Tapping into China’s growth story

June 24 marks an important date in the diary for emerging market stock investors, with the debut inclusion of more than 1,000 large, mid and small cap Chinese domestically-listed stocks called ‘A Shares’ into FTSE Russell’s global equity benchmarks.

Penny Ning Pan, director, Product Management, FTSE Russell
Penny Ning Pan, director, Product Management, FTSE Russell

Just one of these benchmarks, the FTSE Emerging Index is tracked by over $140bn of institutional and retail investor assets and is used by fund managers to measure performance or replicate the index through index tracking funds or Exchange Traded Funds (ETFs).

The inclusion of Chinese companies listed on the Shanghai and Shenzhen stock exchanges into FTSE Russell’s global indexes marks the latest milestone in China’s rapid economic ascent; from the emergence of a manufacturing powerhouse, to a transition to a service-based economy.

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Underpinning this transformation has been decades of economic and policy reform, which has helped propel the country to the second largest economy in the world. Such changes have resulted in rising prosperity of its middle class and urbanization. At the beginning of economic reforms in 1978, about 18 per cent of the Chinese population lived in urban areas. By 2018, this figure had risen to 57.9 per cent and is forecast to approach 80 per cent by 2050, according to United Nations estimates.

While double digit GDP growth had for a period become the norm, the country’s economy is now maturing. China's growth rate is on a trajectory to grow by a more sustainable 6 per cent per annum.

But the driving force behind this growth is also evolving and China’s high-tech sectors are playing an increasingly important role, as household names such as Alibaba and Tencent continue to grow both in domestic and international markets.

However, there is still considerable room for growth. On a relative percentage basis, China’s per capita GNI, a measure of total national income per year divided by its population, is only 11.3 per cent of that of the United States with large parts of the country still resembling the early stages of economic development seen in South Korea and Japan.

And as China’s economy has transformed, so have its equity market. The Chinese domestic equity market is now the second largest in the world with a market capitalization of about $9 trillion, second only to the United States. Historically however, international investors have had limited access to China’s domestic equity market, which was a main reason China A Shares have not been included in FTSE Russell’s global equity indexes.

The Chinese regulators over the years have been working to open the market to international investors via several access routes. The introduction and enhancement of the Stock Connect

programme between Hong Kong and China significantly eased the international access to domestic Chinese market, and paved way for FTSE Russell’s decision to incorporate Stock Connect eligible A Shares into its global equity indexes.

While some foreign investors have voiced concerns over market risks and international trade uncertainty, it is important to take a longer-term view. Like any emerging market, development is not linear and FTSE Russell’s decision to include China A Shares in its global benchmarks is the result of a defined country classification analysis and frequent dialogue and feedback with the global investor community.

The is an important development for global investors and will also provide a boost for emerging markets and their profile with international investors. According to FTSE Russell’s implementation plan, by March 2020, 25 per cent of the China A Shares investability weights will be included into FTSE Russell global indexes, and China A Shares are projected to represent approximately 5.5 per cent of the total FTSE Emerging Index. An estimated $10bn is expected to flow into A Shares from passive funds that track FTSE indexes, as they

readjust their portfolios to include A Shares. This will mean a real-term impact for retail investors and pension scheme holders, as greater exposure to China’s equity markets is incorporated into mutual funds and ETFs which use FTSE Russell indexes.

All this represents significant new opportunities for international investors. One segment of the Chinese companies due for inclusion are ChiNext stocks. Created in 2009 by the Shenzhen Stock Exchange, the ChiNext Board is designed to attract listings from innovative growth-oriented Chinese firms—including many high-tech companies. FTSE Russell will be the first index provider to incorporate approximately 140 ChiNext stocks, amounting to $400bn in market capitalisation. In addition, over 300 small cap Chinese firms also qualify for inclusion in the index later this month, as well as large and mid cap stocks. All these companies meet FTSE Russell’s standardised screening on liquidity and free-float rules to ensure market participants can trade in and out of these companies and tracker funds can adjust portfolios when the constituents of the index change over time.

Complementing this, the corporate governance framework in China is developing and adapting as the country's economy transforms. Stock exchanges and regulators are driving changes to the listing requirements as well as the way companies report.

While June 24 is only the beginning of the process, it is a significant milestone. China's listed equity markets are significantly larger than the rest of the emerging markets and could in time, form half of all stock in FTSE Emerging Markets according to FTSE Russell research. One thing is for certain, investors will be watching closely.