As China grew to become the world’s second largest economy after the US, foreign investors often struggled to benefit from the country’s full range of growth opportunities. This story is changing quickly, as policymakers seek to liberalize access to Chinese stock and bond markets while making them more squarely aligned with international standards. This has material implications for all investors, whether individuals or large, sophisticated institutional investors. Much is changing in China, and it’s worth understanding the potential emerging opportunity over the longer term.
Sources: Wind, as of December 2018. Foreign holdings of onshore equity & bond are estimated based on Qualified Foreign Institutional Investor (QFII) holdings and bond holdings via CIBM Direct until 2013, and based on PBoC’s disclosure of foreign holdings of equity/bond starting from 2014 to 2018.
The onshore Chinese equity market is becoming increasingly hard to ignore for investors. With more than 3,000 listed companies, A-shares - which are listed on exchanges in Shanghai and Shenzhen - give investors access to what has historically been a relatively isolated market. Eased restrictions and continuing market liberalization now mean international investors can trade A-shares and manage liquidity easily through the Stock Connect program without the hassle of going through the previous quota system.
The increasing inclusion of China A-shares in major international indexes is supporting the transition of Chinese equities to a more common asset class. In 2018, MSCI started including A-shares in their global emerging market benchmarks, and announced they will be increasing the weight of A-shares throughout 2019. FTSE is set to follow suit, with inclusion in FTSE Global and emerging market indexes commencing in June 2019. In many cases, A-shares are one of the only options for investors to gain exposure to quality Chinese companies with sustainable business models, low sensitivity to policy cycles, and high growth potential from consumption upgrading and technological advancement.
The rise of China’s bond market has largely lacked foreign participation – only about 3% of the US$12 trillion market is in foreign hands.1 This is poised to change relatively quickly, underpinned by better access channels and greater alignment with international standards.
As of April 2019, the Bloomberg Barclays Global Aggregate Index, a major tracker of global bond performance, added Chinese sovereign and bank policy bonds to its mix. We estimate the inclusion could bring at least US$150 billion of inflows from foreign investors over the 20-month inclusion period (ending November 2020), just from rebalancing passive strategies tied to this benchmark.2 At the current market value, this would represent about 6% of the Bloomberg Barclays Global Aggregate Bond Index. Our estimate could be conservative, especially if China’s bond market, already the second biggest in the world, maintains its current growth path. Also, this estimate does not reflect potential inflows from active strategies, which could be significant but are harder to predict.