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Invest in Chinese markets: Is it a risk?

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Invest in Chinese markets: Is it a risk?

This year, the mainland Chinese stock markets are positive while developed country markets are still in the red.

The Hong Kong Stock Exchange, which historically has always been open to international investors, has been the only exception. Returning to the local markets of this people’s republic, the most surprising thing is not that they look green, but that, from the highs of February to the lows of March, they fell less than half as much as the rest of the world.

In 2018, the MSCI China A, which includes the shares of Shanghai and Shenzhen with free access for any investor, suffered in euros falls of more than 25% while the world stock market did not reach 5%. 2018 was no exception, Chinese stock exchanges used to behave much worse in crisis, especially their continental markets.

Chinese markets are undeveloped

In 2008, the MSCI China A was not yet calculated, because those shares were barely accessible to the international investor, but the CSI 300, a performance index similar to the MSCI China A, plummeted by more than 60%. On the positive side was the 2009 recovery with a euro return of over 90%. Next to this market, the movements of the global index in 2008 and 2009, with returns of -37% and +26% respectively, seem to be small.

This year, however, from highs to lows, developed stock markets were plunging by more than 30%, while the MSCI China A was down just over 10%.

“The Chinese economy grew at an average rate of 10% per year for three decades until 2010 and that year overtook Japan to become the world’s second largest economy. It is also one of the largest markets by market capitalization and debt issuance.

However, international investment in its capital markets is still negligible, and this is very surprising compared to the weight of its economy. It has its explanation: its financial markets are immature and some of its securities had limited access to foreign investors.

 

Invest in Chinese markets: Is it a risk?

This is changing. China is opening up all its stock and bond markets to international investors and as a result, they are beginning to be included in global indices to an increasing extent.

The inclusion of Chinese A-stocks in the MSCI indices is being done partly and gradually from 2018 onwards as a matter of prudence. As they point out in a document that can be found on their website, they are aware that many investors are starting to invest in this type of stock only recently and, as we saw earlier, until 2020 these stocks were very volatile.

MSCI indices are widely used by funds as a benchmark and by ETFs that replicate them. Their construction criteria place great emphasis on them being investable and representative of the market in question, so, although they are not the only ones, they are among the most followed by professionals for equity markets.

Chinese stocks only account for 4.5% of the MSC All Countries, a small percentage compared to what they should have by capitalization, but China’s share in global funds is even lower, not even 3%.

It is true that investing in Chinese equities is complex: the composition of the various indices not only differs greatly in the companies that make them up, but even in their sectoral distribution.

Some have a very high concentration in a single sector or in some stocks. To give an example: the MSCI China, which represents the entire universe of stocks available to any investor, concentrates more than 30% in its two leading positions (Alibaba and Tencent). So it does not seem to be a very efficient index in terms of diversification of specific risks.

The good news is that there are actively managed funds which, being safer in terms of risk diversification, consistently and strongly beat this index. Disproving the theory that diversification detracts from profitability.

Seeing the many and varied financial products available to the individual investor and given that Chinese stock markets could be more volatile than developed ones again and bonds most likely as well, I ended my previous podium by saying: Investing in China is inadvisable for individual investors without professional advice’.

However, seeing how little global funds devote to China, I would like to change that to:

Chinese markets have to be there. However, as long as the indices are poorly diversified and the market is fragmented, it is better to use actively managed funds

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Jose Limardo

Jose Limardo

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