Thanks to the news that the MSCI will finally include Chinese mainland A-shares in several key indices in the coming months, it should come as no surprise to learn that investor interest in the the Chinese CSI 300, which tracks the performance of 300 stocks listed in Shanghai and Shenzhen, has risen.
The difficulty is that after the “great retracement” of Chinese shares in June 2015, foreign investors have found it difficult to assess the level of risk in the market.
Many investors deserted Chinese A-shares and Hong Kong H-shares two years ago this month after Chinese bourses plummeted by a magnitude larger and further than anything seen in the US during the depths of the Great Depression.
Chinese shares became unpopular (literally) overnight. Those who chose to remain were criticised for being behind the curve.
But a cohort within the ultra high net worth investment community chose to hold onto their Sino shares. They were conscious of a longer term and ultimately more robust mega-trend.
Since 2014 we have supported the case that China’s CSI 300 has the real possibility of tripling or even quadrupling from then current market valuations within a decade.
Removal of restrictions
This week, chief China economist for Citibank Dr Liu Li-Gang’s seemed to back this view, predicting that “foreign investors could invest US$3 trillion ($3.8 trillion) into Chinese stockmarkets by 2025 because of the removal of restrictions to entry, together with eventual inclusion of China in various global capital market indexes”.
Li-Gang said that “2017 could be viewed as a tipping point for global asset allocation”, following the long-awaited inclusion of China A-shares into the MSCI emerging market index on June 20.
Thus begun the integration of the second largest equity market in the world and made Chinese A-Shares trendy again, simply because they went from being a “nice-to-have” to a “have-to-have” global portfolio allocation.
Notwithstanding, UHNW investors are acutely conscious that this mega-trend has more to it than simply MSCI index inclusion.
They realised that the Chinese Communist Party’s (CCP) state-led model allowed individuals to invest in real estate so that China could continue its progression from developing to developed world status.
The shadow banking sector played a useful role here, providing liquidity to the property market to keep prices buoyant when the regulated banks could no longer lend.
In early 2014, the CCP opened a new gate for its citizens to invest more easily in the CSI 300 and other Chinese stockmarkets for two primary reasons.
The first is that they desired an advanced capital market architecture, just like countries in the OECD.
Second, and more interesting, the CCP itself is a significant stakeholder in a majority of State Owned Enterprises (SOEs) so will benefit when share prices rise.
UHNW investors have known that when the CCP achieves what it wants, only then will it relax its infamous “iron curtain” capital controls, giving all investors access to mainland Chinese markets, not just institutions and wealthy investors.
Rates in positive territory
Furthermore, for all its woes, China’s interest rates have remained in positive territory, while more than 40 per cent of developed world monetary systems have turned to negative rates.
The lesson for investors is that China’s move to becoming a developed economy can lead to only one outcome for its leading stockmarket bourses.
It is good news for other markets too.
Australian investors must remember that even if Sino markets unexpectedly fall again, China’s central bank, the People’s Bank of China, retains a powerful set of options that, if deployed, would not only stoke Sino bourses, but Australia’s ASX 200 as well.
Indeed, if the PBOC was forced into a corner, say by another fall in the CSI 300, unconventional monetary policies, such as quantitative easing, negative rates and money printing tools, could inflate global markets like never before.
by Stirling Larkin
Stirling Larkin is chief investment officer of Australian Standfirst