June 22, 2017—What did MSCI decide?

MSCI, the principal international equity benchmark index provider, has decided for the first time to include some Chinese “A” shares in its emerging markets (EM) index. The decision goes into effect June 2018.

“A” shares are listed on the Shanghai and Shenzen stock exchanges. Historically, the EM index has included only those Chinese stocks listed on the Hong Kong exchange or which have ADRs traded in the United States. Accessibility, liquidity, transparency, and currency convertibility have all been issues that have prevented the inclusion of “A” shares.

MSCI decided to include only those “A” shares accessible to international investors through the “Stock Connect” system between China and Hong Kong. Inclusion is scaled to the daily limits on trading volumes through the “Stock Connect” system.

MSCI decided to exclude small- and mid-cap stocks as well as those subject to trading suspensions. These exclusions should help to shield the EM index from Chinese A-share volatility. 

Why are the consequences of the MSCI decision?

 The MSCI EM index forms the basis for most market-cap-weighted emerging markets equity ETFs and passive funds. Many billions of dollars will flow into the EM index as a result of this decision. In addition, active EM equity managers are more likely to view “A” shares as within their eligible universe.

The decision immediately results in the addition of some 222 Chinese “A” shares to the EM index. This decision will increase the Chinese weight in the index from the current 26.7% to approximately 27.4%. The next largest weights in the index are South Korea at 15.4%, Taiwan at 12.1%, and India at 9.8%.

While today’s MSCI action may seem limited and incremental, it potentially opens the path toward much greater Chinese weight in EM ETFs and passive funds. If limits on Stock Connect trading volumes are substantially increased, or are eliminated altogether, MSCI will add even more Chinese “A” shares to the EM index. Eventually, the Chinese weight in market-cap-weighted ETFs would exceed 30% and may even reach 35%.

Core narrative

We are currently overweight emerging markets equities. Our positive view is informed by the progress of economies and equity markets in the broader Asia ex-Japan region, including China. Of course, we continue to monitor Chinese economic, political, and equity market developments, to ensure that our overweight remains justified.

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