The world of emerging market ETFs just got that little bit bigger at the start of June when MSCI formally included a selection of Chinese mega-caps within its Emerging Market index.
The decision regarding the Shanghai-traded so-called A-Shares was taken late last year and was announced as a two-step programme that will see some A-Shares included now and a further tranche entering the index in September.
In total, up to 5% of Shanghai's 3,000 listed blue chips will be included in the index and they will comprise 0.73% of the total EM index and 0.1% of the MSCI All Country World Index.
MSCI had previously rejected the inclusion of A-Shares because of issues around transparency and capital restrictions. What changed was the introduction of Stock Connect which is a trading programme which allows for two-way trading between Hong Kong and China.
"The Stock Connect is what's really changed," said Brendan Ahern, chief investment officer at KraneShares, a US-based provider of exchange-traded funds focused on Chinese equities.
To be clear, the introduction of the initial tranche of shares will not transform exposure to China via the MSCI emerging market index. Indeed, as of now the Chinese proportion of the index has gone up by a mere 0.8% to 31.3% based on current values.
But should the Chinese stock market liberalise even further to potentially warrant full inclusion of the A-Shares then Chinese equities would comprise 42% of the MSCI Emerging Markets index, with A-Shares alone accounting for about 16% of index weight.
Danny Dolan, managing director of China Post Global which runs a number of emerging market and commodity-focused ETFs, said that MSCI's move was further acknowledgment of a "long-term megatrend."
"International investors have noticed the country's ever-growing importance to the global economy and are increasingly keen to benefit from China's ongoing strong growth," he said. "The MSCI inclusion is a further concrete step in the ongoing opening up of the Chinese stock market and reflects the strong demand from international investors as well as the greatly-improved access.
Concerns remain, of course, among them volatility and the degree of leverage involved with many Chinese blue chip companies.
Chin Ping Chia, head of research for Asia Paciifc at MSCI, said even the partial inclusion of China A-Shares may also trigger other important investment questions such as how investors should evaluate the role of their emerging-market allocations as China accounts for a bigger slice of the index.
He also said investors would need to understand also whether the inclusion of A-Shares altered the fundamental characteristics of emerging markets and whether systematic strategies would work well in China.
Dolan said that China Post Global was pursuing a smart beta selective approach on order to mitigate concerns considerably. "Given the relative lack of international familiarity with the Chinese market, we see stronger demand among international investors for diversified and innovative China funds than for individual A-Shares at this point."
While emerging market country exposure may become more concentrated if China's exposure increases, the inclusion of A-Shares also may help open the doors to a part of China that was not accessible until recent years," said Chia. "This change may bring potential opportunities and diversification benefits."
Others suggested, however, have previously suggested there is a "strong argument" not to invest in A-Shares right now due to the cost of establishing position is such a relatively small basket of stocks.
The custody ticket charges, brokerage and other trading costs, to gain exposure to 222 stocks with a weight of 0.37% is an expense that could justifiably be considered too high for risk reduction of 0.04%," said Andrew Howson, senior portfolio manager for global equity beta solutions at State Street in a note issued last September.
"Even in the second phase of implementation, the cost of including 0.75% of China A-Shares to reduce tracking error by 0.10% could be considered inefficient."
However, this will change as MSCI ups the A-Shares exposure. "How quickly this will happen is unknown as MSCI has not announced any implementation plans past September," he added at the time. "One thing is for sure, China A-Shares cannot be ignored as they move towards 100% IIF and a weight of roughly 13.0% in the MSCI EM Index."