China's A-Share Market: More Investable than Skeptics Think
China’s domestic A-share stock market grabbed global headlines in 2015 with its roller-coaster performance and frequent government intervention. “China’s stock markets have given investors a stomach-churning ride,” commented the Financial Times at the time.1 More than two years later, such impressions still linger but China’s A-share market has grown too large for investors to ignore. With US$8.5 trillion in market capitalization and more than 3,400 listed companies,2 China’s A-share market is the second-largest stock market in the world, behind only the U.S. market.3 In recognition of this, index provider MSCI recently decided to allow 222 of China’s large-capitalization domestic A-share stocks to be gradually included into its Emerging Market Index, starting in mid-2018. The inclusion of the A-share market is set to alter portfolio allocation strategies.
During conversations with investors, we often have found that their hesitation to invest in A-share companies stemmed from a perception of poor corporate governance. Is the A-share market really a jungle too difficult for investors to navigate? We would argue that it isn’t; however, investing in A-shares has its pitfalls. State-owned enterprises (SOEs), for example, accounted for over 60% of the CSI 300 Index weight and about 80% of total revenue in 2016.4 (China’s domestic CSI 300 Index tracks the largest A-share companies in Shanghai and Shenzhen.) SOEs historically have been poor capital allocators and SOE managers have been prone to putting government directives ahead of shareholder interests. This means a passive approach to investing in A-shares could lead to excessive exposure to SOEs in portfolios. Also, investor concerns remain about the possibility of poor disclosure and accounting standards among companies in the A-share market. Furthermore, retail investors tend to dominate the trading in the market, often leading to higher levels of volatility.
Seeing Investment Opportunities
Nevertheless, we believe China’s domestic A-share market provides attractive investment opportunities. It is important to recognize that the breadth and depth in the A-share market are much greater than those offered by offshore Chinese equities. Over 200 health care companies with a market-cap value of US$100 million or more are listed in the A-share market, for instance, while only about 80 companies are listed in offshore markets .5 Also, leading producers of Chinese distilled liquor—a market with sales of US$115 billion in 2015—are listed only in the A-share market.6
Overall, the A-share market opens more opportunities for global investors to take part in China’s dynamic economy that is taking shape as the country shifts away from exports and manufacturing and more toward innovation, consumer consumption and services. Non-domestic access to A-share stocks also has been improving. China’s regulators further opened the country’s capital markets by creating “Stock Connect,” a trading link that connects the Shanghai and Shenzhen stock exchanges to the Hong Kong Stock Exchange, enabling foreign investors to buy A-shares with fewer restrictions.
Next, we will explore the reasons we believe the A-share market has become more investable, including improved corporate governance and better disclosures, the ability of companies to create value for investors, company discipline around capital allocation and the fading role of state ownership in certain sectors.