(Quietly) China A-Shares Account for 11% of Global Market Cap
You are probably under-allocated to China A-shares. This may seem unintuitive at first glance. China A-shares—that is, stocks listed in the Shanghai or Shenzhen Stock Exchanges—make up 0.57% of MSCI ACWI. Why would anyone expend any mental energy on such a small allocation?
By contrast, China ADRs and H-shares, Red Chips, and P-Chips (which we call “HRP stocks” and are mainland Chinese stocks listed in Hong Kong) make up 2.53% of ACWI. In fact, a single P-Chip, Tencent, has a 0.44% weight in ACWI. Sweden has a 0.77% weight. And yet, I do not write long-winded articles about precisely what the allocations to Tencent or Sweden should be. But there are reasons you should focus more on China A-shares.
The first is that China A-shares has a 20% multiplier applied to its weight in MSCI ACWI. In other words, if it were included at its full float-adjusted market capitalization, its weight would be roughly 5 times higher at 2.9%. There was some sense to this multiplier before because A-shares were less easily accessible and more likely to be suspended from trading. However, because of the Hong Kong Connect Program, China A-shares are easily accessible, far easier than stock markets like India’s, for example. Moreover, while stocks can be suspended, the percentage of stocks that are suspended has dropped dramatically and currently stands at about 0.26%.
In other words, if you are allocating similarly to MSCI ACWI or MSCI Emerging Markets, then you are underweight China A-shares relative to its free float market capitalization for reasons that no longer hold particularly well.
But even that 2.53% weight does not do China A-shares justice. China A-shares is the second largest stock market either by total market capitalization (with $12.3 trillion compared to $48.8 trillion for the United States) or by float-adjusted market capitalization (with $5.4 trillion compared to $42.7 trillion for the United States). By total market capitalization, A-shares is 11.04% of global market cap. By float-adjusted market cap, it is 6.96%.
The only reason A-shares is not the second largest weight in global indices is the 20% weight multiplier and the fact that China A-shares has a long tail of stocks from large cap to small cap. China A-shares has 4,714 stocks compared to 1,329 mainland Chinese stocks listed in Hong Kong and 239 listed in the United States.
But why not just invest in mainland Chinese stocks listed in Hong Kong or the US? The short is answer is China A-shares is far more diversified from an industry perspective, acts as a better diversifier from a covariance perspective in a global portfolio, and has a massive amount of alpha to be captured. Moreover, offshore China is far more subject to regulatory risks. We have discussed these last two points in prior articles, so we will discuss the first two here.
“Investing in China” versus “Investing in China A-Shares”
If you were to say you invest in Chinese stocks, that could mean many things. It could mean that you invest in China ADRs like Netease or Baidu—that is, Chinese firms with depository receipts in the United States. It could mean that you invest in those aforementioned HRP stocks, which are mainland Chinese stocks listed in Hong Kong like Tencent Holdings. Lastly, it could mean that you invest in China A-shares—equities listed in Shanghai, Shenzhen, and now Beijing. I will ignore the comparatively few and increasingly illiquid China B-shares, which are listed in Shanghai or Shenzhen, but are investable outside China.
Despite all being Chinese stocks, these different exchanges list very different types of firms. ADRs and HRP stocks are disproportionately more likely to be consumer tech firms. They also tend to be fewer but larger, while China A-shares are multitudinous but smaller cap. China A-shares have historically been less efficiently priced, probably in part due to the high level of retail trading.
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Industry Allocation
These differences matter. Retail firms and specifically tech retail firms are heavily represented in ADRs and HRP. Collectively, China ADRs and HRP stocks are called “Offshore China.” The largest offshore China stocks are Tencent, Alibaba, and Meituan. Tencent Holdings is a tech and entertainment conglomerate. Alibaba is a large online retailer. And Meituan is an online delivery platform. They are all consumer tech. In fact, the top 10 largest offshore China stocks are either consumer tech firms or financial firms.
But what of the largest A-share stocks? They are Kweichow Moutai, a distiller; Contemporary Amperex, a battery manufacturer; China Merchants Bank, a bank; Wuliangye Yibin, another distiller; and China Yangtze, a utility. China A-shares in general are far more diverse with weights more equally distributed across industries.
Diversification
We already discussed how China A-shares are more diversified from an industry perspective, but I want to discuss a different the more traditional type of diversification—return correlation. If you already hold a portfolio of US stocks, developed ex US stocks, or EM ex China stocks, you can get a massive diversification benefit from investing in China A-shares.
The correlation between US stocks and China A-shares is 0.39. For comparison, that is nearly identical to the correlation between US stocks and US corporate bonds. The China A-shares correlation with US stocks is lower than any other large market’s correlation with US stocks.
Accessing China A-Shares
We have made the case that the China A-shares market is massively underrepresented in popular indices, that it is more diversified on an industry level than offshore China, and that it provides greater return diversification for a global investor. But how does one get access to China A-shares?
One option is to apply for a qualified foreign institutional investor (QFII) quota, but I imagine this is not particularly compelling if you want to invest in public equities. Alternatively, you can buy stocks through Hong Kong Stock Connect as long as your broker supports it.
But for most, this is too effortful. Unless you have truly substantial sums of money and an eye for alpha opportunities in the middle kingdom, using a less labor-intensive approach is likely sensible. ETFs and mutual funds are likely more accessible for most investors.
Whatever approach you take to gaining A-share exposure, a truly diversified portfolio likely holds some China A-shares and more than is found in most indices.
Clinic Physician at between positions
1 年I usually prefer not to support anything Chinese. Their governors are fascist pigs, serious evil intentions IMHO. However, if handled right, maybe they can be reformed over the next 30 years.
Group CFO | Corporate Finance | Ex-Founder | China / APAC | INSEAD | MFin, MSc, CFA, CMA, FMVA, BIDA
2 年Very insightful, thanks for sharing.
Business Development and Accounts Director, Arro Financial Communications
2 年Thanks Jason! I always learn something new and interesting from your posts!
Investment and Software Developer
2 年Which ETF should we buy? If China companies are delisted in US, will the ETF becomes worthless?
The China Guys 联合创始人 | 协助西方企业更顺利进入中国市场
2 年A very well-spoken argument, thanks for sharing ??