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A-share inclusion to erode EM equity differentiation

AXA Investment Managers and M&G Investments recently echoed these views and said passive funds in particular are likely to lose distinction as they all realign their portfolios to include A-shares. 

 A-share inclusion would have a “knock-on effect for the passive investment industry”, said Matthew Vaight, global and Asian emerging markets fund manager at M&G.

 “Over time, China will most likely come to represent a significant portion of the emerging markets universe – possibly up to 40%. This would certainly present problems for diversification,” Vaight said.

 “Arguably, it would also distort the nature of emerging market funds and blur the line with Asia-focused funds. Buyers of emerging market ETFs and index products could in theory end up owning very China-centric products.”

 Mark Tinker, head of AXA Framlington in Asia, is also concerned about undifferentiated products.

 “The inclusion of China A-shares into the emerging markets index at a full weighting would present some real headaches for many investors, as it would end up accounting for almost half of the benchmark and, as some have pointed out, could lead to a significant overlap between pan-Asia, global emerging markets and China-only funds,” he wrote in his latest research note.  

 Last week, after its annual review, MSCI put off a decision to include China A‐shares in its global benchmark index until issues related to market accessibility are resolved. If certain criteria are met, the index provider said a fresh decision could come outside its annual review process.

 Possible index inclusion roadmap of China A-shares, as sourced from MSCI consultation:


 Passive vs active

A-share inclusion will impact passive funds, including ETFs and smart beta offerings from the index providers the most, Tinker added. These products are likely to face a “highly disruptive period”, as they will be forced to re-weight portfolios in accordance with index changes, leading to increased volatility, Tinker added.

 Active managers are likely to be less impacted as they tend to invest without strictly adhering to the benchmark.

 The opening of the Chinese market is good news for active investors, M&G’s Vaight said. 

 “It offers a huge number of potential investments that provide exposure to the domestic economy, which has been hard to obtain in the past. The range of companies in China is incredibly broad in terms of sectors, size, and most importantly, quality, or governance.”

 In order to identify the most promising investments and construct a diversified portfolio, a selective approach is essential, Vaight said.

FTSE moves, too

Apart from the MSCI, the FTSE Russell recently said it will launch two indices for emerging markets that will include China A-shares. The initial weighting of China A-shares in the new FTSE Emerging Markets China A Inclusion indices will be about 5% and is expected to increase to 32% when China A-shares are fully available to international investors.

 “This is a competitive space and that perhaps explains why MSCI have added that they may consider inclusion before their next scheduled review,” Tinker wrote.

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