China Spotlight A-Share Market's Coming of Age

China Spotlight A-share market's coming of age

April 20, 2021

Gene Ma, Head of China Research, [email protected], +1 202 857 3305, @genemaIIF Phoebe Feng, Senior Research Analyst, [email protected], +86 5836 9080, @phoebefeng_xy Lu Zhang, Research Intern, [email protected]

• China's onshore stock market is now the world's second largest, with a market capitalization of $12 tln, … • …led by an increase in start-up and technology stock listings and in ownership by institutional investors. • Foreign investors now own 4.3% of the total market capitalization and about 9% of the free-float shares. • Stricter accounting rules and enforcement mechanisms are needed for it to become a more mature market.

China's stock market has typically been thought of as volatile, driven by capricious retail investors. The market has im- Exhibit 1. China's stock market capitalization proved markedly in the past few years, thanks to greater par- ¥ tln ticipation of domestic and global institutional investors. This 100 note examines the growth of China's A-share market. Main board SME Board 80 A much deeper market ChiNext STAR Board With nearly 4,200 listed companies, Shanghai and Shenzhen stock exchanges' combined market capitalization reached 60 $12.2 tln at the end-2020 (Exhibit 1). It is now the world's second-largest stock market, after the US ($45 tln), but 40 ahead of Tokyo ($6.7 tln), HKEx ($6.1 tln), London ($4.0 tln), and Frankfurt ($2.3 tln), using data at end-2020. The 20 SME board (for small caps), ChiNext (for start-ups), and STAR board (for technology companies) now account for 0 30% of the total capitalization. 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 Source: Haver, IIF Shanghai and Shenzhen exchanges together raised $69 bln through IPOs in 2020. This lags the Nasdaq and NYSE ($85 bln) but is ahead of HKEx ($52 bln), London ($13.4 bln), Eu- Exhibit 2. Margin and short positions as % of market cap ronext ($7.3 bln), and Tokyo ($3.5 bln). 4% Margin position/Cap 0.2% The A-share market is also highly liquid. Its annual trading Short position/Cap, RS value is about 1/3 of US markets (Nasdaq & NYSE), but almost 10 times London's. Its share turnover velocity (turno- 3% ver over market cap) is one of the highest globally, at about five times the HKEx and LSE velocity. Such liquidity pro- 2% 0.1% vides fertile soil for high-frequency trading.

The market is also less leveraged and more sophisticated 1% than before. The outstanding margin positions dropped from 3.5% of the market capitalization in 2015 to 2% today (Exhibit 2). The short sell positions started to take off in 0% 0.0% 2012 2014 2016 2018 2020 2020 and rose from virtually zero to about 2% of the market cap, thanks to the growing local hedge fund industry. Source: Haver, IIF

Institutional investors gaining against retail investors Institutional investors' share of market cap increased from Exhibit 3. Growing foreign and institutional ownership 72% in 2014 to 78% in 2020, per estimates by CICC (Exhibit Share of free-floating Mkt cap 3), and its share of free-floating stocks increased from 28% 100% Foreign investors to 48% in the same period. Domestic mutual funds, insur- Others ance, hedge funds (a.k.a. private funds) account for 8.8%, 80% 8.8%, and 6.8% of the free-float shares. The market has be- Securities come more institutional-owned. 60% Private fund

Though holding only 22% of the market capitalization, the Social security fund 40% 180 million retail investors still account for about 80% of the trading volume. However, we suspect this volume data may Insurers 20% be inflated by local hedge fund trading. Mutual fund

Growing foreign participation 0% Retail investors Foreign investors can access China's stock market through 2015 2020 schemes such as QFII (Qualified Foreign Institutional Inves- Source: CICC, IIF tor), RQFII (RMB QFII), and Stock Connects. Since the

Shanghai-HK Stock Connect launched in 2015, the cumulative net northbound flows to Shanghai and Shenzhen Exhibit 4. Foreign holding of onshore equities reached ¥1.2 tln, about 80% of the total equity inflows dur- ing the period. ¥ tln 4 5% Foreign investors' holding of Chinese stocks increased to Foreign holding ¥3.4 tln, 4.3% of the total market cap, by end-2020 (Exhibit Foreign holding/Mkt cap (RS) 4% 3 4). As almost half of the Chinese stocks are non-tradable en- tity-owned shares, foreign ownership now reaches about 9% 3% of the tradable free-float shares. Foreign investors have out- 2 performed the broad market and often became the market 2% leader in the past two years. 1 1% Chinese equities are attractive to global investors because A- shares offer easy access to China's economic dividends. Be- 0 0% ing the least correlated with global markets (Exhibit 5), Chi- 2014 2016 2018 2020 nese equities offer one of the best diversification opportuni- ties for global portfolios. Source: Haver, IIF

China's stock market should continue to grow. Its capitalization was 78% of GDP at the end-2020, still below the US Exhibit 5. Correlations of major stock markets (216%), Japan (129%), and the UK (149%). Deleveraging China's economy also requires more equity financing. The MSCI: MSCI: MSCI: MSCI: MSCI: China: China: World US Japan EM Euro CSI- Shang- cumulative equity financing raised is only 30% of outstand- Area 300 hai ing corporate bonds and 5% of outstanding bank loans. De- MSCI: 1.00 spite the growing allocation, foreign ownership of Chinese World MSCI: 0.98 1.00 onshore equity at 4.3% is still much lower than those of other US MSCI: major markets, such as the US (16%). Japan 0.92 0.88 1.00 MSCI: EM 0.78 0.68 0.81 1.00 The A-share market, however, is likely to experience growing MSCI: pains before becoming truly mature. For instance, equity de- Euro 0.50 0.34 0.59 0.83 1.00 Area rivatives are still too restrictive, even for hedging purposes. China: CSI- 0.71 0.73 0.74 0.47 0.19 1.00 Much stricter disclosure and accounting rules are called for, 300 and investor protections remain weak. More long-term China: Shang- 0.20 0.21 0.36 0.11 0.01 0.80 1.00 hai funds from retirement, insurance, and endowment accounts can help to reduce market churn and improve stability. Source: MSCI, Haver, IIF calculation