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November 8, 2019

Where next for China A-shares?

<strong>By: Louisa Lo, Head of Greater China Equities, <a href="https://ad.doubleclick.net/ddm/clk/455624783;260068194;p" target="_blank" rel="noopener noreferrer">Schroders</a></strong><strong><img class="alignleft wp-image-140581 " src="https://www.cover.co.za/wp-content/uploads/2019/11/Louisa-Lo-Deputy-225x300.jpg" alt="" width="169" height="225" />The rise of China’s A-shares market is a theme that can’t be ignored. Here’s where we’re seeing opportunities in the country.</strong><span style="font-weight: 400;">China’s domestic stock market is on the rise and we think it represents a potentially very attractive long term opportunity for investors.</span><span style="font-weight: 400;">There is a striking disparity between China’s share of global economic growth and its share of the global stockmarket index. Chinese stocks currently represent just 3.8% of the MSCI All-Country World Index, while China’s share of global GDP is 16%.</span><span style="font-weight: 400;">With the market opening up to foreign investors, and given MSCI’s recent decision to include China A-shares into its global indices, we expect China’s representation in global portfolios to increase significantly over the coming years..</span><h3><span style="color: #002462;"><b>How investors access Chinese shares</b></span></h3><strong>Investors can access Chinese equities through a variety of channels:</strong><ul><li style="font-weight: 400;"><span style="font-weight: 400;">The companies quoted in Hong Kong (H-shares, red chips and P-chips)</span></li><li style="font-weight: 400;"><span style="font-weight: 400;">The depository receipts quoted on the NASDAQ exchange in the US (these are called American Depositary Receipts and enable access to the likes of tech giants Alibaba or Baidu)</span></li><li style="font-weight: 400;"><span style="font-weight: 400;">The on-shore domestic market (A-shares).</span></li></ul><span style="font-weight: 400;">There is still important progress to be made in A-shares, with the on-shore market only recently opening up to international investors through the Shanghai-Hong Kong (2014) and Shenzhen-Hong Kong (2016) Stock Connect programmes.  </span><span style="font-weight: 400;">These programmes allow foreign investors to access domestic Chinese equities (A-shares) through the Hong Kong Stock Exchange. However, only 3% of investors in the domestic market are foreigners.</span><h3><span style="color: #002462;"><b>Retail investor dominance</b></span></h3><span style="font-weight: 400;">The A-shares market remains dominated by domestic retail investors who make up 86% of daily trading volume, compared to 35% for the Hong Kong market.</span><span style="font-weight: 400;">This high proportion of retail investors contributes to the higher volatility of the market relative to more developed exchanges. This is because retail investors typically have shorter investment time horizons and respond more to market events, resulting in more buying and selling of shares and higher market volatility.</span><span style="font-weight: 400;">That said, the market is attractive for active fund managers who can take advantage of the inefficiencies in the market. Looking across the board, the median China A-shares fund manager has outperformed the MSCI China A Onshore benchmark in four of the last five years.</span><h3><span style="color: #002462;"><b>Market shifts</b></span></h3><span style="font-weight: 400;">Over the last few years, investor interest has shifted from "old" China (infrastructure, banks, telecoms) to a greater focus on consumer (staples, food &amp; beverages) and so-called "new economy" stocks (healthcare, consumer discretionary, IT).</span><span style="font-weight: 400;">This is because the driving force behind Chinese growth is increasingly based on the consumer. We expect this shift to continue.  </span><span style="font-weight: 400;">Another theme we’ve been seeing in China is the push towards automation, given the need for China to improve productivity. This move is also consistent with the need to produce goods with better quality, and to become more self reliant in terms of technological capability.</span><span style="font-weight: 400;">The A-shares market remains very well balanced in terms of sectors, especially when compared to Hong Kong where technology, banks and commodities still dominate the index. This means it is possible to manage a more diversified portfolio on the A-shares market.</span><span style="font-weight: 400;">Meanwhile, inflows to the market have been strong since the start of the year, despite constant headlines around US-China trade tensions.</span><span style="font-weight: 400;">It’s also worth noting that the Chinese market has a low correlation to the other global markets, which can provide diversification benefits. But investors need to remember that this is still an emerging market, with a higher level of volatility.</span><h3><span style="color: #002462;"><b>Which sectors in China A-shares are of interest?</b></span></h3><span style="font-weight: 400;">At the moment, we continue to see a number of potentially attractive investment opportunities in the Chinese market</span><span style="font-weight: 400;">One of the sectors we are especially interested in is healthcare. There has been a strong trend towards the outsourcing of manufacturing and research &amp; development of drugs by pharmaceutical companies. We expect firms operating in this area to become more prevalent going forward.</span><span style="font-weight: 400;">Elsewhere, while we remain cautious on real estate companies, insurance companies are of interest to us due to the level of penetration of insurance products in China, which remains low.</span><h3><span style="color: #002462;"><b>Corporate governance catch-up</b></span></h3><span style="font-weight: 400;">Finally, from a corporate governance perspective, in many cases companies are still catching up, in terms of the standards generally seen in more developed markets. However, the trend is definitely positive and we think the level of domestic ESG (Environmental Social and Governance) standards will improve going forward, with increased engagement from institutional investors.</span><h3><a href="https://ad.doubleclick.net/ddm/clk/455624783;260068194;p" target="_blank" rel="noopener noreferrer"><strong>Find out more about the Global Investor Study here</strong></a></h3><em><span style="font-weight: 400;">Regions and sectors discussed for illustrative purposes only and should not be viewed as a recommendation to buy or sell. </span></em><em><b>Important Information:</b><span style="font-weight: 400;"> For professional investors and advisers only. The material is not suitable for retail clients. We define ‘Professional investors’ as those who have the appropriate expertise and knowledge e.g. asset managers, distributors and financial intermediaries. Past performance is not a guide to future performance and may not be repeated. Schroders Investment Management Ltd is an authorised financial services provider FSP No: 48998, registration number: 01893220</span></em>