Is It Time For Indian Investors To Ride The Chinese Dragon?
MSCI Inc, the world's largest index provider, recently announced the inclusion of the MSCI Saudi Arabia and MSCI Argentina indexes in its closely watched emerging-markets index. It is estimated that approximately USD 1.8 trillion is tied to the MSCI Emerging Market Index.
While changes to the index are made regularly, the single largest change made by MSCI has been adding stocks listed in Mainland China (these are typically called A shares) to the MSCI Index, impacting MSCI Emerging Market Index as well as MSCI Asia Pacific Indices. This inclusion has happened in two steps in May and August 2018, but the inclusion factor is quite low at 5%.
It is notewrothy that until China opened up its Mainland market to foreigners; international investors were able to access Chinese stocks via overseas listings, mostly in Hong Kong. The Mainland exchanges Shanghai and Shenzhen were largely closed to foreigners. The Chinese government opened up the Mainland market to foreigners via schemes, post which shares listed in Mainland China were added to international indices in 2018.
China is just too big to ignore in terms of market capitalization, it is the second largest equity market in the world with a market capitalization of USD 6.4 trillion, and is underrepresented in the portfolios of global investors. MSCI is aiming to increase the representation through a number of steps taken from May 2019 to May 2020. Firstly their inclusion factor will be increased from 5% to 20%, secondly stocks from CHinext (Technology heavy NASDAQ-style board of the Shenzhen Stock Exchange) will be added to international indices and thirdly China A Mid Cap stocks will be added.
The net impact will be 0.95% increase in the weight of China in the emerging market indices. This along with the inclusion of Saudi Arabia and Argentina will reduce the weight of other markets. Consequently, India’s weight in the emerging market indices will drop approximately 0.3% by May 2020.
India is likely to experience outflows from passive funds, which is a headwind for the market. However, depending on fundamentals, inflows from actively managed foreign funds as well as domestic funds can make up for the shortfall.
However, this does urge one to ask if Indian investors should consider investing in China, along with reasons of International diversification. Historically Indian stock markets have performed better, over the last 20 years; MSCI China is up by 4.1% CAGR, compared to Indian stocks which are up by 8.6% CAGR, both in USD Dollars. This is despite significantly higher GDP growth of 9.1% compared to 6.7% in India, because profitability of Chinese stocks has lagged as compared to its Indian peers. More importantly Indian equities have consistently done better in terms of Return on Equity, outperforming Chinese peers by 0.5% on an average over the last 10 years.
However, there are reasons to believe that Chinese equities may do better in the future, firstly their valuation levels are significantly lower at a 12 month forward PE ratio of 12X, compared to Indian indices at a 12 month forward PE ratio of 18x. Secondly, China can be viewed as a two paced market, with state owned enterprises that dominate sectors like Metals & Mining, Oil & Gas Financial Services etc. These firms are growing slower and their stock price has lagged. On the other hand you have private firms which typically operate in the areas of Technology that are growing rapidly, and compare well in profitability metrics. As these companies grow in size, the Chinese market has become more attractive. In addition, Chinese firms especially in the Technology sector have been moving up the global value chain.
It is a good time for Indian investors to consider adding Chinese stocks to their portfolio. Many diverse options are emerging in the form of numerous Mutual Funds that are available and specialize in investing in China, as well as China dedicated ETFs.
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