Despite well-documented macroeconomic challenges in China, many investors remain underexposed to equities in one of the world's largest economies, particularly its onshore market.
Drawing parallels with Taiwan and Korea, onshore Chinese equities are expected to gain, increasing weight in global indices over time. As China A-shares become more integrated into global portfolios, investors have a unique opportunity to tap into the growth potential of Chinese equities.
1. High Returns Forecasted for Chinese Equities
J.P. Morgan’s 2024 LTCMA forecasts for Chinese equities in local currency were adjusted down from 9.5% to 8.9%, with projections of 9.1% in euros and 10.8% in U.S. dollars. These remain higher than both emerging and developed market equity return assumptions.
The shift in China's equity market towards technology and consumer sectors, which tend to have higher margins, is reflected in the outlook. However, net dilution continues to pose a significant challenge, lowering long-term earnings per share forecasts. Despite this, the currently undervalued market is expected to boost returns, with currency trends, especially in USD, providing additional support.
Key factors that could further influence long-term projections for Chinese assets include the pace of structural reforms, policies aimed at balancing economic efficiency with equality, liquidity conditions, and the broader external environment.
2. Diversification Benefits
Chinese onshore equities have historically demonstrated low correlation with other assets, providing investors with potential diversification benefits. While correlations may increase as foreign investor participation grows, they are expected to remain lower compared to developed market assets due to China's distinct economic and policy cycles. A gradual recovery in consumption is anticipated in 2024, despite continued challenges from the real estate sector, highlighting the uniqueness of China’s market environment.
Many investors fail to differentiate between offshore equities, such as Hong Kong-listed H-shares and U.S.-listed ADRs, and onshore A-shares, which are less correlated with global markets. The divergence between these markets was evident in 2021 when concerns over ADR delisting and regulatory changes primarily impacted offshore stocks, while onshore equities delivered positive, albeit modest, returns as China eased stimulus.
In the last quarter of 2022, onshore equities lagged behind MSCI China by nearly 10%, as offshore stocks responded more favorably to policy support for the real estate and tech sectors, and optimism around the end of zero-Covid policies.
3. Exposure to China’s Consumer-led Economy
China’s equity market is transitioning towards sectors benefiting from its shift to a more consumption and innovation-driven economy, moving away from those dependent on investment and exports.
Key beneficiaries of this economic transformation include consumer goods, technology, healthcare, and high-end manufacturing. The MSCI China A Index offers significantly higher exposure to small and mid-cap stocks, which primarily serve the domestic economy. Over 20% of companies within the index have a market cap below $5 billion, compared to less than 10% in the MSCI China and MSCI EM indices. This composition means that these smaller firms are more insulated from US-China tensions and less affected by regulatory interventions that have primarily targeted mega-cap companies typically listed offshore.
Conclusion
Adding Chinese A-shares to investment portfolios presents a compelling opportunity for investors looking to tap into one of the world’s largest economies. The shift towards sectors driven by consumption and innovation, along with the potential for high returns, underscores the importance of onshore equities in capturing growth. Furthermore, with forecasts indicating higher returns relative to both emerging and developed markets, and the unique diversification benefits of A-shares, investors can enhance their portfolios by incorporating this asset class.
For those looking to gain exposure to Chinese A-shares while managing risk, SGX FTSE A50 Futures offer a strategic solution. These futures allow investors to hedge their positions while benefiting from the performance of China’s top companies. By utilizing these financial instruments, investors can effectively navigate the complexities of the Chinese market and position themselves for potential long-term gains in a rapidly evolving economic landscape.
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