Factors that previously had little effect on returns have gotten a lift as new players rush in
In recent years, there’s been much fanfare around the expanding opportunity for investors to gain Chinese stock-market exposure. Though see the country’s increasing openness to foreign investment as a plus, some have pointed to Chinese stock-market volatility and soft economic indicators as reasons for concern.
Those spots of weakness have also held certain major players back from implementing their investment strategies to China A shares. “Commonly held perceptions about China A shares … have influenced institutional investors to think that fundamental factor strategies may not work in the Chinese equity markets,” wrote Oleg Ruban, head of Analytics Applied Research for Asia Pacific at MSCI in a new note. “Our research suggests this may be changing.”
Ruban zeroed in on value and quality, well-known fundamental factor strategies in wide use among institutional investors’ portfolios. Referring to research conducted last year, he said that these, along with other factors, demonstrated weaker long-run return premia within China A shares relative to emerging and developed markets.
But after revisiting the problem with new data, Ruban said he and his colleagues found that book-to-price, a value factor, and earnings quality made it among the top-performing style factors in China A shares. That was true for full-year 2018 and year-to-date 2019 data, despite the transition from a bear to a bull market — something that, historically, has occurred more sharply within China relative to developed and other emerging markets.
“Further, we observed convergence between China A shares and global market returns for book-to-price and earnings quality,” Ruban added. That was evident in graphs comparing global and China-specific risk-adjusted returns for earnings quality and book-to-price ratio; divergent for most of their history going back to 2009, Chinese returns and returns in the global market started to sync up sometime in 2018.
Ruban attributed this change, at least in part, to local institutional investors in China A shares that are aware of quality and value strategies. With institutions establishing a stronger foothold in the market, he said, there could be a wider adoption of fundamental factor strategies.
Another possible contributor to the convergence of global and China-market returns from value and quality, he said, is the rising participation of international investors in the A-shares market. Recent research by Galaxy Securities, which draws from data released by the People’s Bank of China, noted that foreign investors now hold CNY 1,684 billion worth of China A shares, as compared to CNY 1,946 billion held by local mutual funds. In December 2013, the numbers were CNY 344.8 billion and CNY 1,315 billion, respectively.
“Despite retail investors’ enduring influence, fundamental factors were increasingly important return drivers in China A shares,” Ruban said. “Recent return patterns suggest that gradual institutionalization and internationalization of the A-share market may further increase the importance of systematic, factor-based investment strategies.”
