Australia
China
India
Indonesia
Japan
Malaysia
Philippines
Singapore
South Korea
Taiwan
Thailand
Vietnam
One of the reasons why China has grown into a developed economy from a developing economy is the massive rise in the demand for Chinese securities. China’s equity market is the second largest in the world by total market capitalisation. Diverse opportunities are bound to flourish in such a vast market. However, to reap the advantages of the markets, investors must know the several types of securities which include China A-shares, B-shares and H-shares.
What are China A-shares?
There are two segments of China’s stock market – the onshore or China A-shares or the offshore securities market or B-shares.
China A-shares are the shares of incorporated companies denominated in Renminbi based in mainland China listed on the Shanghai or Shenzhen stock exchanges. Top companies like Midea Group, Fosun Pharma, and the Industrial and Commercial Bank of China (ICBC), have their A-shares listed on domestic stock exchanges.
At the same time, China B-shares also known as Special Renminbi-Denominated Shares are listed on the Shanghai B-shares market and the Shenzhen B-shares market. The B-shares listed on the Shanghai Stock Exchange are settled in US dollars, while those listed on the Shenzhen Stock Exchange are settled in Hong Kong dollars. The trading participants of B-Shares are primarily foreign investors.
Then there are China H-shares which are stocks of Chinese mainland companies listed on the Hong Kong Stock Exchange or other overseas exchanges. H-shares are denominated in Hong Kong dollars but regulated by Chinese laws. H-shares are traded in the same way as other stocks on the Hong Kong exchange.
Stock Connect and MSCI Inclusion were the game-changers for China A-shares
Earlier, only mainland Chinese citizens were allowed to trade in Chinese A-shares. But now, the market is in an expansion mode, and global investors can now access it. Since 2003, foreign investors have selected access through programs like the QFII, RQFII, and Stock Connect.
The Stock Connect program, a scheme allowing international investors to buy domestic shares and onshore investors to invest in Hong Kong-listed Chinese stocks, has facilitated foreign inflows into the market to a considerable extent steadily since 2014.
Usually, several investors are not able to distinguish between the performance of the offshore (Hong Kong-listed H-shares and US-listed ADRs) and onshore A-shares. In 2021, concerns over the forced delisting of ADRs overshadowed offshore equities. On the contrary, onshore equities hardly have ADRs and associated regulatory risks are less.
How big is the China A-share market?
As of Dec. 30, 2022, China A-shares denoted 75% of China’s total equity value -equivalent to $11 tn in total market cap. Making the onshore listings market the second largest globally after the US. While large-cap China A-shares represented the largest market after the U.S., the mid-cap stocks or the S&P China A MidCap 500 Index were roughly the size of Germany. It is also larger than several established markets like Australia, South Korea, Hong Kong, Sweden, the Netherlands and Brazil.
Although China is one of the largest and fastest-growing economies, investors have limited exposure to Chinese stocks, especially China A-shares. According to S&P, the average international investor’s total exposure to Chinese equities is just 4.6% of its total assets. A major part of this is likely to be in offshore Chinese equities through emerging market (EM) equity strategies benchmarked to the MSCI EM Index. For example, Chinese equities accounts comprise about 34% of the MSCI EM Index, but the proportion of Chinese onshore equities is only about 5%.
Foreign investors sweep China’s onshore market in 2023
Considering the potential opportunity from China’s reopening after the pandemic and its historically low correlation with global markets, foreign investors are flocking to the China onshore market. The net foreign inflows to China A-shares through Stock Connect, for the year ended April 28, 2023, surpassed the total annual net inflows of 2022. There were inflows worth $19.4 bn, which is nearly 50% more than the previous monthly record set in 2017.
Top reasons to invest in China A-shares
Diversification benefits
Due to China’s unique economic and policy cycles, its onshore equities have historically had a low correlation to other assets, offering clear diversification opportunities. This is also because foreign investors have little role in this market and A-shares are less likely to see capital flight when global equities are volatile. According to JP Morgan, “A dedicated allocation to A-shares of up to 10% over and above current benchmark index weights would result in a more optimised portfolio with an improved efficient frontier — which means A-share investors can expect higher returns for each given level of additional risk.”
Opportunity to tap into China’s newly expanding consumer sectors
China’s economy is undergoing a realignment and the equity market is reflecting it. It is transitioning from an investment and export-driven economy to a more consumption and innovation-driven market. Thus, the equity market is shifting more towards consumer-based sectors and moving away from the export-oriented ones. Some of the other beneficiaries of China’s economic transformation include technology, health care and high-end manufacturing.
Offshore-focused benchmarks focus more on the technology and communication services sectors, but onshore indices offer a broad-based exposure to an expanding share of consumer-oriented companies. Without adequately including the A-shares, China-specific exposure would not yield desired results. S&P says, “We expect these shifts to continue, potentially offering China A-share investors more exposure to these high growth sectors compared to emerging markets overall.”
Balanced exposure across market caps
The MSCI China-A Index offers greater exposure to small and mid-cap stocks that typically service the domestic economy. It has about 25% allocation to companies under a $10 bn market cap, as against 16% in both MSCI China and MSCI EM. This implies that the onshore Chinese equities are insulated from US-China tensions. They are also less likely to get impacted by Chinese regulatory policies which usually target offshore-listed large-cap companies, as per Alliance Bernstein.
China A-share market: associated risks?
Lack of regulatory protection
As the Chinese A-shares are not as regulated as the ADRs or the H-shares, they experience low regulatory risks. But there is also a downside to it. Lack of regulatory compliance and strict governance rules also means investors have less protection and recourse. Also investing through an index makes it challenging for investors to differentiate between the strong and weak stocks.
Misrepresentation in the MSCI Index
The sector representation in the MSCI EM index is uneven. Financial and industrial sectors (coal and steel), which have heavy weightage, are more exposed to political risks arising from the US-China trade tensions. At the same time, the index does not offer enough exposure to the healthcare or IT sectors, two of the rapidly growing markets in China.
China A-share market: massive opportunity to tap into the major growth sectors
China A-shares is an evolving asset and offers attractive growth from the fast-growing consumer and service demand. They are also benefiting from continued reform efforts. However, the market is still immature and relatively volatile. According to Invesco, about 80% of the participants in the onshore market are retail investors who often overreact to market sentiment. This leads to inadequate distribution and buying and selling are just a few sectors causing volatility. According to the MSCI, small- and mid-cap segments of the China onshore market witnessed higher dispersion of returns historically and were riskier compared to larger-size segments.
Even the regulatory framework is quite restrictive to safeguard retail investors. The pool of borrowable stocks for single-stock short-selling is restricted. There are also caps on pricing in initial public offerings (IPOs) not allowing newly listed stocks to realise their market value.
Gradually, the distinction between the onshore and offshore markets is blurring. To play the situation to their advantage, many investors are adopting the ‘unified China’ approach. While offshore shares consist of high-quality large-cap stocks offering stability, the onshore market comprising the China A-shares offers untapped growth opportunities. Experts believe that an integrated opportunity that includes both onshore China A-shares and offshore equities might offer more diversified exposure to the Chinese economy.
Increasing numbers of Chinese companies depending on domestic demand aren’t as affected by global economic and interest rate cycles. Government-linked firms also support the A-share market during periods of weak investor sentiment.
It will be interesting to watch if China’s increased healthcare spending, technological innovation and net-zero goals spur growth in the China A-shares market.
