China is changing. Change is afoot across a number of dimensions, from economics to demographics to the very definition of "China"—at least as global index providers define the country. Many benchmark providers are considering adding different classes of Chinese shares (namely A-Shares and N-Shares) to their global indices. They also are creating new indices that include A-Shares to underlie index-tracking ETFs and mutual funds, as well as for use by active managers as new benchmarks that better reflect their rapidly evolving opportunity set.
We launched a research report “Change Is Afoot in China”. This report should help investors navigate the changes currently taking place in Chinese markets, and in the indexes indices and exchange-traded funds that track them.
In this paper, we will:
- Look at how index providers are changing the way that they "define" China.
- Evaluate how some of these definitional changes may affect investors.
- Discuss areas investors should be mindful of when using Chinese equity ETFs.
- Discuss how benchmark changes might affect investors in Chinese equity ETFs.
How are index providers changing the way that they "define" China?
The major index providers, including MSCI, FTSE Russell, and S&P are considering adding A-Shares to their global benchmarks. They also are creating new indices that include A-Shares to underlie index-tracking ETFs and mutual funds, as well as for use by active managers as new benchmarks that better reflect their rapidly evolving opportunity set. Additionally, MSCI has announced that effective November 2015, "overseas listed companies" such as Alibaba and Baidu will become eligible for potential inclusion in the MSCI China Index.
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How might some of these definitional changes affect investors?
The inclusion of Chinese A-Shares in emerging markets and global benchmarks likely will alter the risk/return profile of the index, while achieving some degree of diversification benefit as the onshore and offshore Chinese equities have historically exhibited low correlation.
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What should investors be mindful of?
Investors should be mindful of the associated costs stemming from these transitions, premiums, and discounts within the relevant ETFs, the nuances of benchmark construction, and so on. All these various considerations could affect investors’ decisions and ultimate outcomes.
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In summary, we suggest that investors investing in or considering an investment in Chinese equity ETFs be prepared well ahead of these changes. Specifically, they should be able to answer the following questions:
- How are the Chinese equity indices that I am considering changing their definition of "China"?
- How might the changes affect the index's risk/return profile? Its sector weights? Single-stock concentration?
- How might the changes affect the total cost of ETF ownership (that is, both explicit and implicit costs)?
- How are the ETFs under consideration implementing these changes? Are they following the same index or changing their benchmark? What about the way in which the ETF invests into the different Chinese equity markets, for example, using the QFII/RQFII/Stock Connect channels to invest into A-Shares or using A-Share ETFs.
For details please refer to the full report.
