According to Morningstar data, net flows into A-shares by European-based investors rose five-fold last year to €1.1bn from €172.4m in 2016.
This was even more impressive when compared to the outflows seen by China equity funds, which Morningstar defines as those which invest primarily in Chinese companies listed on the stock exchanges in China and Hong Kong and in companies that derive significant revenues from or have substantial business ties with the China market. These funds saw net outflows of €1.2bn over the past year.
A shares are issued by Chinese mainland companies exclusively denominated in renmimbi and traded on either the Shenzhen or Shanghai stock exchanges.
In terms of net assets under management, China equity funds reached a sizable €29.5bn at the end of last year compared to €3.7bn for China A-shares funds, but inclusion into the MSCI Emerging Markets index should change this according to Deutsche Asset Management.
“A shares inclusion in the MSCI in May could bring support for domestic A-share market,” said the firm’s chief investment officer for Apac, Sean Taylor.
He added: “For the year ahead we are still expecting low teen earnings growth for MSCI China – no change here, with the recent market correction offering buy opportunities as valuations look cheaper for global investors.”
China’s A-share market currently has a market capitalisation of $8.3trn (€6.7trn) and over 3,000 stocks. The first round of integration of these A-shares into the MSCI Emerging Market index will include 222 stocks and account for 0.7% of the becnchmark’s market capitalisation. But by the time China A-shares are fully included in the index they will likely account for more than 20% of the benchmark.
AllianceBernstein’s China equities portfolio manager, John Lin, noted that the full index revision would be expected to unleash $100bn of investments in A-shares through emerging market vehicles.
Pointing to a report by the People’s Bank of China, Lin said that overseas investment funds were keen on China and had boosted their exposure to Chinese stocks by 81% in 2017.
Since the MSCI announced the inclusion in June last year, Ireland and Luxembourg domiciled A-shares funds gained €1.1bn in net assets, according to the Morningstar data.
Investors’ spike in interest in China has been further proven just by looking at the MSCI China index, where its annual rise of 54.33% in 2017 was up from 1.11% in 2016.
Greater China funds domiciled in Ireland and Luxembourg performance for the year to 31 January 2018 was a gain of 32.14% and China funds were up 31.31% for the same period, according to FE Analytics.
The data found the top performing fund over the three years to 31 January 2018 was UBS Equity – China Opportunity fund at 78.24%. This was followed by UBS Equity Greater China at 72.38%, Banor Sicav Greater China Equity fund at 71.27%, Vontobel mtx China Leaders fund at 69.8%, and Neuberger Berman Europe’s China Equity fund at 64.28%.
The lowest five funds still did well – returning between 13.31% to 19.35% – apart from one fund that returned a negative 3.31% over the same period.
Proceed with caution
Hermes Investment Management’s head of emerging markets, Gary Greenberg, said most global and emerging market investors were caught off guard by China’s strong market last year as it outpaced the vast majority of global markets.
“Industrial margin growth was stronger than expected and internet stocks surprised most observers with tremendous earnings growth, but this year the fundamentals still look pretty good, despite the market trading at a modest premium to its long term price-to-earnings ratio,” he said.
“Thus, the market valuation is still sensible and the 2% yield provides solid support. The economy should continue to grow at a good clip even if it slows down from 2017’s GDP growth rate of 6.8% to a more sedate 6.1%.”
However, AllianceBernstein’s Lin warned that there were good reasons to be cautious about A-shares and that investors needed to navigate structural imbalances in the country’s debt-laden economy. His main concerns were about the government’s macroeconomic stewardship and the large contingent of state-owned enterprises in the market.
“Ignoring A-shares, however, means missing the full potential of China’s expansion. For example, the onshore market is full of growing healthcare companies serving the country’s ageing generation,” Lin said.
“Many technology firms from the Shenzhen market are inaccessible offshore. The market also provides access to China’s explosive consumer growth and local brands popular with the growing middle class.”
“Finding opportunities like these is challenging in the A-share market, which is dominated by retail investors and notoriously inefficient. Chinese retail investors often lack critical information about company performance, and information dissemination is imperfect.”
The top funds mentioned above had their largest weightings towards technology, finance, and consumer products. The tech stocks with the largest holdings were the usual Tencent Holdings, Alibaba, Baidu, and Netease.
BNY Mellon’s Newton Investment Management’s portfolio manager, Naomi Waistell, said because one-fifth of the world’s population lived in China, data-capture of their characteristics, habits, and purchases was extremely powerful.
“Capital-light internet platforms are able to use this to strong advantage via increasingly powerful artificial intelligence,” she said.
“For this reason we continue to be excited about the long runway for growth in Chinese internet names, and see this long-term horizon as a key differentiator in our approach.”
However, Old Mutual Global Investors’ head of Asian equities, Josh Crabb said investors needed to be selective when it came to stocks and not pay fancy multiples for the dominant players in the area.
“Look at lesser known names such as Primax Electronics and Advanced Wireless Semiconductor,” Crabb said.
“While the notable feature of the latest correction is that the chasm between growth and value stocks remains wide, the fall-out is a timely reminder that investors need to be certain of earnings forecasts and, where possible, look for companies with some asset backing.”