By Adam Goff, managing director, investment process and risk, Russell Investments
China has been the largest contributor to world economic growth in recent years, and has therefore demanded attention from investors when considering the global equity opportunity set.
Notwithstanding the focus on China in the media most investors continue to under-allocate to China relative to what its free-float weight would be in the absence of restrictions on foreign investors’ access to China. Here we explain why we think investors should be allocating more than the current free- float weight within their global equity portfolios. In the Russell Global Equity Index, China constituted 0.04% of the total market cap by country of exchange as at the end of 2011. This under-allocation has been primarily due to restrictions on foreign investors’ access to China’s onshore equity market. Foreign investors can access Chinese companies through offshore listed Chinese stocks; however, they constitute only 1.69% of the Russell Global Equity Index by market cap. Assuming that there were no restrictions and adjusting for free-float, China would represent an allocation of 7.93% in terms of global market cap by country of exchange and 9.45% by country of domicile.
For those who view the global equity opportunity set in terms of market cap, there is clearly a big underweight to China given the restrictions on foreign ownership. As a result of the continuing growth of the Chinese economy and market, most investors have a perplexing and growing ‘China problem’ created by the limited access to investment in China granted by the authorities there. In order to get fully representative exposure to global equity markets, they likely need to hold much more Chinese equity than they currently do, more than their current index reflects, and likely more than their Asia or global equity managers are able to hold. This problem will arguably only become greater over coming years, assuming Chinese economic dynamism and growth prospects continue to make it the key driver of global economic growth and Chinese stock market holdings continue to increase in value. We recommend that investors access China by investing in China A shares.
The A share market is the largest and deepest market for China equity shares, with over 2300 companies listed on the Shanghai and Shenzhen stock exchanges with a total market capitalisation of almost $4trn. It is an onshore market accessible only to domestic Chinese investors or qualified foreign institutional investor (QFII) quota holders. While recognising the scarcity of QFII quotas, we recommend investing through a fund with its own QFII quota; this is the most direct and transparent way of actively investing in the A share market. Many forecasters predict that China’s real growth rate is likely to be in a 5-8% range over the next decade rather than the double- digit rates of the past two decades. Notwithstanding this slowdown, this pace of growth would still place China on track to overtake the United States as the world’s largest economy some time before 2030. Against this background it is important that investors are clear on how they are going to increase their allocation to China if they wish to hold portfolios that are representative of the full investable opportunity set.
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