Global investors are often underweight Asian equities. China is the second largest economy after the U.S. but it is still ‘emerging’ and has the growth potential of EM. However many global, even EM equity, investment managers do not appear to appreciate fully the importance of the inclusion of the China A shares in MSCI indices and have zero exposure to these onshore listings.
Nonetheless, we believe allocating capital to Chinese equities, including onshore A shares, deserves careful consideration by global investors seeking to lower their portfolio risk in a meaningful way while also accessing new and different sources of alpha.
The Chinese equity market has gone through transformation over the last two decades, including the launch of the Stock Connect that provides foreign investors with more access. But the market has so far retained some of its unique features, with high participation by retail investors who tend to be less sophisticated. Both the onshore MSCI China A and the general MSCI China indices have relatively low correlation with other global markets, providing good diversification benefits for investors.
With inefficiencies and ample liquidity, this retail-heavy market offers rich alpha opportunities. Chinese equities exhibit low average pairwise correlation and high return dispersion compared to many other global markets, and they appear to be less driven by global macroeconomic factors. All of these characteristics are favourable to stock picking.