Evolving markets and indexes hold important implications for investors of China.
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China is rapidly changing across a number of dimensions, from economics and demographics to the very definition of “China”—at least as global index providers define the country.
Many benchmark providers are considering adding A-shares and other share classes of Chinese equity to their global indexes. They also are creating new benchmarks that underlie index-tracking exchange-traded funds and mutual funds, as well as for use by active managers, to better reflect the rapidly evolving opportunity set available in China’s markets.
For investors, these changes will have major ramifications. Chinese A-shares are companies listed on mainland exchanges, and their inclusion in emerging-markets and global benchmarks will alter these indexes’ risk/return profiles. They will also achieve some degree of diversification benefit, as onshore and offshore Chinese equities have historically exhibited low correlation. Investors also will need to be mindful of the costs stemming from these transitions; the premiums and discounts within the ETFs; and the nuances of benchmark construction.
In this article, we will explore these important changes taking place in Chinese equity markets and in the indexes and ETFs that track them.
What Is ‘China’?
The very definition of “Chinese equity” is being altered, and the definition will continue to evolve in coming years in different ways, based on the varying interpretations of index providers. Staying on top of these changes will be paramount for investors looking to achieve exposure to Chinese equities via an index-tracking ETF or mutual fund.
China A-shares are companies listed onshore either on the Shanghai or Shenzhen stock exchanges. Historically, foreigners had very limited access to these shares because China has a “mostly closed” capital account—meaning that investors, as well as companies and banks, could not move money in and out of the country except in accordance with strict rules.
But China gradually is opening up its market. Foreign institutional investors now can gain access to China’s onshore market via a Qualified Foreign Institutional Investor (QFII) or Renminbi Qualified Foreign Institutional Investor (RQFII) license. License holders have to go through an approval process and are granted a quota, which they can use to invest in Chinese securities. Foreign investors can also purchase certain Shanghai-listed stocks on the Hong Kong Stock Exchange under the new Shanghai-Hong Kong Stock Connect program.