Indexing strategies can prove an attractive alternative to direct investments in Chinese equities.
China's emergence as a modern economic power has attracted the interest of institutional investors seeking greater global portfolio diversification. With the growth of China's mainland stock markets in Shanghai and Shenzhen and greater access to "A-shares" — equities available to international investors only through specially qualified channels — investors have new opportunities to gain direct exposure to mainland companies while diversifying their portfolios.
China is one of the world's largest economies, second only to the United States, as measured by gross domestic product (GDP). The International Monetary Fund projects that China's GDP will grow at an annualized rate of 7.8% this year and 8.2% in 2013, outpacing most emerging markets.
With such strong growth prospects, the Chinese market may present favorable diversification opportunities for international investors. Correlation of the Chinese stock market, particularly A-shares, to other world markets historically has been low, as indicated in the table below. And at a time when the correlation of most developed markets to emerging markets is increasing, Chinese A-shares also maintain a comparatively low correlation to the MSCI Emerging Market Index. This is mainly a result of Chinese-established capital controls preventing Chinese-listed securities from being included in these indexes.
Given these characteristics, institutional investors around the world continue to seek new ways to add an appropriate exposure to China.
While Chinese A-shares have piqued the interests of many institutional investors, to-date large investors have had to pursue costly entrée into the markets through direct investments, synthetic ETFs that gain access to the market through derivative instruments or actively managed pooled funds. Generally one of the most cost-effective investment approaches, however, is a passively managed index fund. In addition to the traditional benefits of an index strategy, such as reduced fees relative to an actively managed portfolio, investors in a passively managed fund tied to an appropriate index also add greater diversification through a broader exposure to the stocks of China's mainland companies.
When taking an index approach to investing in China, it is important to select a benchmark that is truly representative of the Chinese stock markets. While there are a number of benchmarks from global index providers designed to represent the Chinese economy, the popular Chinese Securities Index 300 is perhaps the closest representation of today's China. Composed of 300 securities denominated in renminbi, the CSI 300 Index offers increased exposure to industrials and materials — as well as sizable corporations — that may not be found in other benchmarks. For example, the MSCI China Index features 148 names that are intended to represent China, but most are listed in Hong Kong and, as such, are denominated in Hong Kong dollars rather than Chinese renminbi, thus changing the true exposure of the fund.
If you're interested in discussing how you can achieve an appropriate global mix within your diversified portfolio — and whether an exposure to China may align with your broader risk tolerances and goals — contact your Northern Trust representative today.