ETF Securities launches first ETF on MSCI China A with physical replication on Euronext Paris
ETF Securities partnered with E Fund, one of China’s largest asset management companies, to launch Europe’s first physically replicated UCITS exchange traded fund (ETF) tracking the MSCI China A Index. ”ETFS-E Fund MSCI China A GO UCITS ETF” is denominated in EUR and listed on Euronext Paris as of today. ETF Securities launches first ETF on MSCI China A with physical replication on Euronext Paris
This ETF can serve as a tool in a strategic asset allocation; and can also allow investors to gain a tactical exposure to A shares where valuations are still very attractive.
The MSCI China A Index has the broadest and most comprehensive A share stock coverage, with strong historical outperformance compared to other A share benchmarks. Henri Boua, Associate Director for France and Monaco said: “ETFS-E Fund MSCI China A GO UCITS ETF aims to track the performance of the MSCI China A Index that comprises over 460 Chinese stocks and provides more diversified sector coverage than other China A indices which typically have a high concentration in fewer sectors and stocks.”
“ETF Securities is delighted to be working on this product with E Fund, the second largest RQFII Quota holder with approximately RMB27 billion. As one of China’s top asset managers, they have extensive experience in the industry, having previously launched China A Share ETFs in China.”
ETF Securities celebrates the launch of the first physical UCITS ETF to track the MSCI China A Index. The ETF gives investors cost efficient exposure to local Chinese stocks listed on the Shanghai and Shenzhen stock exchanges.
ETF Securities, a provider of exchange-traded investment products and a pioneer in exchange-traded commodities, is dedicated to develop liquid, transparent investment solutions that can be traded on world stock exchanges. ETF Securities listed the world’s first gold exchange-traded commodity in 2003, and many other market-leading investment solutions have since followed. Head of Benelux at ETF Securities, Philippe Roset, sounds the gong.
MSCI Annual Market Classification Review . MSCI announced today that China A-shares will not be included in the MSCI Emerging Markets Index as part of the 2014 Annual Market Classification Review, but will remain on the review list as part of the 2015 Review.
This is one of the three potential outcomes (option three) we pointed out in our recent report “Including China A shares in MSCI EM index: is it the time?”. As we explained in that report, while China has made significant progress in opening up its capital market, the three obstacles still exist and no major progress has been made.
We notice that there have been promises that some of these issues will be resolved soon (at least partially), but MSCI’s decision may not be based on the expectation of the future developments. In addition, based on our conversations with fund managers, they still feel it is quite difficult to manage funds including China A shares. Postponing the decision to next annual market classification review in 2015 will give China more time to further open up, which will bolster the case for MSCI inclusion. This will also give enough time for MSCI and the investment community to fully analyze the situation, and prepare for the inclusion.
On the other hand, MSCI acknowledged that “the A share market is effectively opening as we speak” because many investors are already investing in the China A-shares and the quota granted has increased significantly. MSCI also highlighted further regulatory reforms and other changes expected in the near term, such as implementation of the Shanghai/Hong Kong Stock Connect program (expected in October 2014). Therefore, we believe an off-cycle review (for example in December 2014) is still possible (the option two in the report mentioned above).
In addition, MSCI will introduce by June 27, 2014, the MSCI China A International Index as a standalone index. This index and its regional and global combinations can be used as benchmarks by QFII and RQFII investors to complement the already extensive series of MSCI China A Indexes.
MSCI also announced that it will not promote Korea and Taiwan to Developed Markets index. This is consistent with what we expected in our earlier report. Furthermore, MSCI will remove these two countries from the review list for potential reclassification for 2015, due to the absence of significant improvements in key accessibility areas for the past few years. Both countries may be added back to the review list as soon as there will be meaningful improvements.
MSCI will announce its annual market classification review results on June 11
MSCI announced in June 2013 that it included China A shares in the review list for potential inclusion to its Emerging Markets (EM) index, which currently include only some of the Chinese shares listed overseas and B-shares listed in China. In March 2014, MSCI initiated a consultation on a proposed roadmap for inclusion of China A shares. MSCI will announce its decision in the morning of June 11, 2014 (Hong Kong time). If MSCI decides to include China A shares, the first change will be implemented in May 2015. In addition, Korea and Taiwan are also in the review list to be promoted from EM to DM.
A small step, but an important milestone in opening up China’s equity market
MSCI proposes to include 5% of China A shares’ float market cap as the first step (60 bps in MSCI EM, and 2.9% in MSCI China). China’s country weight will increase from currently 19% to approximately 20%. While this is a very small step, it is the first time China A shares included in a global benchmark.
China has made significant progress in market liberalization
The pace of reform and market liberalization in China has been accelerating in the past 12 months. A number of key changes (MSCI roadmap, RQFII expansion to Paris, Shanghai/Hong Kong Connect, “New National Nine Rules”, etc.) announced in the past 3 months. The timing and magnitude of these changes exceed the expectations of many investors.
Three possible outcomes from MSCI’s annual market classification review.
While China has made significant progress in opening up its capital market, obstacles still exist. We see three possible outcomes from this review. The first is that MSCI will confirm the proposed roadmap to include China A shares in May 2015. MSCI may also continue to exclude China A share at this time, and will review it again in the next review in June 2015 (then the implementation will be in May 2016). Another option is to postpone the decision to December this year for implementation in November 2015. Our view is all three outcomes are likely, but the last one is a better solution.
Index inclusion may act as a positive catalyst to the A share market
China’s equity market has been under pressure recently. Year to date, CSI300 and FTSE China A50 have been down 8.4% and 6.1% respectively. Inclusion of China A shares in MSCI or other major benchmarks could improve the sentiment and provide significant support for the market going forward. We estimate the proposed 5% inclusion could potential attract over $7bn inflow to China A shares. Other benefits include shift in investor base toward long-term institutional investors, and a boost in liquidity in equity markets.
Korea and Taiwan are unlikely to be upgraded to DM in MSCI.
We believe the most likely scenario is that MSCI will maintain these two countries in the EM index at this review, while we cannot completely rule out the possibility of an upgrade given the subjective nature of the assessment
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CHINA AT AN INFLECTION POINT. We are pleased to introduce the inaugural issue of the China Macro Monitor. This publication is a new regular report focusing on macro developments in China relevant to investors across asset classes and markets. The report will focus on recent developments as well as take periodic deep dives into areas that may affect macro and market conditions going forward.
In this first report we outline our base case macro scenario for China and summarise significant recent developments.
We believe China’s economy has bottomed and growth will rebound in H2 2014. After experiencing a modest slowdown in H1 2014, we anticipate growth will recover in H2 2014 as financial easing, fiscal stimulus and improving global growth boost the economy.
China will see an increase in defaults and bankruptcies in 2014. However, this is part of a deliberate move by the government to increase the role of the market in allocating capital, not a harbinger of financial crisis as some commentators have postulated.
China A shares present good long term value at current levels. China A shares are trading at very low valuations relative to history and relative to most other major global equity benchmarks. We believe the China local equity markets have found a bottom together with the economy and present good long term value at current levels.
CHINA OUTLOOK 2014
China’s GDP rose by 7.7% in 2013, making it one of the fastest growing economies in the world. While the economy has been stronger than many analysts expected, China’s growth rate has slowed from the 10%-12% growth rates of the 2009-10 period to what we would argue is a much healthier and sustainable 7%- 8% range. The slowdown in growth has occurred as a consequence of policy tightening put in place by the government in 2011 to reduce speculative lending by non-bank financial institutions (“shadow banks”) and overinvestment stemming from the government’s aggressive easing of monetary controls following the 2008 global financial crisis.
Currently, monetary policy is being targeted to keep economic growth high enough to maintain full employment (7% GDP growth is generally considered the lower limit), but tight enough to rein in speculative credit activity and prevent destabilising asset bubbles from forming. With GDP growth slowing to 7.4% in 1Q 2014 and inflation well below target, the bulk of stimulus is currently focused on fiscal policy.
A new stimulus program
In early April the government announced measures to stimulate growth, accelerating infrastructure investment programs, including stepped-up spending on regional railways and low cost housing. It also extended preferential tax policies on small businesses.
Further measures are likely to be announced in the coming months, potentially including policies to further open up domestic markets to foreign investors, policies to deepen bond and other domestic financial markets, and stepped-up restructuring of state-owned enterprises.
Accelerated urbanisation
While government spending has played a central role in boosting growth since the global financial crisis, private consumption and private sector-led investment is expected to play an increasingly important role over the next decade. A key focus of the government’s five year plan unveiled at the government’s 3rd Party Plenum last November, is the reform of the state-owned sector, with an emphasis on unleashing productivity gains from private sector-led growth. Stepped-up urbanisation programs are expected to boost both productivity and private consumption by bringing more labour into urban services sectors.
Financial liberalisation to boost productivity
Another key prong to the reform plan announced last November is accelerated financial liberalisation. In March the People’s Bank of China widened the daily trading band of the Chinese Renminbi in order to increase two-way risk in the currency and allow it to more accurately reflect market forces. However, with foreign exchange reserves rising to nearly US$4 trillion at the end of March, and the country continuing to run current account surpluses, further medium-term appreciation of the currency seems likely. As part of its move to increase the importance of markets in allocating resources, the central bank has also allowed greater volatility in short-term interest rates and has indicated that it plans to gradually liberalise bank deposit rates over the next two years.
Real estate market to weaken but defaults will be contained
While recent defaults by Chinese corporates and wealth management products have had a negative impact on investor sentiment, we believe these controlled defaults and bankruptcies – by introducing risk into financial markets – are a critical part of the government’s move to increase the role of market forces in allocating resources.
Of course there is always a risk that defaults do not remain under control and that contagion and panic cause a systemic financial crisis. Local government debts are large and there has been substantial misallocation of capital over many years that means banks are sitting on a large number of loans that are unlikely to be paid back.
The government is explicitly trying to cool down an overheated property market – particularly in second and third tier cities. This also will likely add pressure on banks and local governments’ balance sheets. These are risks the government will have to manage carefully to limit contagion and prevent individual instances of bankruptcy and default turning into wider financial and economic dislocation.
Government has substantial resources at its disposal
The central government, however, has substantial resources available to it that should ensure a systemic crisis will be avoided. The government has a small debt burden (around 23% of GDP) and only a small portion of this is foreign debt.
Unlike a number of European countries in the 2008-10 global financial crisis, China has the fiscal resources to support its economy if necessary. In addition, with nearly US$4 trillion in foreign exchange reserves at its disposal, the balance of payments is well protected and there are substantial funds available if financial conditions deteriorate. Therefore, while China is moving into unchartered territory as it liberalises its markets and moves to a more market-based system, it goes into this process with policy-makers well aware of the risks and very well-armed with the fiscal and financial resources to ensure the transition does not disrupt the country’s growth path.
China A shares trading on lowest PE since 2008
The China A share market, as measured by the MSCI China A Index, is currently trading on a price-to-earnings ratio of around 10.8X current earnings at 9X forward earnings, making it the cheapest it’s been since the worst part of the 2008 global financial crisis and one of the cheapest markets in the world. Assuming China is able to manage its current transition period without any substantial policy mistakes, and real GDP growth stabilises in the 7%-8% range as we expect, in our view China equities currently present good value for long-term investors.
