Emma Wall: Hello and welcome to the Morningstar Series "Ask the Expert". I'm Emma Wall and I'm joined today by Jackie Choy, Morningstar's Head of ETF Research in Asia.
Hi Jackie.
Jackie Choy: Hi Emma.
Wall: So, finally after some years of speculation the index provider MSCI has confirmed that from June it will be including China A Shares in its China index and its emerging markets index. I thought perhaps first we could recap with, what are China A Shares?
Choy: So, China A Shares are companies incorporated in China and listed on the Chinese exchanges. So, they are the Shanghai Stock Exchange and the Shenzhen Stock Exchange only available to domestic Chinese investors.
Wall: And I think a lot of investors don’t realise that that when are buying a China fund quite often they are not buying stocks that are listed in Mainland China, they are buying stocks that are listed here in Hong Kong which are called China H Shares.
Choy: That’s correct. So, there are different class of shares for Chinese companies, a bit of history in there. But in short they are the same company offering different class of shares A Shares and H Shares, not all companies have H Shares or A Shares, but lot of them only have A shares so only available on the Chinese exchanges. And there are also different sort of Chinese companies listed elsewhere, for example Alibaba is only available in the US market.
Wall: And what impact will MSCI including these A Shares have on in particular investors in ETFs and passive funds?
Choy: So, the change itself at the very first place is only a very little amount in number terms. If you look at the inclusion only 0.73% would be included into the MSCI EM Index when you count the A Shares at the first time when it's included. But this will only increase as time goes on.
Wall: And so, I suppose in a nutshell that means that investors in these ETFs, into ETFs that track these indices will suddenly have a much higher exposure to China than they did before.
Choy: That’s correct. So that can only increase. So, as I mentioned it's 0.73% and increasing going forward. The reason why this increase, because MSCI is rather only to include 5% of the market cap of the 222 large-cap companies Chinese A Shares into the MSCI EM Index. So as and when they include the mid-caps and also increasing that 5% market cap threshold the percentage will increase. That 0.73% will increase.
Wall: I suppose the big question is this a good thing. Is it a good thing to have more China shares in particular A Shares in these portfolios?
Choy: Well that depends on your view in the Chinese A Share market for one. But in the other perspective if you look at from a portfolio construction perspective this provides you with some kind of diversification benefit, because if you look at the MSCI China Index which is the version without the A Shares, historically the correlation with the rest of the world, MSCI world, is around 80%. The MSCI China A Index the only A Shares version is around 60% with rest of the world. So, combining the A Shares into the MSCI EM Index that could provide investors with little bit of additional diversification benefit.
Wall: I suppose the big question also is this going to affect absolutely all individuals who invest in passive funds and ETFs in emerging markets and China?
Choy: Well, that’s a very good question Emma. So, remember this change is only for MSCI index given by MSCI obviously. So, for ETFs or passive funds tracking the MSCI EM Index or the MSCI China Index this will be affected from June 2018, A Shares will be included. But an ETF is tracking say for example FTSE EM Index this would not be affected.
Wall: And so how do you tell for example looking at the two largest providers of ETFs globally, iShares and Vanguard. whether you will be impacted by this change.
Choy: So, investors should really look at the not just the name of the ETF, they should look at what index they are actually tracking for that particular ETF. Even iShares or Vanguard, if they track the MSCI EM Index very likely they will include A Shares immediately. But they track the FTSE Index, that would be different story. And bear in mind that there are different versions of the indices as well, for example Vanguard, the Vanguard Emerging Market Index ETF (VWO) they already included A Shares into their ETF back in November 2015. They just use different version of the index.
Wall: So you may find actually if you invest in that ETF you already have A Shares exposure.
Choy: That's correct. So look at the index not just the name of the ETF.
Wall: Jackie thank you very much.
Choy: You are welcome Emma.
Wall: This is Emma Wall from Morningstar. Thank you for watching.
