Elaine Tse, Portfolio Manager with the Global Emerging Markets Equity team at Wells Fargo Asset Management, lends insight into what China’s A-shares mean for investors.
Laurie King: I’m Laurie King, and you are listening to On the Trading Desk®. China’s transformation over the last 40 years with pro-market reforms have made investing in its companies attractive. But one opportunity set has remained off-limits—the Chinese A-shares. Until now, that is. We’re going to hear from portfolio manager Elaine Tse, who’s been investing in China for years, and learn what the new opportunity set China’s A-shares means for investors. And to do that is my colleague Matt Alexander, a thought leadership manager at Wells Fargo Asset Management. Matt, welcome to On the Trading Desk.
Matt Alexander: Glad to be here Laurie.
Laurie: You’ve been covering Elaine’s Global Emerging Markets Equity team and helped them bring an insights paper to market called China: A new opening for investors. What is most compelling about this opportunity in China now?
Matt: In a word, I would say, “access.” Direct access to mainland companies than most global investors ever had before.
Many of these companies are applying and developing cutting-edge technologies that make them global leaders. And investors can now take direct ownership stake in that.
Laurie: Let’s hear that conversation between you and Elaine and rejoin after.
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Matt: Well, Elaine, thanks for taking time to meet up with us today.
Elaine Tse: Thank you, Matt. I’m always happy to trade ideas with you.
Matt: You called the extent of pro-market reforms in China over the last 40 years a “metamorphosis.” That’s a strong word, isn’t it?
Elaine: Well, that indeed is a strong word, but the transformation in China over the last 40 years has been truly remarkable.
Now, back in the late 1970s, China was still a very poor country—largely agrarian—with less than 20% of its population living in cities. And I remember back then, if you go to the markets to buy fruits, you could only find a very limited selection of maybe two to three different kinds of fruit. And Shenzhen in 1980 was just a small fishing village with just 20,000 people.
Fast-forward to today. Shenzhen has a population of over 12 million. [They are] developing a major technology industry to rival that of Silicon Valley. Beijing and Shanghai are world-class cities comparable to New York and London. And if you were to buy fruits today, you can buy it online from a new format retail store, which provides the freshest fruits and vegetables with free delivery within 30 minutes—all transactions completed with digital payment. That, to me, is nothing short of a metamorphosis.
Matt: So why is China courting foreign investors now?
Elaine: I don’t really think of it as China courting foreign investors as much as China reducing restrictions and opening up its marketplace to investors all over the world.
China’s now the world second-largest economy. And it’s not only huge, but it’s also very integrated with the global economy. When a country is young and less-developed—no different from a child—it is arguably better off in a protected environment with strict rules and regulations. But now that China has grown up and is ready to join the big leagues, it must play by a different set of rules and be able to operate like the G7 economies can.
So for China to be worthy of this global leadership status, it should liberalize its capital accounts and move towards a freely floating currency, and it must open up its capital markets to foreign investors—including its fixed-income markets and the A-share equity markets.
Matt: So what exactly is an A-share? Can you define that for us?
Elaine: A-shares are domestic Chinese equities that are denominated in RMB [renminbi], and they trade in Shanghai and Shenzhen stock exchanges. And this in contrast to H-shares that are Chinese companies listed in Hong Kong and traditionally the easiest way for investors to invest in Chinese companies. The A-share market is, in fact, much larger than the Hong Kong stock exchange with over a trillion dollar market cap, which makes it the second-largest equity market in the world.
Matt: There’s a chart in the paper that illustrates the potential impact that the A-shares will have on the MSCI Emerging Markets Index* over time. Why is this important to investors?
Elaine: Well, this is an important event on several fronts. First and foremost, the inclusion gives the A-share market an effective stamp of approval certifying that the market has made sufficient progress in granting access and allowing capital mobility and setting regulatory controls. Furthermore, the listed companies have made significant improvement in accounting standards, disclosure, corporate governance, and et cetera. The process, in fact, took 4 to 5 years but with the MSCI inclusion, now gain comfort and confidence to invest in this market.
The inclusion also brings meaningful flows to the market. But in my opinion, it’s not just the flows in and of itself that’s important, but the virtuous circle it can create. With more foreign investor participation, companies will be held to a higher standard, both in the quality of disclosure and quality of earnings they deliver. Domestic Chinese investors will learn to be longer-term in their investment horizon and more cognizant of valuations. So, overall, we expect the A-share market to be raised to higher international standards and become more sophisticated as a result of the MSCI inclusion.
Matt: Wow, that is a transformation!
Matt: Okay, well Elaine, in the second part of this conversation I’d like to hear your thoughts on the risks and potential opportunities in this space, particularly how you and the San Francisco Emerging Markets Equity team are navigating the market. But thank you for now.
Elaine: Thank you.
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Laurie: Matt, as I was listening, one key takeaway I found intriguing was the development of A-shares is creating a sort of “virtuous circle.”
Matt: Yeah, I picked up on that as well, and I think what this means for investors is likely that this is going to improve disclosures of companies operating in China to the public and also improve their financial reporting, and, just generally, improve the standard of companies operating in this space.
Laurie: A quick program note to our audience, we encourage you to contact your Wells Fargo Asset Management relationship manager to get Elaine’s team’s full market insights. And, we’ll continue this conversation in part two where Elaine talks about sifting through all this new opportunity in China. For the moment, Matt Alexander, thank you!
Matt: My pleasure Laurie.
Laurie: Until next time; I’m Laurie King, take care.
*Source: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI.
All investing involves risks, including the possible loss of principal. There can be no assurance that any investment strategy will be successful. Investments fluctuate with changes in market and economic conditions and in different environments due to numerous factors, some of which may be unpredictable. Each asset class has its own risk and return characteristics. Foreign investments are especially volatile and can rise or fall dramatically due to differences in the political and economic conditions of the host country. These risks are generally intensified in emerging markets.