&l;span&g;MSCI Inc.&s;s inclusion of A-shares in its influential emerging markets index is expected to steer RMB400 billion of foreign inflows into the Mainland China A-share market over the next five to 10 years. &l;/span&g;
&l;span&g;But the prospect of generous inflows inspired by this significant milestone in the growth of Mainland China&a;rsquo;s capital markets isn&a;rsquo;t the only reason why global investors should be investing in A-shares.&l;/span&g;
&l;span&g;For one, &l;strong&g;valuations look attractive&l;/strong&g;. Specifically, the 234 A-shares that are set to be included in MSCI&a;rsquo;s emerging markets index on June 1 on average trade at 11 times 2018 earnings against expected earnings growth of 15.9% this year. Putting things in context against the rest of Asia, only South Korea trades at a lower price-to-earnings multiple, while only India is expected to deliver a higher pace of earnings growth. Moreover, the 11 times 2018 earnings at which the 234 A-shares trade is also markedly lower than the 17 times earnings commanded by U.S. stocks.&l;/span&g;
&l;span&g;Importantly, &l;strong&g;A-shares also offer ample diversification benefits to global investors&l;/strong&g;. The historical average correlation between U.S. stocks and Mainland China A-shares is only 11%, which is even lower than the 32% for Hong Kong stocks. Additionally, the A-share market provides a very broad universe of stocks for investors to capture China&a;rsquo;s growth and economic trends. Its total market capitalization of $8.75 trillion is the second largest in the world. There are also a number of unique sectors that can only be accessed through the A-share market such as baijiu (or white liquor), home appliances and traditional Chinese medicine.&l;/span&g;
&l;img class=&q;size-full wp-image-50&q; src=&q;http://blogs-images.forbes.com/valuepartners/files/2018/05/Correlation-A-shares-and-SP500.jpg?width=960&q; alt=&q;&q; data-height=&q;510&q; data-width=&q;804&q;&g; The historical average correlation between U.S. stocks and Mainland China A-shares is only 11%.
&l;span style=&q;font-weight: normal !msorm&q;&g;&l;strong&g;Market inefficiency in&l;/strong&g;&l;/span&g;&l;strong&g; the A-share&l;span style=&q;font-weight: normal !msorm&q;&g; market &l;/span&g;offers&l;span style=&q;font-weight: normal !msorm&q;&g; a source of alpha for investors&l;/span&g;&l;/strong&g; &a;ndash; but meticulous on-the-ground research and disciplined stock picking are essential. Retail investors accounted for 86% of total market trading volume in 2016, according to data from the Shanghai Stock Exchange. The level is more than double the 35% retail investor participation rate for the Hong Kong stock market. Low participation by institutional investors and even lower participation by quant investors mean there is greater mispricing in the A-share market compared to more mature markets. And greater mispricing means there is more room for portfolio managers to generate alpha through disciplined bottom-up stock picking. As a long-time investor of A-shares, we established an office in Shanghai in 2009 to conduct the meticulous on-the-ground research that&a;rsquo;s paramount to successful stock picking in the A-share market.
&l;img class=&q;size-full wp-image-51&q; src=&q;http://blogs-images.forbes.com/valuepartners/files/2018/05/Retail-Participation.jpg?width=960&q; alt=&q;&q; data-height=&q;510&q; data-width=&q;786&q;&g; Retail investors account for a massive 86% of turnover on the Mainland China A-share market.
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The A-share market is less concentrated in large cap stocks compared to the U.S. stock market. While the top decile of companies by market cap account for 75% of the total market cap of the U.S. stock market, the level is only 59% for the A-share market. But despite their prevalence, small-cap and growth stocks command unparalleled popularity and generous valuation premiums to large cap stocks in the A-share market due to the high retail participation rate. As a result, large cap stocks tend to trade at a relative discount and present a &l;strong&g;good hunting ground of quality stocks for value investors&l;/strong&g;.
&l;span&g;Finally&l;/span&g;, the start of the initial round of A-share inclusion this week, while no doubt symbolically significant, marks&l;strong&g; only the beginning of the internationalization of the A-share market&l;/strong&g;. While A-shares are expected to account for only 0.9% of the MSCI Asia ex-Japan index by the end of the initial phase of inclusion taking place this week and in September, their weighting is set to increase substantially over time. A-shares could account for more than 18% of the MSCI Asia ex-Japan index if MSCI eventually includes more stocks and increases the weighting of A-shares to full weighting from the 5% partial inclusion weighting adopted for the initial phase. And that could translate to between RMB200 billion to RMB400 billion of inflows into A-shares over the next five to 10 years.
&l;strong&g;&l;em&g;Disclaimer:&a;nbsp;&l;/em&g;&l;/strong&g;&l;em&g;The views expressed are the views of Value Partners Hong Kong Limited only and are subject to change based on market and other conditions. The information provided does not constitute investment advice and it should not be relied on as such. All materials have been obtained from sources believed to be reliable, but its accuracy is not guaranteed. This material contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.&l;/em&g;&l;/p&g;
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