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Will China's inclusion with MSCI ease volatility?

China’s potential inclusion in the MSCI Emerging Market Index will likely be welcomed by investors, providing further investment opportunities and reducing the overall risk for them, while the volatility seen over the past few months will likely subside upon full inclusion.

Jun 13, 2016 // 4:39PM

Increased awareness of and interest in Chinese corporates – on the debt and equity side – post-inclusion is unlikely to be dented by concerns over rising corporate debt levels.

Although it was blocked from joining the MSCI EM Index last year, China’s membership is again up for consideration, and this time around there is a greater chance of the country being incorporated.

“If a market exists and satisfies the basic conditions for inclusion in indices then there is no reason why it should not be in the index,” said Jan Dehn, Head of Research at Ashmore Investment Management.

Its inclusion could have significant benefits for the investment community, as the more countries in an index, the better for investors. It increases the range of available investment opportunities, and the added diversification reduces the overall level of risk.

Dehn added that the size of China’s market also makes it a more interesting choice for investors, because it is more liquid than smaller markets.

Although a liquid market, China’s A-share market, which includes the country’s top blue chip corporates, has experienced volatility as of late. The Shanghai Composite Index fell by 70.239, or 2.31%, from 3042.823 to 2972.584 on April 20 alone, according to Bloomberg.

This volatility would only likely put off investors in the short term however. “Over the cycle it will not affect interest. The key is index inclusion: Once the market is in the index most investors will have to go on average market weight or risk, introducing benchmark performance risk into their portfolios.”

Although China’s A-share markets would likely enter the MSCI index with a 5% weighting, a modest amount according to Dehn, once fully incorporated it will constitute almost 40% of the MSCI EM index. “This makes China’s inclusion hugely important.”

The heightened profile that will be gained by Chinese entities from an inclusion in the index will lead to an increasing understanding of both bonds and equities amongst foreign analysts.

Although Dehn said it would be difficult to gauge how long it would take for investors to become comfortable with Chinese companies, he added: “We have been in this market for years and we are already comfortable taking views on Chinese names. I do not see why China should be different from any other new market.”

Despite IMF warnings over the rise of China’s corporate debt, which currently stands at 145% of GDP, Dehn noted that it was unlikely to affect interest in investing in Chinese stocks: “China’s corporates are not over indebted,” he added. 

Asia Pacific Macro

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