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MSCI Inclusion Could Fuel Demand for Some Chinese Tech Majors
China will be most affected by MSCI’s decision as many of the country’s top companies trade abroad
By WEI GU And CAROLYN CUI
Nov. 4, 2015 3:43 p.m. ET
MSCI Inc.’s expected decision to add U.S.-listed Chinese companies to some of its most heavily tracked stock indexes this month could give a boost to some of China’s prominent technology champions, whose shares have already endured a roller-coaster ride this year.
The move is part of MSCI’s efforts to include more companies in its indexes whose shares are traded outside their home markets. Companies from the Netherlands to Israel and Hong Kong will be among the beneficiaries from what analysts at Société Générale SA have dubbed MSCI’s “most significant rule change” since 2008.
But the decision will affect China most because many of its top companies are traded abroad. More than 200 Chinese companies are listed on U.S. exchanges, mostly as so-called American depositary receipts, dwarfing listings from any other country.
Major Chinese firms with ADRs traded in the U.S. include tech stocks like Alibaba Group Holding Ltd. and Baidu Inc. From later this month, these will likely be among around 14 Chinese companies added to indexes such as the MSCI Emerging Markets Index and MSCI China, according to MSCI’s semiannual review earlier this year.
Such indexes attract hundreds of billions of investment from both active and passive investors: Goldman Sachs estimates $78 billion could flow into the U.S.-listed Chinese companies set for inclusion—equivalent to about a quarter of their current market capitalization—though some argue the actual amount may be lower.
The move will trigger immediate buying among funds that passively track the indexes. It could also lead to more purchases among the actively managed index funds in the long run.
Kim Catechis, head of global emerging markets at U.K.-based fund manager Martin Currie said its funds already invest in some U.S.-listed Chinese stocks, with such “off benchmark” positions amounting to as much as 10% of fund portfolios. The MSCI’s rule change would allow funds more room to buy other off-benchmark stocks, he said.
The move comes amid renewed interest in China among some overseas investors, despite its recent relative economic weakness and the sharp drop in its domestic equity markets.
The International Monetary Fund may add the Chinese currency to its basket of reserve currencies as early as November, which should boost global demand for the yuan. U.S.-listed Chinese stocks have, meanwhile, hit a post-July high, with the BNY Mellon China ADR Index up 20% since Oct. 1.
“When I recently met investors in the U.S. and Europe, I was surprised to see their high level of interest in China ADRs due to the pending inclusion,” said Kinger Lau, chief China strategist at Goldman Sachs.
The $148 million KraneShares CSI China Internet ETF, which includes many of the MSCI candidates, has seen its size more than double since end-August, thanks to cash inflows and price gains, according to Brendan Ahern, chief investment officer at KraneShares.
The rule change will mean indexes like MSCI China will have a greater weighting toward companies from China’s so-called new economy, like Alibaba and Baidu. China’s future growth is expected to come more from hi-tech, consumer-focused companies, rather than the state-owned industrial and financial companies it has relied on in the past.
U.S.-listed Chinese companies, largely Internet and the services companies, are likely to continue to outperform Hong Kong-listed Chinese stocks, which mainly comprise financials and industrials, said Jonathan Garner, chief Asia and emerging-market equity strategist at Morgan Stanley. The weighting of Chinese financial stocks in the MSCI China index will drop to 35% from 42%, while Chinese Internet companies’ weighting will rise to 23% from 14%.
MSCI considered including all mainland China-listed shares in its emerging-market indexes earlier this year, but decided against the move in June, because of a lack of access to Chinese markets for foreign investors. Although MSCI’s latest move isn’t linked to broader inclusion of Chinese shares, usually known as A-shares, in its indexes, analysts expect that to happen next year.
The current planned inclusions will take place in two phases, with 50% to be added in November and the rest in May of 2016. Upon completion, these newly added shares will account for 14.3% of the MSCI China index, or about 4% of the broad MSCI Emerging Markets index, according to Morgan Stanley.
Many U.S.-listed Chinese companies have struggled to gain attention from global investors and have suffered from low valuations compared to peers in their home markets, prompting a string of recent bids from buyout groups who want to take them private and then relist them in China. Alibaba’s shares lost as much as 44% from their peak late last year, but they have rebounded 30% from their September trough as MSCI inclusion has neared, and following better-than-expected earnings.
U.S.-listed Chinese stocks have also caught the eye of China-based investors recently.
“Many of them are the best companies in China, and they are cheaper than their China-listed counterparts,” said Chen Dong, CEO of China Life Franklin Asset Management Co., which oversees about 120 billion Hong Kong dollars (US$15 billion) in assets.
Write to Wei Gu at wei.gu@wsj.com and Carolyn Cui at carolyn.cui@wsj.com
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