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  • Home>Research & Insights>Spotlight>China Opens "A" Door for U.S., Foreign Investors

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    China Opens "A" Door for U.S., Foreign Investors

    It's just a matter of time before China A-shares enter emerging-markets indexes.

    Patricia Oey, 10/06/2015

    This article is an abridged version of a recently published research paper under the same title. For a copy of this paper, please contact the author at patricia.oey@morningstar.com.

    Most investors do not have exposure to the large, $1 trillion (float-adjusted) Shanghai and Shenzhen equity markets. China has a “mostly closed” capital account, under which money cannot freely flow into and out of China.

    However, the door is starting to open.

    Over the past few years, China has implemented a number of initiatives to allow for controlled foreign fund flows into its onshore equity markets, as part of its goal to gradually liberalize its economy. Index provider MSCI is monitoring these efforts and currently has Shanghai- and Shenzhen-listed stocks, also known as China A-shares, on a watchlist for inclusion in its global equity indexes.

    The addition of China A-shares would have a significant impact the MSCI Emerging Markets Index. China already accounts for 25% to 30% (via Hong Kong-listed Chinese stocks) in this benchmark, so the addition of China A-shares would result in a much larger China allocation.

    Vanguard decided to get ahead of this possible benchmark change (and potentially large foreign fund inflows) by announcing that it will add China A-shares to its emerging-markets index fund. Vanguard Emerging Markets Stock Index Fund and ETF VEIEX VWO is transitioning to an index that includes China A-shares at a capped level. This A-share allocation will rise gradually as China liberalizes foreign investor access to its equity markets.

    Investors may be concerned about a large allocation to China. Most listed Chinese companies are government-controlled firms, and at times, state interests can take precedence over profitability. The government maintains a very heavy hand in the market, as it recently helped fuel an equity market bubble, only to have to take aggressive measures to try to mitigate a subsequent slide.

    China is also trying to implement a wide range of economic reforms, as well as manage a slowing economy. There is regulatory uncertainty regarding how China plans to meet these goals, and this continues to be a significant source of market volatility.

    Patricia Oey is an ETF analyst at Morningstar.