MSCI’s recent decision to delay including China’s local shares in its widely tracked emerging markets equity index reflects the views of its clients: namely, the global investors who use the index as a benchmark for constructing portfolios and measuring their performance.
To put the decision in perspective, China has the second-largest equity market in the world, and global investors will inevitably face the task of integrating these assets into their portfolios. But with the MSCI announcement, investors may be saying, “not yet.”
There are several reasons why investors would want to slow the process. First and most visible, China’s growth slowdown and uncertainty over its currency policy have created significant volatility in the country’s equity markets (and others) over the past year, notably last August and at the start of 2016. China’s stock markets are still struggling to find a valuation floor based on local demand.
Global investors are perhaps even more concerned about access to their invested funds. Chinese authorities have introduced significant improvements to the accessibility of local A shares, but there is still a 20% monthly repatriation limit. In addition, Chinese authorities have yet to effectively implement the recently announced changes to the Qualified Foreign Institutional Investor (QFII) program and clarify new rules on equity trading suspension.
It is not surprising then that global investors want to see more changes before adding Chinese local shares to their portfolios. However, it is worth noting that they are not slamming on the brakes: If developments warrant, MSCI said it will revisit its decision before the next scheduled index review in 12 months. We expect that Chinese authorities will try even harder to fulfill MSCI’s criteria over the next year.