China’s place in the Emerging Market Club

Last week saw the resolution of a long-running saga in the emerging markets investment community: the inclusion of China’s restricted main market ‘A-shares’ in the MSCI Emerging Markets index.

The decision was watched very carefully by active and passive investors alike. For passive EM funds, the MSCI EM index is the most significant globally by far, with around $1.7 trillion of indexed investment. For active investors, any change in the weighting of the index (which they are benchmarked against) forces them to reassess the composition of their portfolios. After the recent 12-month rally, China’s equity market (which is worth around $10 trillion) is now the second largest in the world after the US.

Although China’s A-share remains on course to be accepted onto the EM index, the MSCI is holding off for the time being. The index provider says it needs assurance from authorities that foreign investment quotas are transparent and predictable, and also that there is enough liquidity, capital mobility as well as a defined account ownership structure in its new StockConnect programme.

MSCI will revisit the topic in May 2017; the focus for now is on how investors plan to allocate assets to China as part of the broader market opening.

A recent FT piece made an interesting point — if all A-shares were to be included at their full weighting, China would take up 43.6 per cent of the emerging markets index. This is a good illustration of China’s importance to the emerging world, although there are profound practical implications for fund managers looking for diversified exposure to global EMs.

Speculation in the press is already mounting over the likely emergence of a spate of “EM ex-China” funds.