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New MSCI EM Stocks Provide Exposure to 3 Major Transformational Changes Unfolding in China

Summary: Some 200+ Chinese A-share stocks were added to MSCI’s emerging markets index on Friday. Several provide exposure to three transformational changes that are unfolding in China today: The aging of China’s population, the development of the world’s first surveillance economy, and China’s electric vehicle & green energy revolution.

Roughly 230 Chinese A-share stocks were added to MSCI’s emerging markets index on Friday. A-shares are stocks of Chinese companies that are incorporated on the mainland, quoted in renminbi, and listed in Shanghai and Shenzhen. Until now, A-shares were only open to a select number of qualified financial institutions which needed regulatory approval in Beijing. With this change, ordinary foreign investors will now have access to China’s secular growth sectors such as materials, industrials, consumer discretionary, and healthcare, which are currently under-represented in other share classes.

Some of the stocks newly added to the MSCI EM index provide exposure to three transformational changes that are unfolding in China today: The aging of China’s population, the development of the world’s first surveillance economy, and China’s electric vehicle & green energy revolution.

CHINA’S GOLDEN AGERS ARE LIFTING THE HEALTHCARE & PHARMA SECTOR: China’s healthcare market is expected to be worth $2.4 trillion by 2030, as the country moves towards becoming the world’s most aged society that decade. More than 143 million Chinese residents, or 10% of the population, were over the age of 65 last year — a percentage that will double in the next 20 years, per the United Nations. With the nation’s per-capita health expenditure still very low relative to that of the United States ($9,892 in the U.S. versus $733 in China in 2016), that leaves a huge upside potential for additional spending increases, both public and private.

The biggest beneficiaries will be providers of senior living & skilled nursing facilities, and services that cater to age-related health problems such as cancer, diabetes, heart disease, hypertension and respiratory illness. Chinese drug manufacturers that generate the majority of their sales domestically will also be big winners.

Some popular names in this category include Jiangsu Hengrui Medicine Co., the nation’s biggest drug maker by market value, antibiotics maker Sichuan Kelun Pharmaceutical Co., and cough syrup maker Zhangzhou Pientzehuang Pharmaceutical Co. The shares of these companies have already risen a whopping 90% in the past year, and more gains are likely to come. Pharma firms and other health stocks, as a whole, have been China’s best performers in 2018, up 22% YTD.

THE RISE OF THE SURVEILLANCE STATE IS BOOSTING MAKERS OF MONITORING EQUIPMENT: China’s embrace of digital surveillance has been noted in some of our previous DIBs reports, as banks, airports, hotels, and other businesses try to verify people’s identities by analyzing their faces. Indeed, China’s law enforcement is already using facial recognition and artificial intelligence to track suspects, predict crime, coordinate the work of emergency services, and to monitor the comings and goings of the country’s 1.4 billion people. In some cities, stun gun-wielding police robots even patrol crowds, interact with customers, and help human police officers identify suspects.

At the back end of these efforts are security cameras that scan roads, shopping malls and transportation hubs, integrating everything into one nationwide surveillance and data-sharing platform. Across the country, 170 million CCTV cameras are already in place and an estimated 400 million new ones will be installed by 2020. Companies such as Hangzhou Hikvision Digital Technology Co. and Zhejiang Dahua Technology Co. are big beneficiaries of that demand.

BATTERY & SOLAR COMPONENT MAKERS ARE WINNERS OF CHINA’S GREEN ENERGY BOOM: China’s government is determined to establish the country’s dominance in new-energy vehicles —a category that includes battery-powered, plug-in hybrid and fuel cell cars. China is already the world’s biggest market for electric cars, accounting for more than half of the 1 million units sold globally last year. The government is targeting 7 million vehicles by 2025.

Furthermore, the world’s largest carbon emitter is pushing heavily into renewable energy. In 2017, more than half of global renewable energy investment (nearly $280 billion) came from China. To put that into context, for every $1 the U.S. put into renewable energy last year, China spent $3. Much of that investment went into solar power, followed by wind energy. About 26% of all national electric production came from renewables, as opposed to the global average of 12%.

Chinese battery-component manufacturers stand to gain from the EV push, including Zhejiang Huayou Cobalt Co. and Jiangxi Ganfeng Lithium Co. Meanwhile, companies in the solar industry are benefitting from the renewables boom including LONGi Green Energy Technology Co., the world’s second-largest maker of solar wafers. Its shares have risen more than 100% in 12 months.

OTHER NOTEWORTHY MENTIONS: China’s demographic dividend is also boosting companies in the food & beverage space. For example China’s biggest liquor maker, Kweichow Moutai Co., is now worth $143 billion, about the same size as PepsiCo Inc. Other popular distillers and vintners include Wuliangye Yibin Co., Jiangsu Yanghe Brewery Co. and Shanxi Xinghuacan Fen Wine Factory Co.

On the food side, pig breeder Muyuan Foodstuff Co., seasonings maker Foshan Haitian Flavouring & Food Co. and dairy producer Inner Mongolia Yili Industrial Group Co. are also garnering plenty of attention from domestic investors.

CONCLUSION: MSCI’s EM index is tracked by funds with assets under management (AUM) in excess of $1.9 trillion. Funds that follow the benchmark therefore have to buy Chinese stocks to avoid deviation. The largest US-listed ETF tracking the MSCI EM index is BlackRock’s iShares MSCI Emerging Markets Fund (EEM), with nearly $40 billion in AUM.

Some analysts estimate about $20 billion will initially flow into Chinese stocks, eventually rising to $300 billion if there is full inclusion, as many expect. The A-shares will initially represent less than 1% of the MSCI Emerging Markets Index. Full inclusion would see A-shares account for about 18% of the index, pushing China to more than 40% of the benchmark. Should that happen, South Korea’s weight would fall from 15% to 12.7%, Taiwan from 11.1% to 9.4%, and India from 8.3% to 7%, among others.

Here are links to previously published DIBs reports on the MSCI A-shares change:

We’ve also summarized the following articles related to this topic…

 

China Markets: Chinese stocks make symbolic debut on widely followed index

Close to 230 China A shares debuted on index provider MSCI’s emerging markets benchmark on Friday, a move investors expect will attract billions of dollars in inflows to the mainland market.

The partial inclusion of the A shares — yuan-denominated stocks traded on the mainland — to MSCI’s Emerging Markets Index takes place in two phases, with the second step only coming in August.

Upon completion of initial A shares inclusion, China’s proportion of the index — which currently includes shares of Chinese companies listed in Hong Kong — will stand at 31.3 percent. Full inclusion would see A shares account for 16 percent of the index and China making up 42 percent of the index.

Friday’s inclusion, however, failed to buoy sentiment in greater China markets, which slipped in afternoon trade: The Shanghai composite declined 0.53 percent and the smaller Shenzhen composite fell 0.9 percent. Hong Kong’s Hang Seng Index was lower by 0.17 percent.

The move is seen as an important symbolic one, even though the roughly $22 billion in capital inflows expected to go into A shares is seen as a drop in the bucket compared to the size of China’s domestic market. CNBC

 

China Markets: Chinese shares to transform emerging market investing

A government-controlled supplier of surveillance equipment is one of the most popular Chinese companies in the world right now, at least with institutional investors. Hangzhou Hikvision, one of China’s so-called A-shares, is among the stocks to have been selected for inclusion in the MSCI Emerging Markets Index from Friday, obliging asset managers all over the world to consider investing in them.

Although only 233 A-shares will be added in the first tranche to the index — which is followed by investors controlling $1.6tn in assets — to many, this represents a pivotal moment. Subsequent planned additions are set to radically reshape the global equity landscape.

As more A-shares are added into benchmark equity indices, the flows of international capital into Shanghai and Shenzhen could rise sharply. Based on the experiences of South Korea and Taiwan, after 100 per cent inclusion more than $600bn in foreign capital could flow into the A-share market in the next five to 10 years.

By objective measurable standards, A-shares are among the most highly-leveraged, volatile, worst governed and most heavily-diluted cohort of shares in any emerging market. In spite of this, investors say A-shares represent one of the most compelling opportunities in global equities. And the size of China and the opportunities it affords mean that investors will ultimately have to get comfortable with the multiple risks. FT

 

China Markets: That Calm Chinese Stock Market? It’s Engineered by the State

Long derided as a casino, China’s once-volatile stock market is going through a long stretch of calm. One reason is an orchestrated government effort to keep traders and investors in line.

Three years after a national uproar when Chinese stocks plunged by nearly half in just over two months, traders and brokers say regulators are increasingly stepping in to influence trades and make China’s markets appear less volatile, especially during political events when Beijing wants to project stability. The steps, aided by advanced surveillance techniques to monitor traders, include warning brokerage firms to police trades that are out of step with government wishes and phoning investors directly when they act out of line. Never in over 25 years of watching the Chinese markets has the state been so involved and interfering in micro issues.

Interventions appear to have contributed to the unusually stable Chinese market over the past two years, though other factors, including a stretch of global calm in 2017 and a relatively healthy economy, likely also played a role. The Shanghai market moved more than 1% on 12 out of 244 trading days in 2017, down from 65 times in 2016 and 141 times in 2015. WSJ

 

China Markets: Coming To An ETF Near You: China A-Shares

After years of anticipation, MSCI has finally taken the plunge. Today the index provider followed through on its promise to add China A-shares to its indices, opening the door for billions of dollars of foreign capital to flow into mainland Chinese stocks. With today’s MSCI move, 230 China large-cap A-shares will be added to the MSCI China Index, the MSCI Emerging Markets Index and the MSCI ACWI Index. While certainly symbolic, the question now is whether such a modest inclusion of A-shares into MSCI indices is impactful for investors.

Any funds that track the affected MSCI indices will have to buy A-shares to stay in line with the index’s performance. That includes ETFs such as the $49.8 billion iShares Core MSCI Emerging Markets ETF (IEMG) and the $39.3 billion iShares MSCI Emerging Markets ETF (EEM). Active funds benchmarked to the MSCI indices may also be pressured to buy A-shares.

Full inclusion of China A-shares into MSCI indices won’t come immediately. Outstanding concerns about weak corporate governance, trading suspensions and other issues make it so the route to full inclusion will likely be a gradual process.

Others say China is simply becoming too big a concentration in indices like the MSCI Emerging Markets Index. Investors concerned about concentration could look to emerging market funds that limit their China exposure, or build their own emerging market portfolio using single-country funds. ETF.com

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