MSCI MSCI Inc

By Asjylyn Loder 

Investors are about to buy billions of dollars in mainland Chinese stocks even as trade tensions whipsaw markets.

Two of the largest global index providers, MSCI Inc. and FTSE Russell, will soon begin ratcheting up exposure to companies listed on China's domestic exchanges. The increases will force asset managers to purchase shares of Chinese companies to match their changing benchmark.

MSCI will begin raising the weight of mainland China stocks, called "A shares," in several of its indexes later this month. It is the first of three increases that will quadruple the weight of A shares in the MSCI Emerging Markets Index to 3.3% by the end of the year. The index is tracked by about $1.9 trillion in assets from pensions, endowments, passive funds and other investors, meaning about $50 billion in new money could be chasing China A shares from that index alone. FTSE Russell will begin adding A shares to its indexes next month.

As a result of the changes, investors in index mutual funds and exchange-traded funds will soon have even more of their money invested in China. The country is already the largest slice of both FTSE Russell's and MSCI's emerging-markets indexes, accounting for more than 30% of the portfolios. The exposure is being ramped up even as the U.S. and China engage in a tit-for-tat trade battle that has unsettled stock markets in both countries.

The expansion of index investing marks a new phase in China's decadeslong effort to open up its markets to more foreign investment. China earned a spot in the benchmarks after regulators made progress at allaying concerns about market access and ease of trading.

China A shares are yuan-denominated shares of Chinese companies listed on mainland Chinese stock exchanges. The indexes already included other types of Chinese shares, such as Hong Kong-listed stocks and depositary receipts that trade in U.S. markets.

The A-shares market was opened up to investors beginning in 2003. But it was limited to qualified institutions and subject to certain rules, including restrictions that made it hard to move money out of China. These limitations were a concern for mutual fund and ETF managers, who must be able to meet daily buy and sell orders from shareholders.

"China has made a lot of concessions and developments in their market that has made it more transparent and better regulated," said Luke Oliver, head of U.S. ETF capital markets for DWS Group, the asset-management business of Deutsche Bank AG and the first to offer an A-shares ETF.

But government intervention and limited transparency in China's markets may limit any future expansion of A-shares investing. One concern is caps on foreign ownership of Chinese companies, said Joti Rana, FTSE Russell's head of governance and policy for the Americas.

MSCI has also identified several problems that will have to be addressed, said Chin Ping Chia, a Hong Kong-based managing director of research with MSCI. The barriers include timing differences for trade settlement, Hong Kong holidays that prevent overseas investors from accessing mainland markets even when trading is open, and the inability of non-Chinese investors to take advantage of derivatives used to hedge their exposure, like stock-index futures and options.

Critics say the increase of index investing in China leaves investors increasingly vulnerable to price swings in a single, volatile market, said Steven Schoenfeld, founder and chief investment officer of BlueStar indexes, which focuses on Israeli and other Middle Eastern markets. The benchmark Shanghai Composite Index tumbled almost 25% in 2018, though it has rebounded this year.

"When a single country is a third or more of the index, and the top five countries are two-thirds of the index, you're giving up the diversification benefit of a broad index, which is part of the rationale of being in an index strategy in the first place," Mr. Schoenfeld said.

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Vivian Salama contributed to this article.

Write to Asjylyn Loder at asjylyn.loder@wsj.com

(END) Dow Jones Newswires

May 16, 2019 07:44 ET (11:44 GMT)

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