Tracking back

MSCI lets fund managers ignore China a bit longer

Western asset managers can breathe a sigh of relief: they don't have to start chasing inflated Chinese stocks just yet. Index compiler MSCI has decided the pumped-up $10-trillion equity market is not quite ready for inclusion in its global benchmarks. Even so, fund managers can't ignore China for much longer.

At times, the debate about including China in global indexes verges on the surreal. How can investors disregard the world's second-largest stock market by capitalisation? Yet MSCI and stewards of the estimated $9.5 trillion in assets measured against its yardsticks have good reasons to be cautious.

Buying shares in China is still complicated. Though investors in Hong Kong can now trade Shanghai stocks, a planned link with Shenzhen has not yet gone live. A cap on transactions could prevent investors buying when they wish. Big fund managers can apply for quotas to invest directly, but allocations are far from transparent. Investors also still worry about whether they have an enforceable legal claim on Chinese shares held through third parties.

These factors are unlikely to delay China's inclusion for long - it could even get the green light before MSCI formally reviews its benchmarks again next year. Even then, MSCI will start small. Mainland-listed A-shares will initially account for just 1.3 per cent of MSCI's emerging markets index, compared with a 25 per cent weighting for Chinese companies listed in Hong Kong. That's reassuring for funds which will be under pressure to add the likes of China Shipbuilding Industry - up over 100 per cent this year - to their portfolios.

Yet once Chinese stocks join the club they will only become more important. On full inclusion A-shares would account for a fifth of the MSCI emerging markets index, while all Chinese stocks combined would take up 44 per cent of its value.

By that point China may merit its own index, in the same way that many fund managers today separate Japan's equity market from the rest of Asia. In any case, they will have to take a view. Today, being underweight China is a matter of inertia. It will soon become a conscious choice.