Friday, 25 May 2018

Why investors shouldn’t ignore China’s capital markets

China’s capital markets have been largely beyond the reach of most foreign investors, whose holdings currently account for less than two per cent of its stock and bond markets.

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David Liao

President and CEO, HSBC China

But this is starting to change, and in a big way. Global investors, including Australia’s AUD2.6 trillion superannuation industry, are weighing up the opportunity to take advantage of continued market liberalisation in the world’s second largest economy.

The opening-up of mainland China’s capital markets – begun cautiously some 16 years ago – has sped up markedly in recent years, most prominently with a pair of “stock connects” linking onshore bourses in Shanghai and Shenzhen with the international finance hub in Hong Kong.

The China Interbank Bond Market (CIBM) Direct scheme was also introduced in 2016, followed by a “bond connect” with Hong Kong last July. And a new stock connect could link mainland China with London as soon as the end of this year.

Another major milestone comes on 1 June, when MSCI, the influential index provider, will include more than 200 large-cap mainland-China-listed stocks – also known as A-shares – in its closely-watched Emerging Markets Index.

What may sound like an abstract technical development is in fact hugely significant: the inclusion shows China is becoming accepted into the fabric of the global capital markets. It could also prompt well over half a trillion US dollars in foreign investments to pour into Chinese stocks in the next five to 10 years as institutional investors adjust index-linked portfolios to MSCI’s change.

Clearly, investors – be they European hedge funds, superannuation funds in Australia, sovereign wealth funds from Asia, or ordinary savers around the world – will need to be looking at what might be a once-in-a-generation opportunity in Chinese capital markets.

Their sheer size alone makes them compelling: China’s equity market is the world’s second-biggest, with over 3,000 A-shares listed in blue chips-heavy Shanghai and tech-centric Shenzhen valued at about USD8.7 trillion last year. Its domestic bond market, meanwhile, is the third-largest in the world.

What’s more, China’s economy is now fundamentally different from 20 or 30 years ago, so the composition of what’s investible has also become much more diverse.

Nimble and often innovative private companies are increasingly eclipsing giant state-owned enterprises, with the sector now contributing more than 60 percent of China’s economic growth and 90 percent of new urban jobs.

On the high-tech and innovation front, government policies have led to spectacular growth in e-commerce, advanced manufacturing, and electric vehicles. On the consumption front, rising incomes have created investment opportunities in everything from sportswear, to travel services, to fiery baijiu liquor.

And efforts to promote growth that’s not just higher-value but also good for the environment are set to foster green champions. Case in point: China’s top maker of wind turbines, listed in Shenzhen and in the business for barely 20 years, is now the third-largest manufacturer of renewable energy generators in the world, after only Denmark’s Vestas and Spain’s Siemens Gamesa.

To be sure, investing in China can sometimes feel like it’s not for the faint-hearted: witness the gyrations of A-shares in 2015.

MSCI for one has warned against prolonged trading suspensions of A-shares, and also wants to assign ratings on environmental, social and governance for mainland-listed stock on its index.

The same call has gone out for Chinese bonds. Bloomberg, which announced in March that it plans to add Chinese RMB-denominated government and policy bank bonds to its Global Aggregate Index starting April 2019, has urged additional enhancements to "increase investor confidence and improve market accessibility".

Such changes will take a bit of time. But longer-term, developments that encourage further opening up – such as the MSCI index inclusion – will both strengthen China’s capital markets and help finance its economic transformation.

For one, international inflows will help provide much-needed alternative sources of growth capital for cash-hungry private enterprises, as the government continues to focus on financial deleveraging to fend off risks to its economy.

Increased foreign participation in China’s markets could also contribute to improved financial and governance standards for publicly-traded securities, benefiting not just overseas investors but domestic ones as well.

All this is why we can expect further liberalization in the months and years to come: For Beijing, financial reforms, the opening-up of its capital market, and the growing international use of the renminbi that will come with that – all these are part and parcel of the wider economic rebalancing it wants to achieve.

The direction is clear, and the pace is picking up. For investors around the world, the enormous potential of China’s markets should now be well and truly apparent.

As featured in The Australian on 24 May 2018

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