Nervous excitement over China’s growing index clout

As the country gets even bigger exposure in benchmarks, trade tensions and quirks in the market spur concerns

Nervous excitement over China’s growing index clout

Mainland China will soon hold more of a mainline position in index fund investors’ portfolios even as concerns about threats to the Asian country are raised.

“Two of the largest global index providers, MSCI Inc. and FTSE Russell, will soon begin ratcheting up exposure to companies listed on China’s domestic exchanges,” reported The Wall Street Journal.

Chinese A shares will be given more weight in several MSCI indexes later this month, the first of three increases that will ratchet up their weighting to 3.3% in the MSCI Emerging Markets Index by the end of the year. The A shares will also be admitted into FTSE Russell’s indexes starting next month.

With that increased exposure, asset managers that follow the changing benchmarks will be forced to increase their holdings of Chinese companies. Consequently, index mutual-fund and ETF investors will soon have even more of their money invested in China, which already holds the largest slice of both FTSE Russell’s and MSCI’s emerging-markets indexes with more than 30% of each.

The country’s growing clout in indexes marks a new phase in its decades-long effort to open its doors to foreign investment. China A shares were introduced to investors in 2003, but were limited to qualified institutions and subject to certain rules; they got included in benchmarks after regulators took steps to increase transparency and oversight in the market.

Not everyone is happy with China’s increasing role. Steven Schoenfeld, founder and chief investment officer of BlueStar indexes, argued that the index changes will leave investors more vulnerable to price swings in the country’s volatile market. “When a single country is a third or more of the index, and the top five countries are two-thirds of the index, you’re giving up the diversification benefit of a broad index,” he told the Journal.

The country also faces a host of economic threats. Aside from an escalating trade spat with the US, April figures for economic indicators like retail sales, investment growth, and industrial production failed to impress investors. “The National Bureau of Statistics (NBS) data reflected that retail sales grew at the slowest pace since May 2003, only 7.2% year over year,” wrote Zacks contributor Sweta Jaiswal. Industrial output stumbled with a 5.4% year-over-year rise in April, as compared to 8.5% in March; similarly, manufacturing output decelerated, with 5.3% year-over-year growth in April compared to 9% in March.

Other analysts, however, have pointed to the rise in purchasing power among middle-class Chinese consumers as a reason to keep the faith. A Wednesday report from ratings agency Standard & Poor’s said that many of the Chinese companies it covers should face a “manageable” impact, reported CNN, particularly as many of them focus on the domestic Chinese market rather than on exports.

Government intervention and limited transparency in China’s markets could hamper future expansion in A-shares investing. Joti Rana, FTSE Russell’s head of governance and policy for the Americas, cited caps on foreign ownership of Chinese companies. Chin Ping Chia, a Hong Kong-based managing director of research with MSCI, outlined other barriers such as timing differences for trade settlement, Hong Kong holidays that lock foreign investors out of mainland markets even when trade is open, and the fact that non-Chinese investors cannot take advantage of derivatives to hedge their exposure.


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