MSCI review points to future changes to China ETFs

Dec 1st, 2015 | By | Category: Equities

MSCI, a leading index provider to the exchange-traded funds industry, has announced composition changes to their index suite as set out in the firm’s semi-annual review. One of the important highlights of this review was the decision to include US-listed shares of Chinese companies within the relevant indices, a move which will see significant buying and selling activity in tracking assets such as ETFs.

MSCI Indices review signals future changes to China ETFs

The move is expected to see China’s weighting within the MSCI Emerging Markets Index increase from 25% to 29%.

Currently, China’s involvement in MSCI’s indices has been limited to Hong Kong-listed shares and excludes internationally-listed stocks as well as A-Shares, those listed on China’s domestic platforms, the Shanghai and Shenzhen Stock Exchanges.

Some of the more prominent ETFs to be affected by the inclusion of US-listed shares include the iShares MSCI Emerging Markets ETF (IEEM), which holds over $22bn in assets under management (AUM); the iShares Core MSCI Emerging Markets ETF (IEMG), which holds over $8bn in AUM; and the iShares MSCI China ETF (MCHI), with over $1.8bn in AUM. (Figures as of 28 November 2015)

The review also heralds in significant changes to the sector compositions of China indices and their tracking ETFs. For example, the MSCI China Index will see its exposure to the technology sector expand from 14% to 27% while the financials sector will shrink from 42% to 34%. These changes reflect an updated profile of China’s investment landscape as a modern growth-oriented economy.

All relevant changes will be implemented in two stages, each phase adding half of the free float-adjusted market cap of the new inclusions. The first stage will be applied from 1 December 2015 and the second stage will occur on 1 June 2016. This has been done to minimise trading and market impact costs that tracking assets such as ETFs would incur from large-scale portfolio adjustments; there are roughly $9tn of reference assets linked to MSCI’s index suite and Goldman Sachs has estimated the buying activity linked to this review may exceed $90bn.

Although the current adjustments are significant enough to see China’s weighting within the MSCI Emerging Markets Index increase from 25% to 29%, a more notable change will occur with the eventual inclusion of China’s A-Shares.

The Shenzhen-Hong Kong connect, a programme linking the Shenzhen and Hong Kong exchanges, is due to open up Shenzhen-listed shares to foreign investors. The move may be seen as the last piece of the puzzle after the successful launch of the Shanghai-Hong Kong connect programme. The Shanghai Stock Exchange has historically been known for listing larger, more liquid companies compared to the Shenzhen Exchange; however, with both programmes operational, investors will finally be able to access a broader profile of investments that better reflects the entire Chinese investable universe. This may compel MSCI to allow the inclusion of domestically-listed shares in their indices. Current estimates see China’s share of the MSCI Emerging Markets Index increasing to 40% in this eventuality.

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