China’s $14 trillion equity market is too important to overlook, and it may be time for international investors to consider the country as a standalone allocation, argues Vincent Che, portfolio manager of the Merian China Equity Fund.
China’s equity market hasn’t quite matched the country’s remarkable GDP growth in recent years but we believe that’s changing.
The market including Hong Kong and the mainland is forecast to as much as double in value in the next 10 years as economic fundamentals improve further and policymakers encourage more open capital markets to attract investors.
We expect the Chinese government to continue to reform and direct its economy toward consumption, innovation and supply-side changes. It is worth noting that China’s macro-economic stability has significantly improved over recent years. Overcapacities in the housing, industrials and infrastructure sectors have been targeted, which helps the economy to balance supply and demand.
The elimination of overcapacity also helps improve asset returns and mitigate the debt problem, which eases the pressure of capital outflow. Better macro stability should translate into lower systematic risk and improve long-term valuation of China assets.
We see further improvement in asset utilisation and corporate returns, as companies are increasingly being run for shareholders rather than the state. Higher returns would be a tailwind for Chinese equities.
Policymakers have introduced changes to open up capital markets for international investors. In May, the securities regulator modified rules to allow international financial firms to become majority owners of local joint ventures.
Additionally, the Stock Connect program has ended the historic split in the market between A shares targeted at local investors and H shares available to international investors. This helps to create a more unified stock market in the place of a divided one.
In February, MSCI said it will boost the weighting of China A shares in its indexes by increasing the inclusion factor to 20% by the end of the year from 5% previously.
We believe these changes are improving the accessibility, sophistication and efficiency of the country’s equity markets. This in turn changes the China allocation equation for global investors.
Is it time to consider China as a standalone allocation, rather than part of an emerging markets basket? We think it is, and we believe more international investors will recognize the advantages of China’s emphasis on sustainable, high-quality economic expansion as policymakers encourage innovation and efficiency.
 Morgan Stanley research