Foreign institutions bullish on Chinese shares included in MSCI

Foreign institutions have stayed bullish on Chinese shares included in the MSCI since the global equity index provider announced the inclusion of a number of Shanghai and Shenzhen listed stocks in one of its most traded indexes a month ago.

After a delay of three years, the MSCI announced last month that from June 2018, it will include some China A-shares in its Emerging Markets (EM) index and All Country World Index (ACWI).

The MSCI plans to include 222 China A large-cap stocks, approximately 0.73 percent of the weight of the EM index at a 5-percent partial Inclusion Factor, in its calculations, according to its 2017 market classification review.

Provisional calculations by the MSCI showed the included A shares rallied over the past month, led by material and energy stocks which reported market returns of over 10 percent.

China has opened a path for a transformation of its financial markets that could see them match the United States in size and lure more than 3 trillion U.S. dollars in capital from abroad by 2025, according to a recent study by Citigroup Inc.

"The removal of restrictions of entry, together with eventual inclusion of China in various global capital market indexes, will raise foreign ownership of Chinese assets, likely creating further momentum for market broadening and deepening," Citigroup said in the report.

While China's initial efforts to internationalize its currency hit a bump in 2015, policymakers have shifted tack to focus on developing domestic financial markets rather than opening up the capital account. Steps like the bond and stock "connects" with Hong Kong represent this new approach, the report said.

Chinese authorities approved the bond connect between the Chinese mainland and Hong Kong in mid-May, allowing investors from both sides to trade bonds on each other's interbank markets. Northbound trade started on July 3, without caps on investment volume.

The move came after two similar stocks connect programs initiated in 2014 and 2016, respectively. China has secured another solid step forward in its progressive but persevering drive to internationalize its financial sector and currency.

With the rapid growth of Chinese financial markets, institutional investors will no longer have the option of staying away from China's markets if they want to achieve above-benchmark returns, said Liu Ligang, chief China economist of Citigroup.

"Acceleration of reform of China's capital markets in the next five to ten years has the potential to reshape the allocation of global assets," said Liu.

The country's bond market is forecast to almost triple in size to 188 trillion yuan (about 38 trillion U.S. dollars at expected future exchange rates) while equity markets will grow at a similar rate to 154 trillion yuan by 2025, according to Citigroup's report.

Goldman Sachs also talked up Chinese shares, saying the MSCI inclusion changes A shares from "nice to have" to "have to have" for global investors.

In its recent research report, Goldman Sachs noted that China's A share market has shown low return correlations with global equity markets and does not look expensive relative to other key markets globally in terms of price/earnings to growth.

The unique sectors in A share market offer international investors exposure to monetize China's new economy and consumer stories, the report said.

"Starting next year, we believe the investment case for onshore China stocks has strengthened. We continue to recommend targeted exposure to this large and less-well researched market," Goldman Sachs said in a report earlier this month.