China A-Shares benchmark inclusion raises liquidity concerns

Index provider FTSE Russell last week announced that it will launch two transitional indexes that include China A-Shares, a move that will significantly impact Chinese market flows. With MSCI’s decision on including A shares in its World and Emerging Market indices due on 9 June, demand for these stocks could cause liquidity issues according to Jian Shi Cortesi, Investment Manager at GAM.


“Increasing the allocation to Chinese equities in the MSCI World and Emerging Market indices could markedly boost flow levels for a number of reasons. Most international investors are not currently buying Chinese A-Shares. Sourcing information is challenging for many investors due to the language barrier, and many are not prepared to buy A-Shares as China is not yet included in the index.


“All China related ETFs will have to start buying these Chinese stocks when they are included in the benchmarks. Approximately 25% of the MSCI Emerging Markets Index is currently allocated to China, but with the addition of Chinese A-shares and US ADRs – Chinese equities listed on US exchanges – this could increase to more than 40% of the index.


“The timing of the inclusion is not certain. There could be a series of gradual weighting increases over a few years; this seems sensible given there needs to be enough liquidity in the market for the buy side to purchase underlying A-shares. However, currently China’s QFII schemes and Stock Connect programme have quotas and can digest only a certain amount of flows, and if all index providers announce an inclusion in short proximity, the potential for market dislocation could be quite large.


“As all ETFs have to purchase the underlying shares on the same day that an index provider’s change to its allocation comes into effect, flows into US listed Chinese companies and Chinese A-shares could be very significant.


“US-listed ADRs from China will be added into the existing MSCI China Index, which currently tracks Hong Kong listed Chinese companies, after they have been evaluated during the Index Review in November 2015. This will result in significant inflows into ADRs, but outflows from current index constituents.”