China A-shares Introduction

Executive Summary

Purpose

This report looks to outline the Chinese stock market (A-Shares) and to compare and contrast the behavioral characteristics to already established markets. It will cover government regulation, market cyclical tendencies and the opportunities provided to foreign investors.

 

From June 2018, the MSCI Index announced partial inclusion of the A-Shares market to its index. MSCI Inc added around 230 China listed shares to its emerging market benchmark in a two-step process, firstly in June and then in September. This unleashed foreign inflows into the country’s stock markets as expected. As the 3^rd largest Stock market in the world, the A-shares market has quite different characteristics compared to the established markets. Furthermore, the market is still going through reforms and regulatory changes that significantly impact the share prices of individually listed stocks.

The purpose of this report is to:

●       Introduce the A-shares market; high level statistics and its history

●       Highlight key differences to the US market and other foreign markets

●       Provide benefits of investing in the A-Shares market

●       Bring forth risks of investing in the A-Shares market

 

Key Observation and Analysis

A-Shares Introduction

The A-shares market was originally established in Dec 1990. Over the last 3 decades, the A-Shares market has become the world’s 3^rd largest exchange with 6.09 trillion USD (measured by market capitalization). As at the 13^th of August 2018, it has a total of 3,651 listed companies with a market cap exceeding 50 trillion RMB and daily trading volume of 6.62 billion RMB.

 

                  Table 1: A-share Current trading details and market information. Source: www.eastmoney.com

 

Key Differences to Established Markets

Although the A-Shares market has adopted similar fundamental structure from developed markets, there are still key differences. Some of these we have observed are;

●       Market prices are significantly influenced by government policies and China’s Securities Regulatory Commission (CSRC) regulatory changes

●       Retail investors account for a much higher proportion of share ownership than established markets

●       Company valuations are very different to the US market where large caps tend to have much lower PEs than small caps

●       The A-shares market has a higher turnover than the US market

●       For small to mid-cap listed companies, large shareholders tend to still maintain controlling percentage of share ownership after the IPO process. This often leads to information asymmetry between large shareholders and small shareholders

 

Investment Opportunities

The A-shares market presents many investment opportunities for foreign investors such as:

●       Low P/E valuation compared to the US market

●       MSCI’s recent inclusion of A-shares and China’s continuing to deregulate its capital market has led to a dramatic increase of inflows in foreign funds

●       The high level of retail investors in the A-shares market creates greater ‘alpha’ opportunities for institutional investors due to market inefficiency.

 

Investment Risks

There are also great investment risks for foreign investors who don’t fully understand the A-shares market. Specifically, we have highlighted the following risks:

●       Historically the A-shares market has been more volatile than the US market. The market has been driven by the market sentiment and policy changes

●       Regulatory and policy changes have significantly impacted the market’s liquidity and prices

●       The hidden debt levels and leverage used in companies has led to unexpected losses for investors if not chosen carefully

 

Summary

As the 3^rd largest stock market in the world, A-shares present multiple investment opportunities. Diversification benefits for foreign investors being one of them. Given the different history and continuously changing policies and domestic economy dynamics, it is challenging for foreign investors to fully understand the risks and opportunities. This paper highlights the key different characteristics of potential benefits and risks of A-shares market.

Hopefully, this will help our clients better understand the A-shares market and how this may fit their investment portfolios.

 

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