MSCI China move will ‘change the face’ of emerging markets

The stocks of some of China’s biggest companies are set to join a key global index by the close Thursday, giving ordinary U.S. investors greater access to mainland China.

More than $1.9 trillion in assets is benchmarked to MSCI’s Emerging Markets index, which is tracked by the EEM ETF. The index has so far excluded hard-to-access mainland Chinese-traded stocks known as A shares and only includes Chinese stocks traded in Hong Kong or the U.S.

But by Thursday’s close, around 230 of the A shares are scheduled to be included, kicking off a process that could eventually give A shares 16 percent allocation in the MSCI Emerging Markets Index and China a 42 percent weighting.

“This is a really important event that could change the face of EM investing,” Sebastien Lieblich, global head of index management research for MSCI, said in a call with media Thursday morning New York time.

Emerging markets includes countries such as China, India and Brazil that tend to be growing rapidly towards a developed economy. For U.S. investors looking to invest in those foreign stock markets, U.S.-traded ETFs such as BlackRock’s iShares MSCI Emerging Markets ETF (EEM) can offer access.

According to MSCI’s April 23 provisional index, Chinese stocks up for addition to the index include: BYD, an electric automaker that Warren Buffett has invested in; SAIC Motor, a major automaker with a joint venture with General Motors; Kweichow Moutai, manufacturer of a popular Chinese liquor with 53 percent alcohol; major Chinese oil producer PetroChina and China Construction Bank.

MSCI announced Wednesday that five Chinese stocks, including ZTE, will not be added. Trading in shares of the telecom equipment giant has been halted since the U.S. in April banned American companies from selling components to ZTE for seven years.

For Beijing, getting some of its mainland stocks added to a major global index is a major step towards its goal of opening up domestic markets to foreign investment.

MSCI decided against adding the A shares for three years due to issues such as foreign market access and trading suspensions. Last June, the index company finally decided that China had made enough improvements, particularly by expanding a stock connect program to link Hong Kong’s markets with that in Shenzhen as well as Shanghai.

Due to daily trading limits on the Stock Connect program, MSCI said it will add the A shares in two phases.

Thursday’s A share inclusion will add just 2.5 percent of the market capitalization of the 230 A shares. Another 2.5 percent is set for addition to the index in August, raising China’s weighting in the overall index by 0.8 percent to about 31 percent.

That should result in $22 billion in inflows to Chinese A shares, Goldman Sachs analysts estimated in a Tuesday note.

However, other estimates point to a more limited immediate impact.

Morgan Stanley analysts estimated in a May 15 report that Thursday’s inclusion should result in just a $1.7 billion passive fund flow. The second phase of inclusion set for August should result in another $1.7 billion, the report said.

The total $3 billion to $3.5 billion represents about 0.9 percent of the total free float market cap for A share markets, the analysts said.

KraneShares Bosera MSCI China A ETF (KBA), which seeks to track the A shares set for inclusion, traded more than 1 percent higher Thursday afternoon. EEM itself has struggled this year, falling about 3 percent. But it is up 10 percent over the last 12 months and has $37.7 billion in assets.

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