Completion of MSCI index inclusion, positive outlook help funds exploit cheap valuations

Overseas investors' interest in the Chinese stock markets has reached record highs in the wake of the opening-up policy and the A shares' inclusion in the Morgan Stanley Capital International's emerging markets index.

On Sept 1, MSCI completed the phased inclusion of A shares in its popular index. Now, 5 percent of A shares, or 236 key stocks, are part of the index.

According to UBS Investment Research, northbound investment - the term is a reference to Hong Kong-originating investments in the mainland capital markets - in A shares reached 4.21 billion yuan ($616 million) on Aug 31, the last trading day before the completion of the MSCI inclusion.

At the end of trading on Friday, the figure was 2.8 billion yuan, according to Wind Info.

Gao Ting, head of China strategy at UBS Securities, said stocks of food and beverage companies have been the most popular targets of overseas investors, followed by insurance, banking, capital goods and hardware.

Buoyed by investors' positive outlook, overseas investment worth more than 220 billion yuan has flown into A shares via the stock connect mechanisms between Hong Kong and Shanghai, and Hong Kong and Shenzhen so far this year, as calculated by financial services provider Noah Holdings Ltd.

About 7 percent of A shares are now held by overseas investors, which is equal to that held by public funds and insurers.

According to Shenwan Hongyuan Securities, the additional inflows may well reach 1.8 trillion yuan in the long run if all of 3,500 A shares are included in various MSCI sectoral indexes.

Analysts from Pacific Securities wrote in a note that consumer companies have been undervalued since the A-share meltdown over the past few years. But overseas investors usually hold a positive outlook for these companies and hence are investing in their shares.

Data in the public domain showed the benchmark Shanghai Composite Index has dropped nearly 19 percent since the beginning of this year, approaching its historic low after several rounds of fluctuations.

"The market valuations are quite competitive now compared to other markets in the world. So, it would be the right time for overseas investors to tap into the A-share market," said analysts from Pacific Securities.

Yang Delong, chief economist at Shenzhen-based First Seafront Fund, said overseas investors' growing interest in A shares can be seen from the active stock connects. This is a testimony to their confidence in the A-share companies' long-term performance and prospects for share value appreciation, he said.

"As the A-share market becomes more international, overseas funds will certainly step up their investments in the Chinese domestic market," he said.

"With overseas investors taking a bigger role in the A-share market, the prices of A shares will be influenced, which will help optimize the A-share structure and investors' investing style in the long term."

MSCI's flagship index is one of the most influential stock barometers worldwide, and is adopted by over 97 percent of the world's top asset management firms, market mavens said.

Tang Shengbo, head of China financials research at investment bank Nomura, said the bank has seen a growing number of foreign asset management companies setting up branches or subsidiaries in the Chinese mainland.

"Ever since the A shares' inclusion in the MSCI index, foreign institutional investors' demand in the Chinese market has been on the rise. They have instituted local teams to take charge of that," he said.