China

Summary

In May 2018, a number of China’s A-shares will become part of MSCI’s flagship emerging-market index for the first time, and we believe investor interest is likely to grow. But in many ways, this market is as misunderstood as it is underrepresented in portfolios, so here are 10 things investors should know.

Key takeaways
  • China’s stock markets were once notoriously difficult to access, but the government has made a concerted effort to open its markets – including launching the Stock Connect programmes
  • The MSCI Emerging Market index – the benchmark for EM investors globally – will soon include China A-shares for the first time, sending an important signal about the credibility of A-shares
  • High stock turnover, more institutionalized markets and reduced stock suspensions are opening investors’ eyes to China: an estimated USD 18 billion is set to be allocated to A-share markets

China’s equity market is large, deep and liquid

The market capitalization of China A-shares – companies listed on stock exchanges in Shanghai or Shenzhen – is around USD 8 trillion, second only to the US and around 30 per cent bigger than the euro area. But until China recently began making a concerted effort to open its markets, A-shares were purchased primarily by Chinese investors. Foreign investors have been more focused on the smaller H-shares market – stocks listed on the Hong Kong Stock Exchange – in large part because they were easier to access.

A-shares are coming to MSCI

By June 2018, a number of China A-shares are expected to be included in the MSCI Emerging Market Index for the first time. This is big news from what is effectively the world’s benchmark index for emerging-market stocks, and it sends an important signal about the credibility of A-shares. At the outset, MSCI’s initial A-share weighting will be small, with slightly more than 200 stocks added to the index. However, we believe this number will grow over time. MSCI has announced its plans to add more stocks in August, and investor interest is expected to be high: an estimated USD 18 billion is set to be allocated to China’s A-share markets.

Stock Connect is broadening the market

A key catalyst for the inclusion of A-shares in the MSCI’s EM index was the recent launch of China’s Stock Connect schemes – market-access programmes that enable investors to use their local exchanges to trade shares listed on cross-border counterparts. Stock Connect replaced the highly complex QFII and RQFII systems, which required non-Chinese investors to meet strict criteria to purchase A-shares.

High turnover adds to A-share liquidity

Domestic retail investors in China dominate the market for A-shares and account for more than 80 per cent of daily turnover. With the investment culture in China focused more on momentum and short-term trading, the stock turnover ratio of China A-shares is among the highest in the world. High levels of turnover generally make it easier for investors to buy and sell shares.

China A-Shares Have a High Turnover Ratio

China A-Shares

Source: World Federation of Exchanges, Bank of America Merrill Lynch. Data are as at December 2016. Stock turnover ratio is calculated by total turnover divided by ending market capitalization.

An increasingly institutionalized market

Foreign investor ownership of China’s A-shares is growing, but from a low base – moving from 1.5 per cent to around 2 per cent of the market over the last year. Nonetheless, the A-share market is becoming gradually institutionalized, with an increasing number of large market participants making large-scale trades. The A-share market also features a significant number of “quality growth compounders” – high-quality firms that invest back into their businesses – that pushed the market higher in 2017. China’s domestic investors frequently ignore these aspects of an increasingly mature market, but foreign investors may be attracted to such steady signs of improvement.

Fewer stock suspensions

In July 2015, at the peak of a period of significant market instability, 51 per cent of listed China A-share stocks were suspended from trading. Today, that figure is only 8 per cent. New rules have been introduced to curb long and unreasonable stock suspensions, although the regulatory environment in China is unpredictable and continues to evolve.

A-Share Stock Suspensions Have Fallen Significantly

China A-Shares

Source: Wind, Goldman Sachs Global Investment Research. Data are as at 23 Feb 2018.

A significant portion of the market is held by a small number of investors

As a result of the 2015 volatility, China formed a “national team” to help stabilize the market by purchasing A-shares. An estimated USD 544 billion in A-shares – approximately 7 per cent of China’s market cap – is still held by this group. As a result, China A-shares remain vulnerable to market intervention. However, this policy did boost stability: the volatility of China A-shares fell from 38.9 per cent in December 2015 to 11.4 per cent in December 2017.

Governance is getting better, though there is room for improvement

As in all emerging markets, corporate governance is a key issue in China, but things have been starting to change for the better. Approximately half of China A-share companies employ well-known international auditing firms. In addition, all listed Chinese companies are required to file quarterly reports and end their fiscal years on 31 December. Moreover, China’s generally accepted accounting principles have moved closer to International Financial Reporting Standards. However, it is still uncommon for Chinese firms to have English-speaking investor-relation departments, or to host overseas roadshows.

Investment professionals in China are less experienced

According to March 2018 data from UBS, China has approximately 5,000 equity-research analysts, and around 98 per cent of all covered companies receive a “buy” rating. There are also just over 1,600 portfolio managers in China, and they have only 3.1 years of experience on average. An overoptimistic, less experienced community may create opportunities for more seasoned investment professionals.

Lower correlations can bring benefits to portfolios

China A-shares have a correlation of less than 0.2 with global indices, and their correlation with Hong Kong-listed stocks is less than 0.5. This suggests that investing in A-shares could bring additional diversification benefits to portfolios. The gradual institutionalization of China A-share markets is expected to result in a higher correlation with their offshore counterparts, but this process could take many years.

  • Unattractive correlations
  •  
  • Attractive correlations

 

China A-shares

Hong Kong-listed China stocks

Asia Pacific (ex Japan) equities

Emerging-market equities

Japan equities

US equities

European equities

World equities

China A-shares

1

0.49

0.34

0.29

0.22

0.13

0.16

0.17

Hong Kong-listed China stocks

0.49

1

0.89

0.85

0.56

0.58

0.64

0.67

Asia Pacific (ex Japan) equities

0.34

0.89

1

0.96

0.65

0.73

0.82

0.84

Emerging-market equities

0.29

0.85

0.96

1

0.58

0.75

0.84

0.85

Japan equities

0.22

0.56

0.65

0.58

1

0.52

0.58

0.64

US equities

0.13

0.58

0.73

0.75

0.52

1

0.84

0.96

European equities

0.16

0.64

0.82

0.84

0.58

0.84

1

0.95

World equities

0.17

0.67

0.84

0.85

0.64

0.96

0.95

1

Source: Bloomberg, Allianz Global Investors. Data as at 31 December 2017. Correlation data are calculated based on historical returns of respective MSCI indices for the past 10 years, using weekly US dollar returns.




Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security. The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted. This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations. This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission; Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Operator), No. 424, Member of Japan Investment Advisers Association and Investment Trust Association, Japan];and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan.


471460

Expert-Image

William Russell

Global Head of Product Specialists Equity
Hong Kong
Mr Russell is the Head of Product Specialists Equity and a managing director with Allianz Global Investors, which he joined in 2014. Before joining the firm, he worked at Fidelity Worldwide Investment and M&G Investments. Mr Russell began his investment career as a research analyst and Asian equity fund manager, and subsequently held product, market and distribution roles in Europe and Asia. He has a first-class honours degree in economics & social history from Bristol University and a post-graduate diploma in Mandarin Chinese from Beijing University.
Expert-Image

Shannon Zheng

Product Specialist
Hong Kong
Ms Zheng is a Product Specialist covering regional and China equity strategies with Allianz Global Investors, which she joined in 2010. She has a bachelor’s degree in economics and finance from the University of Hong Kong.

ESG is going mainstream because it’s business-critical

Steffen Hörter | 07/05/2018
Innovation

Summary

Companies that recognise the importance of ESG factors – and manage them well – are increasingly attractive to investors, while companies that fail to pay attention to ESG can be perceived as higher risk. This is causing a paradigm shift in the investment world.

Key takeaways

  • ESG investing is going mainstream in large part because it deals with business-critical issues such as water management, health and safety, board accountability and executive pay
  • ESG factors can directly affect a company's reputation, intellectual property and brand value – which can impact its stock's valuation
  • Socially responsible investing and impact investing use screening methods that can be limiting; an active, integrated ESG approach can be much more flexible and allow access to a broader opportunity set

Environmental, social and governance (ESG) factors are increasingly recognised as critical determinants in the success or failure of corporations of every stripe. Investors, too, are paying more attention to ESG factors because incorporating them into investment decisions can help manage risk and generate more sustainable long-term returns.

Intangible factors help determine market value

Analysing ESG factors is meant to be a supplement to, rather than a replacement for, more traditional research tools. While it is certainly always important to examine a company's balance sheet and public filings, a growing percentage of corporate assets today are of a more intangible nature.

These intangible assets include a company’s reputation, intellectual property and brand value – and many are directly related to, or affected by, mainstream ESG factors:

  • Environmental – climate change, pollution, water management, biodiversity
  • Social – human rights, labour relations, health and safety, community relations, diversity
  • Governance – board structure and accountability, executive pay, bribery and corruption

Companies grow increasingly attractive to investors if they recognise the ESG factors relevant to their enterprises, invest in them as business opportunities and manage them well. Conversely, poorly managed companies that ignore ESG factors may be riskier investments.

As the accompanying chart shows, one study found that over the past 30 years, intangible assets constituted an increasingly large component of companies’ market value.

Intangible assets have grown increasingly valuable

Components of S&P 500 market value

 

Source: Ocean Tomo (2015), "2015 Annual Study of Intangible Asset Market Value". For illustrative purposes only.

Three ways to incorporate ESG

The growing interest in ESG is causing a paradigm shift in the investment world. While there are many approaches, ESG investments generally fall into one of three categories.

Socially responsible investing (SRI)

This approach typically aims to avoid companies or sectors with bad ESG practices, such as poor corporate behaviour. After applying negative screens or positive filters to their investable universes, SRI strategies are able to invest in only a portion of their benchmark indices. Since SRI strategies are a first-generation approach to ESG investing, dating back more than 20 years, they currently make up the bulk of the ESG market.

Impact investing

Part of the SRI landscape, impact investing aims to create a positive social and environmental impact along with a positive financial return. Impact investments frequently focus on one or more of the United Nations’ 17 Sustainable Development Goals, such as providing access to clean energy or clean water, but they can also focus on areas such as providing quality education and gender equality. With this approach, there is a causal connection between making an investment and generating an impact.

Integrated ESG

This is a “next-generation” approach that we follow at Allianz Global Investors for our mainstream investment strategies. It is built around conducting deep, proprietary research on corporate ESG risks and opportunities. Integrated ESG portfolios are not constrained by ESG filters that narrow the investable universe; instead, portfolio managers make an educated ESG risk/return trade-off across all potential holdings – with a special focus on avoiding ESG tail risks. For example, a portfolio manager who wants to invest in a lithium company for exposure to the electric-vehicle revolution would need to consider whether its manufacturing operations could be shut down for safety or pollution reasons.

ESG and active investing

Corporate ESG issues are seldom black or white. That’s why in our view, the practice of packaging up complex issues into passive ESG indices by indiscriminately applying rules-based criteria and third-party ESG research holds relatively little prospect of success. Active investment strategies, on the other hand, can build ESG factors into a portfolio in a far more flexible way by allowing access to securities that are mechanically “screened out” by many passive sustainability strategies. We believe it is in this broader opportunity set where the most attractive investment prospects are often found.

Another benefit of an active approach to ESG investing is active engagement between portfolio managers and corporate management teams. Our integrated ESG approach aims to improve how companies perform on financially material ESG issues by emphasising strong stewardship, consistent proxy voting and regular, direct contact with management. In this way, we aim to help corporations move towards more successful business outcomes – and help our clients improve their performance potential over the long term.

Learn more about our approach to active engagement

We’ve launched a new tool that provides real-time updates on how we are voting on resolutions at thousands of companies, alongside commentary on why we voted the way we did. We also invite you to learn more about our ESG approach by exploring how we integrate ESG criteria across the entire investment value chain.

 

 

 

Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security. The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted. This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations. This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission; Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Operator), No. 424, Member of Japan Investment Advisers Association and Investment Trust Association, Japan];and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan.

485071

Expert-Image

Steffen Hörter

Global Head of ESG
Dr Steffen Hoerter is the Global Head of ESG at Allianz Global Investors which he joined in 2001. He is internationally responsible for the ESG integration strategy at AllianzGI including ESG Policy and Framework, ESG Investment Positioning, ESG Investment Offering/ Product Design and ESG Client Investment Advisory. Dr Hoerter has published various whitepapers and thought leader pieces on financial materiality of ESG in Equities, ESG in Corporate Fixed Income, ESG in Sovereign Bonds and ESG in Strategic Asset Allocation. Between 2010 and 2016 he has been advising institutional investors, in particular pension funds in Europe on investment strategy, risk management and ESG. Prior to joining Allianz Global Investors, Dr Hoerter worked as a Management Consultant for banks and risk management at an international consultancy firm. Dr Hoerter studied Business Administration in Regensburg, Edinburgh and Ingolstadt/Eichstaett. He holds a doctorate from the Catholic University of Eichstaett-Ingolstadt, where he worked as a lecturer at the Department of Finance and Banking at WFI – Ingolstadt School of Management.
Active is:
Allianz Global Investors
Contact
For more information on our products and services
Contact Us