China A: Implications – Bigger Is Not Necessarily Better

We are very excited about the news by MSCI to raise the China A class in its Emerging Markets allocation. As we like to say, Structure Matters and the decision by MSCI will have significant evolutionary consequences. However, while the targeted 20% weighting number (up from 5%)  may be higher than some people had been expecting the news should not be a shocker to most institutional players. Kraneshares has been openly pounding the table on this possibility for over a year. Thank you Brendan Ahern.  https://kraneshares.com/2019-outlook-the-case-for-rebalancing-to-china/

https://www.msci.com/documents/10199/238444/China_A_Further_Weight_Increase_PR_Eng.pdf/43f3ee8b-5182-68d4-a758-2968b4206e54

Here in the U.S. there are 52 ETFs listed with specific targeted china holding worth about $18.54 Billion. The overlap of such ETFs is all over the place and bigger is NOT necessarily better.  $ASHR, $KBA, $MCHI, $KWEB, $FXI, $GXC, $CQQQ.

Bonus Structure Matters comment: The 3X Direxion Daily FTSE BULL ETF (YINN) had a major uptick in options activity (Calls) yesterday.

Per the news Remy Briand, MSCI Managing Director and Chairman of the MSCI Index Policy Committee explained some of the rational for the change  “The strong commitment by the Chinese regulators to continue to improve market accessibility, evidenced by, among other things, the significant reduction in trading suspensions in recent months, is another critical factor that has won the support of international institutional investors.”

Also worth noting, because of the feedback from institutions and consultants the change will come in three steps rather than two “to alleviate potential execution pressure on the implementation dates. In addition, a significant proportion of investors also highlighted that China A Mid Cap shares should be included in the MSCI Indexes jointly with the weight increase in Large Cap shares to allow for a smoother implementation.”

The release says MSCI will increase the weight of China A shares in the MSCI Indexes according to the following schedule:

  • Step 1: MSCI will increase the index inclusion factor of all China A Large Cap shares in the MSCI Indexes from 5% to 10% and add ChiNext Large Cap shares with a 10% inclusion factor coinciding with the May 2019 Semi Annual Index Review.
  • Step 2: MSCI will increase the inclusion factor of all China A Large Cap shares in the MSCI Indexes from 10% to 15% coinciding with the August 2019 Quarterly Index Review.
  • Step 3: MSCI will increase the inclusion factor of all China A Large Cap shares in the MSCI Indexes from 15% to 20% and add China A Mid Cap shares, including eligible ChiNext shares, with a 20% inclusion factor to the MSCI Indexes coinciding with the November 2019 Semi-Annual Index Review.

On completion of this three-step implementation, there will be 253 Large and 168 Mid Cap China A shares, including 27 ChiNext shares, on a pro forma basis in the MSCI Emerging Markets Index, representing a weight of 3.3% in the pro forma index.

China should be viewed as a long term play so rushing into the decisions to buy ETFs on this news is not recommended. This is a meaningful change and china should be a  consideration for all portfolios with a long term time horizon, but the volatility and complexity of such an investment must  be reviewed in the context of personal risk.

If ever there was case that ETFs and the issuers behind them provide meaningful insights for investors, we highlight KraneShares. Some key articles to review are available below.

It is important that all readers review the below disclosure and manage their own risk. These comments should not be considered investment advice. Critical disclosure link:  http://www.torosoam.com/general-disclosure.php

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