MSCI China Inclusion: The Road To $430 Billion In Inflows

Earlier this evening, MSCI (finally) gave China the thumbs up with regard to the inclusion of A shares in benchmark indices.

The yuan got a quick boost from the news and while we noted that “this might not be very momentous given the ‘watered down’ character of MSCI’s plan,” it’s nevertheless welcome news for Beijing who will take all the inflows they can get.

It’s also worth noting that China’s locally-traded shares will comprise 0.7% of MSCI’s global EM gauge, with 222 companies included – that’s more than the initial expectation of a 0.5% weight on 169 names.

Since the decision, we’ve gotten the following headlines:

  • MSCI is “very focused” on adding China’s mid-cap stocks to its indexes on the next inclusion, CEO Henry Fernandez says on Bloomberg TV.
  • Next time will probably see a larger inclusion factor; current A share weighting was smaller than Fernandez would have liked
  • MSCI decided on taking 2-step process for the A share inclusion due to daily limits on stock link programs between Hong Kong and China
  • CSRC Vice Chairman Fang Xinghai played a “very strong” role in getting A shares included

According to UBS, MSCI index inclusion should mean somewhere between $8 billion and $10 billion more in fund flows to China’s A shares.

“Over the long term, assuming further liberalization and regulatory reform of the mainland stock markets, the depth of China’s A-share market could mean China gains substantial weight within those broader indices,” Nick Beecroft, an Asian equity portfolio specialist at T. Rowe Price quoted by Bloomberg says.

For their part, MSCI sees $30 billion to $35 billion in inflows if 450 names are eventually included. As you’ll read below, the end game (full inclusion) could see inflows reach nearly a half trillion across mandates.

The near-term question is what this will mean for the yuan. Below, find Goldman’s quick take ahead of the overnight session…

Via Goldman

While MSCI’s inclusion of China’s A-shares is positive overall for sentiment, we do not expect this to translate into significant sustained appreciation pressure on the CNY given limited implications for initial flows.

Main points:
In line with our portfolio strategy team’s expectations, the MSCI announced today that China’s domestic A-shares will be included in the MSCI equity index. Our portfolio strategy colleagues estimate around US$18bn of potential inflows to onshore equities due to index inclusion over the coming year. This is quite modest compared to the recent pace of FX outflows (at around $20bn in May and an average of around $15bn per month over the last few months).

As such, inclusion is unlikely to result in a significant shift in the underlying flow picture, in our view. While short-term sentiment could be favorable, over the longer term we continue to expect the CNY to move in a managed path, gravitating gradually towards a weaker level against the USD due to fundamental forces (e.g. a divergent China-US monetary policy outlook, diversification needs of Chinese residents). We maintain our 12-month $/CNY forecast of 7.20.

And here’s a bit more detail from Goldman’s team on the longer-term outlook…

Via Goldman

After four consecutive years of consultation, MSCI has decided to add A-shares to its benchmarks, as part of its 2017 Annual Market Classification Review announced on June 21 HKT. Implementation will be done in two stages: in May and Aug 2018.

Key facts to note

  • Universe? 222 A-shares in the MSCI China A Large Cap Index with a total market cap of US$696bn, all tradable via (R)QFII schemes and Connect.
  • To what indexes? All standard country and regional indexes, including MSCI China, MSCI AC Asia, MSCI APxJ, MSCI EM, and MSCI All Country World.
  • Inclusion factor (IF)? 5%. It means that only 5% of the index market cap of the 222 A shares (i.e. 5% of US$696bn) will be added to the universe.
  • Index weight: We estimate China A will account for 2.6%/0.7%/0.7%/0.1% of MSCI China/APxJ/EM/ACWI after Aug 2018, and ‘China’ (A+H+ADRs) will represent 26%/28%/3% of APxJ/EM/ACWI, based on June 19 price.
  • Flows: We estimate about US$12bn of net buying from EM funds for the 222 A shares, equivalent to one day of turnover (@ 100% ADT).

Flows

  • Impacts on others: In Asia/EM, Korea, Taiwan, and India could see the largest dilution in index weights, but selling pressures are likely to be modest (~1d).

Our views and strategy

  • A surprise? Maybe not for foreign investors (US$4bn/270mn of Northbound/ETF inflows since May) but the universe is slightly larger than originally proposed.
  • Market reactions: Mixed results historically for other markets, but we like China A on its favorable growth/valuation/sentiment profile.
  • Looking ahead: China A could account for 9%/1% in EM/ACWI in the next five years and bring in about US$230bn of index flows. Cumulative flows could reach US$430bn on full inclusion across mandates.
  • Ideas: (1) Flow intermediaries (brokers and exchanges); in the 222 stock universe: (2) 21 GS Buy-rated names; (3) stocks with the highest number of days of buying; (4) ‘foreign favorites’.

GSChina

Flowslong

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