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MSCI Q&A How Do Investors Think About MSCI?

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MSCI Q&A How Do Investors Think About MSCI? May 15, 2018 MSCI Q&A How do investors think about MSCI? 1. Does MSCI announcement meet expectation? 2. What did investors do after MSCI announced to include A-shares in June last year? 3. What implications we can find from foreign investors purchasing behavior? 4. Who will be the first adopter of A-shares after MSCI inclusion? When and what will they buy? 5. What are the major concerns of clients on MSCI inclusion and A-share market? 6. What can clients buy to allocate A-shares? 7. What are the differences between MSCI China A Inclusion Index and CSI 300 Index as they are both broad-based indexes with similar valuation? 1. Does MSCI announcement meet expectation? On May 31, 2018, MSCI has announced to include 226 A-shares into EM Index by two steps. On June 1, MSCI will include A-shares with an inclusion factor of 2.5%. The factor will increase to 5% in September after MSCI’s next quarterly rebalance. The decision is in line with market expectation. Partial inclusion in June will bring around US$10.6 billion inflows, and another US$10.6 billion will come in the second half of this year. In the coming 5-10 years, there will be around 200-400 billion RMB inflows every year. Chart 1 shows the sector composition of MSCI China A Inclusion Index, based on our preliminary calculation. Chart 1 MSCI China A Inclusion Index Sector Composition Financials 33.5% Industrials 13.3% Consumer Staples 11.7% Consumer Discretionary 9.9% Information Technology 8.0% Materials 6.8% Real Estate 5.8% Health Care 5.7% Utilities 3.2% Energy 2.1% Telecommunication Services 0.1% Source: Bloomberg, as of May 14 2018 1 2.What did investors do after MSCI announced to include A-shares in June last year? • Stock Connect data shows northbound inflow increased sharply recently, despite the volatility and corrections in A-share market. In April alone there were 38.65 billion RMB inflows——the biggest monthly inflows since the beginning of 2017. • More than 75% northbound inflows since June 2017 went to MSCI-inclusion stocks.(Chart 2) The overlap ratio is even higher recently. • Financials, industrials, materials, IT, consumer staples attracted the most inflows in April (Chart 3). By the end of April, financials, consumer discretionary and consumer staples are the top three sector holdings under northbound connect, as well as under the QFII regime. Chart 2 Northbound Flow by Sectors (RMB MM) 25,000 Telecommunication Services 20,000 Energy 15,000 Consumer Staples 10,000 Health Care 5,000 Utilities - Information Technology (5,000) Consumer Discretionary (10,000) Materials (15,000) Industrials Real Estate Source: CCASS, Wind, Bloomberg, as of April 30, 2018 Financials Chart 3 Northbound Inflow vs. MSCI-inclusion Stocks (RMB MM) 25,000 20,000 15,000 10,000 5,000 - (5,000) (10,000) (15,000) Total Net Flow MSCI-Inclusion Net Flow Source: CCASS, Wind, Bloomberg, as of April 30, 2018 2 3. What implications we can find from foreign investors purchasing behavior? Foreign investors have proved to be good at buying A-shares at right timing. Inflow was seen through channels like RQFII and Stock Connect, when A-share valuation became attractive. (Chart 4) MSCI China A Inclusion Index now also posts attractive valuations comparing with benchmarks in other emerging markets and developed markets (Chart 5). It is quite likely to attract value investors overseas. Chart 4 The Launch of Major Market Opening Policies vs. A-share Valuation (RMB MM) SHCOMP & SHCOMP CSI300 FTSE A50 2016.12.5 CSI300 Level FTSE A50 Shenzhen Level 2014.11.17 8000 2011.12.26 – HK Stock 25000 RQFII First Shanghai – HK Connect Stock Connect 20000 6000 2003.7.9 QFII First Introduced 15000 4000 Introduced 10000 Index Level Index 2000 5000 0 0 60 50 40 PE Level 30 20 10 0 10 8 6 4 PB Level 2 0 Source: Bloomberg, as of April 30, 2018. Chart 5 Valuation Comparison of MSCI China A Inclusion Index A-share Emerging Markets Developed Markets MSCI China A SENSEX S&P Dow Nikkei FTSE Indicator Inclusion Index KOSPI TWII 30 500 Jones 225 100 P/E 12.21 11.22 16.15 23.93 23.35 23.69 16.83 13.93 P/B 1.46 1.08 1.71 3.13 3.14 3.89 1.81 1.84 Source: Bloomberg, as of April 2018. 3 4.Who will be the first adopter of A-shares after MSCI inclusion? When and what will they buy? The chart below is the feedback collected by our sales team, who interviewed more than 100 asset managers, advisors, private banks and distributors from different regions during March 1~ April 27, 2018. To sum up, after MSCI’s official inclusion, we expect: • First mover: Southeast Asian sovereign wealth funds may be the first batch of big institutions to enter A-share market. Asia • Overweight: Institutions in Taiwan, Korea and Singapore already have overweight positions in A-shares vs. MSCI EM Index. But may watch the sentiment and ride on a MSCI rally. • Passive first: Large-size foreign fund houses may take actions first with passive tools. Mid- Europe size houses will follow big houses. & US • Waiting for flows: Overseas family offices and independent asset managers will both “wait and see” if the market goes well after MSCI inclusion. • Interest heating up: PBs, ETF distributions see interest heating up but need more education. They believe it’s a passive play. • Underweight: Initial inclusion too small for some US pensions while US market is resilient. Europe • Cautious: hedge funds are cautious against Sino-US trade disputes and prefer single stock & US allocation. Chart 6 Clients Sentiment on MSCI Inclusion Type Feedback • Already bought A-shares. The positions are even higher than A-share’s initial Asia: HK, weighting in MSCI EM Index. Taiwan, • They are cautious about market sentiment. Will allocate more if market sentiment Singapore, Korea turns up due to MSCI inclusion • Retail investors are more active as they want to catch up a MSCI rally Other South- • Large institutions, especially sovereign wealth funds, have started to look at China east Asian market. Although A-share will only make up 0.8% in MSCI EM Index after initial regions inclusion, it’s a large sum of money for SWF. (Thailand, • A-share liquidity is much better vs other Asian markets, and institutions appreciate Indonesia, this. etc.) • Looking for passive A-share strategies Our view: We expect Asian investors to be the first adopters following MSCI inclusion, as they are more familiar with the nature of A-share market, as well as the access to the market and adoptable investment tools. Big South-east Asian Institutions may use ETFs to enter A-share market, and may react quickly following MSCI inclusion, because <1% A-share weighting in MSCI EM Index still means a large amount. Inflow from SWFs will inspire investors global wide. Investors from HK, Taiwan, Singapore and Korean are very flexible and may ride on MSCI rally. 4 Type Feedback Europe: • Starting to look for China Beta products Large-size fund • Expecting more clients to ask for an increased exposure to China houses Europe: • Looking to increase in-house capacity to “study” China Mid-size asset • Interest in China has been picking up especially since MSCI’s decision in June 2017, managers despite A-share turmoil in 2015 • Pension clients are still licking their wounds from two years ago • MSCI inclusion does provide a “jump start” effect on their interests in China but those big ticket buyers will only proceed with caution Europe & US: • Less prepared for the inclusion as they think the weighting is still small and US Pension funds domestic market is still resilient. • Top 3 concerns: RMB strength, potential reversal of current policies, lingering trade conflicts with US Our view: We expect European and US investors to take a “wait and see” attitude, but their interest in China has picked up obviously. MSCI inclusion also forces them to look into the market. Among them, big houses are likely to move first, and may start increasing A-share allocation with passive products such as ETFs. Active products will be followed as clients’ interest picks up further. Mid-size managers may closely watch the move of big fund houses and follow their steps. May try some niche products to seek alpha. Pension funds are very prudent and may not take actions at the early inclusion stage. They need more time to observe China market after MSCI inclusion . Type Feedback • Cautions on Sino-US trade disputes. More interested in single stock allocation US hedge funds instead of broad index. • Education is most needed item to further convince European institutions to invest more in China Europe: • Interest in China is up by a large margin in the last 12 months Independent ETF • Evidence of net inflows, prominent funds loading up A-shares, continuous efforts distributors by the Chinese authorities to accommodate int’l investors are all key elements for A-shares to be a lock for European investors. • Looking into China now as it’s too big to ignore • Very positive investment sentiment on MSCI inclusion theme, due to lack of Europe: theme in Q1. Clients hold cash in Q1 as market was volatile and consider Private banks switching. • Believe this is a passive play rather than single stock or sector play Europe: Family offices/ • Looking for China A-share access on both active and passive space. Independent asset • Looking into investment vehicles from various angles. Will see how the managers institutional flow goes first.
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