Adding more exposure to China A-shares in global portfolios will help investors be better diversified and well-placed to capture the expected outsized alpha from the domestic economy in the years ahead.
The performance figures say it all. In the five years to the end of March 2021, for example, Schroders highlighted that the median A-shares manager has outperformed its benchmark by 10.4% per annum.
“Besides the significant alpha opportunities, the A-shares market could be an important addition to global equity portfolios because of its diversification benefits,” said Kristjan Mee, strategist, research and analytics, at the UK asset manager.
For example, the MSCI China A-share Index has about half the correlation with global equities than the MSCI China Index. “This means that adding A-shares to global equity portfolios could help to reduce overall portfolio risk,” added Mee.
As a result, now is the time for investors to boost allocations to A-shares, he said, rather than wait for index providers to increase China’s weight to make it more in line with its share of global GDP.
Staying focused on fundamentals
Three key characteristics make the China A-shares market stand out – and ripe for potential alpha – compared with opportunities offshore.
First, retail investor participation is high, accounting for more than 80% of the average daily trading volume. This can result in stocks being significantly under or overvalued as the relatively short-term focus of investors triggers more extreme reactions.
Mee believes this offers significant opportunities for more sophisticated investors with rigorous investment processes and longer investment timeframes to take the other side of a trade in anticipation of any mis-pricings being corrected.
Second, since the A-share market comprises a large proportion of mid-cap stocks – which are core to China’s growth story – investors can access companies unavailable offshore. These include in sectors such as: consumer goods, for instance home furnishing retail, housewares and homebuilding; consumer services, such as travel and leisure; consumer staples like distillers, media and broadcasting, and healthcare.
“The majority of the A-shares mid-cap stocks are actively traded and accessible, allowing investors to deploy capital,” explained Mee.
Third, there is limited sell-side analyst coverage of A-share stocks, especially smaller ones.
For example, on average, the MSCI China Onshore Index has fewer than 10 forecasts per stock – even less than in the MSCI China Index and the MSCI Emerging Market Index, which both have 14. Further, 13% of the mid- and large-cap stocks in the MSCI China A Onshore index have no analyst forecasts at all.
“Sell-side analysts are typically less experienced and their recommendations often reflect the momentum of the market,” added Mee. “All this can lead to information inefficiency and open up opportunities for long term investors who are willing to put in the effort and do their homework.”
Adding more weight
Although the US economy accounts for 25% of world GDP, it is by far the largest constituent of the MSCI ACWI Index, with a 58% share. Yet China’s share of the index is just under 5%, despite it comprising 17% of global GDP.
With this in mind, Schroders believes the unique attributes of the A-shares market warrants a satellite allocation, in addition to a global emerging markets mandate.
This would allow investors to access a much larger portion of the A-shares market, as measured by the number of stocks and their market capitalisation. “The broader opportunity set is necessary to reap the full benefits, especially the large alpha opportunities,” explained Mee.
