Five years of investing in China A-shares

Chinese A-shares – shares that trade in mainland China on domestic exchanges and which are priced in the local currency, the renminbi – have been accessible to foreign investors for 20 years. However, for much of that time they were the domain of institutional investors with special licences to buy and sell the shares.

Then, on 31 May 2018, on the back of China’s growing economic strength and improving market accessibility, the MSCI added 222 of the shares to the MSCI Emerging Markets Index and retail investors suddenly had exposure to these extra opportunities. The inclusion ratio of China A-shares in this index started at 5%, rising to 20% the following year*.

China is the second largest equity market globally and its representation in the MSCI Emerging Markets Index has, in fact, been on the rise over the last two decades; from a mere 7% in 2000 to approximately one third today** – this is because other types of Chinese shares were already included, such as those traded on the Hong Kong stock exchange.

How have A-shares performed?

Of the spaghetti soup that is Chinese shares, A-shares have been the top performers over the past five years – although this has not been achieved without significant volatility.

China A-shares returned 18.15%*** over the period, while China H-shares – those listed on the Hong Kong stock exchange and traded in Hong Kong dollars  – have returned just 1.14%***.

China Red Chips (the shares of mainland China companies incorporated outside mainland China and listed in Hong Kong),  P-Chips (Chinese companies listed on the Hong Kong Stock Exchange which are incorporated in the Cayman Islands, Bermuda and the British Virgin Islands with operations in mainland China) and B-shares (those listed in China but priced in either US or Hong Kong dollars) have all lost money***.

China A-shares have also outperformed both the wider MSCI Asia ex Japan index and the MSCI Emerging Markets Index***.

What’s the outlook for China today?

The team behind Allianz China A-Shares says that “Nobody seems to be completely satisfied with China’s economic rebound, not even top government officials.”

“The Politburo meeting at the end of April – the first top-level signal of economic policy since December – painted a balanced picture and did not attempt to sugar-coat the situation,” the team said. “Their summary was that economic growth is better than expected, and market demand has gradually recovered … But the positive turn in the economy is still mainly from a recovery; internal dynamism is not strong, and demand is still insufficient.”

“While equities have experienced a reality check in recent weeks, economic momentum looks to be broadening,” the team continued. “As the labour market tightens, we think there should be room for incomes and spending to improve further.”

“Daily turnover in China A-share markets has been picking up, as have margin transactions. Domestic sentiment looks to be improving,” Allianz continued. “There have been several catalysts, mostly based around the macro-environment.

“However, looking behind the headlines, the recovery is quite uneven. The majority of the Q1 growth came from a rebound in services, as areas such as restaurants, catering, entertainment, and domestic tourism surged once the Covid lockdowns ended. More broadly, the risk appetite in consumer and manufacturing sectors remains subdued. A central bank quarterly survey of 20,000 households in 50 major cities reported that 58% of households are planning more saving (rather than more consumption or more investment).”

The managers behind the FSSA Greater China Growth and All China funds, say that while many think the China market rebounded too quickly, the team thinks equity valuations are still reasonable.

“To put things in context, last year investor sentiment was extremely low — there was a feeling that China was not investable,” they said. “Most of these headwinds have cleared up. Covid-Zero is unlikely to return, after most of the population has been infected or vaccinated. The pessimism around the property market has also improved. And in general, regulations have turned more pro-growth, if you look at areas like property, internet and education.”

Since travel restrictions were lifted in the mainland, the team has taken multiple trips to China and says cities are “bustling with activity,” the managers said. “Restaurants were packed, hotel occupancy was high, and we experienced multiple traffic jams. In contrast to our recent trips to the UK, we rarely heard about anyone working from home. The high-speed train back to Hong Kong was almost full.”

“On the other hand, the companies we met sounded conservative or cautious about the outlook for their businesses — the management believe that things have troughed, but it will take time for any meaningful recovery to materialise, as income growth has been affected by the pandemic restrictions in recent years,” the managers added. “This view was common in consumer companies across electronics, property-related products, specialty lighting and bedding products.”

What about A-shares?

“The A-share market continues to trade at a valuation premium to H-shares and ADRs, perhaps due to lower sentiment among foreign investors. However, we think the appeal of the A-share market is not on valuations, but the market depth and range of choices,” the FSSA team said.

“In certain industries, such as industrials, home appliances, medical equipment and drug companies, investors can only access the best Chinese companies via A-shares. But we do need to be careful about valuations, as the A-share market is largely driven by short-term traders and momentum,” the managers continued. “While this is good for small companies looking to raise funding, as seen in the high number of initial public offerings (IPOs), in certain areas we think valuations are still too high, like electric vehicles for example.

“Another positive is that the China A-share market is still in the process of being included into global indexes like MSCI. Meanwhile, the Chinese government is still keen to attract global investors. As the market becomes more developed and well-researched, we believe our active management approach, 30-year history in China and company relationships built up over this time will allow us to uncover more hidden gems.”

JP Morgan China Growth & Income team added: “Chinese onshore equities have historically had a low correlation to other assets, offering investors potentially attractive portfolio diversification opportunities. Correlations will likely rise as foreign investor participation in the Chinese market rises however, we believe they will remain low relative to developed market assets, given China’s distinct economic and policy cycles.

“With Chinese growth likely to accelerate into 2023, we think China could once again diverge from the global business cycle. China’s equity market is shifting towards sectors that are benefiting from its transition to a more consumption and innovation driven economy, and away from sectors that are more reliant on investment and exports. The beneficiaries of China’s economic transformation and as such, key investment opportunities, include consumer goods, technology, health care and high-end manufacturing. Additionally, there is greater exposure to small and mid-cap stocks that typically service the domestic economy, meaning they are more sheltered from US China tensions, and less subject to Chinese regulatory interventions which have targeted mega-cap companies that are generally listed offshore.”

*Source: MSCI

**Source: Goldman Sachs

***Source: FE fundinfo, total returns in sterling of MSCI China indices, 19 May 2018 to 18 May 2023

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