mid-cap companies. As
illustrated in Exhibit 4, 38.1% of the MSCI China A-Shares
Onshore Index is represented by small- and mid-cap
companies with a market cap below USD 10 billion, compared
to 14.2% in offshore China.
Exhibit 4: China A-shares complement China stocks in the MSCI EM Index and offer a plethora of opportunities among small- and mid-cap companies
As of 31 January 2020
Source: Bloomberg, Allianz Global Investors
Further, while it’s certainly a positive step that MSCI has begun
adding China A-shares to its key MSCI EM Index, representation
will likely remain very small and, in our view, artificially
depressed. From this perspective, we don’t believe that
investors who decide to define their China A-share exposure by
simply “buying the MSCI EM Index” will be properly positioned
to seize this opportunity in the next few years.
That said, we do expect that the A-share weightings of the
MSCI EM Index will increase significantly over time to reflect
the size of China A-share markets, altering the composition
of future EM benchmarks. Exhibit 5 extrapolates what China
weights would look like in the MSCI EM index if those weights
were calculated by a) the current selected number of China
A-shares included in the index, and b) all shares currently
trading in the China A-shares market.
Exhibit 5: China A-shares are substantially under-represented in the MSCI Emerging Market Index
As of February 2020
Middle chart is based on MSCI’s proposal in November 2019 to include 472 large- and mid-cap China A-share stocks into the MSCI Emerging Market Index. Right chart is based on the assumption that all China stocks are available to be included into the MSCI Emerging Market Index. We use an 85% discount factor, which should approximately
represent the large- and mid-cap universe within China A-shares.
Source: MSCI, Bank of America Merrill Lynch, Allianz Global Investors
As Exhibit 5 shows, China would account for 43% of the index
in the first scenario and 50% of the index in the second one.
Although we don’t expect those levels of exposure will
be reached any time in the foreseeable future, the analysis
does reiterate an important issue: investors seeking to be
“ahead of the curve” to fully capture the current opportunity
in the Chinese equity market are unlikely to achieve that
goal by simply sticking to current benchmark weights.
Understanding China A-share risks and how to mitigate them
While the China A-share market represents a significant
opportunity, it carries risks. We expect that the increased
access to China A-shares and the rising importance of
the country’s economy will attract greater participation
from investors. Nevertheless, the market for now remains
dominated by retail investors. Indeed, domestic retail
investors, primarily focused on chasing short-term trading
profits, account for more than 80% of daily turnover. Also,
local Chinese equity analysts tend to be less experienced
than is the case in developed markets, leading to a greater
frequency of earnings surprises than in more mature markets.
As shown in Exhibit 6, all this contributes to higher volatility – something underlined in June 2018, when onshore China
suffered declines of nearly 11%. There is also higher sector
rotation for China A-shares compared to developed-market
indices, and a high dispersion of returns (Exhibit 7).
Exacerbating risks, while the regulatory environment is
evolving at a fast pace, it remains fairly unpredictable.
Exhibit 6: China A-share stock suspensions have declined
% of China A-share stocks suspended
As of 20 February 2020
Source: Goldman Sachs, Allianz Global Investors
Those risks, however, are characteristic of many developing
markets, and they tend to dissipate as the market matures.
It’s worth noting, for example, that the trading experience
of the past 20 years in Taiwan shows that as the influence
of foreign investors and domestic institutions increases and
the dominance of retail investors diminishes, so too does
volatility. As highlighted in Exhibit 6, stock-trading suspensions,
relatively common just a few years ago, have become less
of a concern as the regulatory framework has strengthened.
Exhibit 7: China A-share turnover has spiked and far exceeds comparable developed-market indices, leading to a high dispersion of returns
On balance, we believe that the time has come for investors
to consider a dedicated allocation to China A-shares,
especially since, as noted previously, the asset class can
offer a significant source of diversification for global stock
investors. The opportunity set is substantial, especially for
investors seeking to optimise their equity exposures.
To underscore how relatively absent foreign investors are from
what could be the most significant market opportunity today,
they still only own around 3.8% of China A-shares4, at a time
when MSCI EM is adding China A-shares exposure.
All in all, it is our view that, despite current risks, the China
A-share market has matured enough to accommodate the
arrival of foreign investors. But investors should approach
the market with caution to avoid potential pitfalls and
mitigate inherent risks.
We believe that active management can help investors to
properly – and wisely – exploit the China A-shares market’s
inefficiencies to generate potential outsized returns in general,
and alpha in particular.
Just as important, however, active management can – as our experience in investing in China A-shares has
taught us – generate potential outperformance not only
by selecting the highest-performing stocks but also by
avoiding problematic ones.
This is especially true when investing in a still-developing
marketplace, with volatility levels that are higher than in
developed markets. In the Chinese domestic market, potential
downside protection is as critical as potential upside reward.
Deploying China A-shares in an institutional portfolio
In light of the current opportunity and the early stage of
development of the China A-shares market, investors should,
in our view, take an incremental approach to deploying this
new asset class in their portfolios.
We consider the case for investing in onshore China today as
similar to investing in emerging markets a quarter of a century
ago: back then, many investors viewed deploying capital to
developing economies (and immature capital markets) as
risky. Today, however, an emerging-market allocation is a
typical part of any serious investor’s strategic asset allocation.
We forecast that allocations to onshore China will follow a
As mentioned previously, it is our view that the importance of
China – and China A-shares in particular – is underrepresented
in the benchmark index typically used for emerging-market
allocations, falling far short of both the importance of
China’s economy and its equity market. Consequently, we
believe that adding a more significant allocation to China
A-shares as part of a portfolio’s current emerging-market
allocation makes sense for both risk-return reasons and for
portfolio optimisation, especially given the asset class’ low
correlation to other global equities.
The question then becomes, how heavily should an emerging-market
allocation tilt toward onshore China? While the precise
answer varies among investors, data suggests that the sweet
spot may be between a 10% to 30% direct allocation to China
A-shares, with the money to fund that allocation coming from
investors’ existing emerging-market portfolios.
Using the MSCI EM index as our proxy for a “core” emerging-market
portfolio, we compiled historical data from the past
15 years (Exhibits 8 and 9) to observe what the impact of
adding the MSCI China A-Shares Onshore Index to an MSCI EM
index allocation would be on annualised returns and on risk.
Exhibit 8: Overweighting emerging market allocations to China A-shares may increase the risk-adjusted returns of portfolios
Allocation from global emerging markets to China A-shares
Table shows analysis of returns for the MSCI Emerging Market Index (used as proxy for global emerging markets) and MSCI China A Onshore Index (used as proxy for
the China A-share market) indices from 31 January 2005/2020. Percentages shown in the table represent portion of portfolio allocated to China A-shares.
Past performance is not indicative of future results.
Source: Allianz Global Investors
Our analysis reveals that shifting 10% of one’s global emerging-market
allocation to China A-shares would improve the overall
portfolio return from an annualised 7.5% to 8.3%. And, mainly
due to the asset class’ low correlation characteristics, the
portfolio’s Sharpe ratio would see a significant enhancement
from 0.29 to 0.34.
Exhibit 9: Adding China A-shares to MSCI EM allocations can enhance the risk/return profile of an emerging-market allocation
Chart shows analysis of returns for the MSCI Emerging Market Index (used as proxy
for global emerging markets) and MSCI China A Onshore Index (used as proxy
for the China A-share market) indices from 31 January 2005/2020.
Percentages shown on the chart represent portion of portfolio allocated to China
Source: Allianz Global Investors
A bolder shift of 30% of one’s allocation to China A-shares
would compound the enhancements further, with the
annualised return of the overall portfolio rising to 9.7%
and the Sharpe ratio jumping to 0.4. Our 15-year historical
risk/return analysis suggests that a portfolio’s Sharpe ratio
would be maximised with an allocation of 50%. While any such historical analysis is very dependent on its start and
end points, these results suggest that a meaningful allocation
to China A-shares would be beneficial from a portfolio
The historical analysis highlights many of the benefits that
investors can reap from allocating to the Chinese onshore
equity markets and, we believe, can be used as a starting
point when considering exposure to the asset class. Further,
we recognise that historical analyses are very start- and
end-point sensitive. Those caveats notwithstanding, history
and experience have shown us that the Chinese domestic
equity market is clearly on an evolutionary path, especially
in terms of its outlook for broader investor participation and
potential lower volatility.
With that in mind, we firmly believe that it behooves investors
to consider an increased allocation to China equity through
exposure to the country’s domestic market. But – due to the
evidence presented in this paper – investors should deploy
capital in a steady yet evolutionary fashion, to benefit from a
“first-mover” advantage without overly taxing their risk budgets.
Investors can finally access the domestic Chinese economy with
relative ease through Stock Connect programmes to invest in China
A-shares, giving them the ability to harness the promise of an
increasingly consumer-driven “new economy” – one that is set to
grow into the world’s largest economy within a dozen years. Put
bluntly, the opportunity could be the single most transformative
event in financial markets in the coming decade. However, simply
“buying the MSCI EM Index” – currently still sorely underweight
onshore China – would leave investors at risk of missing out on
most of the potential opportunity.
As a result, we believe that the time is right for investors to
consider increasing allocations to onshore China, as they
did with emerging-market allocations a generation ago.
That can be achieved by investors altering their existing
emerging-market allocations to add direct allocation to
China A-shares in order to better position portfolios for the
intermediate and long term. Historical data suggests that
doing so could improve returns and may also diminish risk,
making it a compelling portfolio optimiser.
List of benchmarks used in Exhibit 2
MSCI China A Onshore Index
MSCI China Index
HK-listed China stocks
MSCI AC Asia ex-Japan Index
Asia-Pacific ex-Japan equities
MSCI Emerging Markets Index
Global Emerging Market equities
S&P 500 Index
MSCI Europe Index
MSCI World Index
* As of 31 December 2019
1) European Central Bank data, as of 31 December 2019.
2) Source: FactSet, MSCI, Goldman Sachs Investment Research, as of 31 December 2019.
3) Some or all the securities identified and described may represent securities purchased in client accounts. The reader should not assume that an investment in
the securities identified was or will be profitable. The securities or companies identified do not represent all of the securities purchased, sold or recommended for
advisory clients. Actual holdings will vary for each client. Alibaba and Tencent are two of the three large-cap technology companies which make up the widely
used “BAT” acronym.
4) Source: FactSet, MSCI, Goldman Sachs Investment Research, as of 31 December 2019.
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