Where next for China A-shares?

China’s domestic stock market is on the rise and we think it represents a potentially very attractive long term opportunity for investors.

There is a striking disparity between China’s share of global economic growth and its share of the global stockmarket index. Chinese stocks currently represent just 3.8% of the MSCI All-Country World Index, while China’s share of global GDP is 16%.

With the market opening up to foreign investors, and given MSCI’s recent decision to include China A-shares into its global indices, we expect China’s representation in global portfolios to increase significantly over the coming years..

How investors access Chinese shares

Investors can access Chinese equities through a variety of channels:

• The companies quoted in Hong Kong (H-shares, red chips and P-chips)
• The depository receipts quoted on the NASDAQ exchange in the US (these are called American Depositary Receipts and enable access to the likes of tech giants Alibaba or Baidu)
• The on-shore domestic market (A-shares).

There is still important progress to be made in A-shares, with the on-shore market only recently opening up to international investors through the Shanghai-Hong Kong (2014) and Shenzhen-Hong Kong (2016) Stock Connect programmes.  

These programmes allow foreign investors to access domestic Chinese equities (A-shares) through the Hong Kong Stock Exchange. However, only 3% of investors in the domestic market are foreigners.

Retail investor dominance

The A-shares market remains dominated by domestic retail investors who make up 86% of daily trading volume, compared to 35% for the Hong Kong market.

This high proportion of retail investors contributes to the higher volatility of the market relative to more developed exchanges. This is because retail investors typically have shorter investment time horizons and respond more to market events, resulting in more buying and selling of shares and higher market volatility.

That said, the market is attractive for active fund managers who can take advantage of the inefficiencies in the market. Looking across the board, the median China A-shares fund manager has outperformed the MSCI China A Onshore benchmark in four of the last five years.

Market shifts

Over the last few years, investor interest has shifted from "old" China (infrastructure, banks, telecoms) to a greater focus on consumer (staples, food & beverages) and so-called "new economy" stocks (healthcare, consumer discretionary, IT).

This is because the driving force behind Chinese growth is increasingly based on the consumer. We expect this shift to continue.  

Another theme we’ve been seeing in China is the push towards automation, given the need for China to improve productivity. This move is also consistent with the need to produce goods with better quality, and to become more self reliant in terms of technological capability.

The A-shares market remains very well balanced in terms of sectors, especially when compared to Hong Kong where technology, banks and commodities still dominate the index. This means it is possible to manage a more diversified portfolio on the A-shares market.

Meanwhile, inflows to the market have been strong since the start of the year, despite constant headlines around US-China trade tensions.

It’s also worth noting that the Chinese market has a low correlation to the other global markets, which can provide diversification benefits. But investors need to remember that this is still an emerging market, with a higher level of volatility.

Which sectors in China A-shares are of interest?

At the moment, we continue to see a number of potentially attractive investment opportunities in the Chinese market

One of the sectors we are especially interested in is healthcare. There has been a strong trend towards the outsourcing of manufacturing and research & development of drugs by pharmaceutical companies. We expect firms operating in this area to become more prevalent going forward.

Elsewhere, while we remain cautious on real estate companies, insurance companies are of interest to us due to the level of penetration of insurance products in China, which remains low.

Corporate governance catch-up

Finally, from a corporate governance perspective, in many cases companies are still catching up, in terms of the standards generally seen in more developed markets. However, the trend is definitely positive and we think the level of domestic ESG (Environmental Social and Governance) standards will improve going forward, with increased engagement from institutional investors.

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The views and opinions contained herein are those of the author and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.