China A-Shares diversifying emerging markets investment universe, but with higher volatility

30 Jan 2019

The inclusion of China A-Shares in major indices will materially increase investment opportunities for active fund managers, according to Zenith. China A-Shares are a class of stocks listed on two Chinese stock exchanges (Shanghai and Shenzen) that provide a more open channel for foreign investors to access Chinese listed companies. Furthermore, the Chinese stock market offers significant depth in a number of different sectors that are not well represented in broader international equities indices.

In mid-2018 China A-Shares were included in the MSCI Emerging Markets and All Country World indices, a move that was well-received by global investors seeking improved access to Chinese stocks. Zenith believes the inclusion in mainstream international equities benchmarks will likely result in increased broker research and greater liquidity.

Thushani De Silva, Zenith Investment Analyst said, “As more China A-Shares are introduced, the composition of the emerging market index will change with increased exposure to sectors such as financials, industrials and real estate. This will give rise to more opportunities for active managers to diversify their portfolios and enhance performance outcomes.”

Zenith’s rated emerging markets fund managers have increased their average exposure to China from 18% to 22% over the past 12 months, with A-Shares exposure doubling from 2% to 4%. 

Although China A-Shares offer attractive investment opportunities, Zenith notes that it also comes with higher risk. The volatility (as measured by standard deviation) of China A-Shares (represented by Shanghai Shenzen CSI 300 Index) was significantly higher than that of the MSCI Emerging Markets Index (25% p.a. versus 10% p.a.) over five years to December 2018.   

Zenith believes the higher volatility of the China A-Share market is a direct result of its high retail investor participation, estimated at approximately 80% by Bloomberg. Retail investors generally have a shorter time horizon compared to institutional investors, increasing the likelihood of shorter-term trading of stocks, thereby increasing volatility.