Yesterday afternoon China got a (well-deserved?) vote of support from the MSCI after three years of being rebuffed by the governing body of “passive flow” money.   Saudi Arabia was also given a positive signal for inclusion.  We outline the news and impact below:

Overall, the announcement for China is positive but the impact on flows will be limited for now.  But the message is clear, China is getting recognition for moving their open market policies forward.  Sentiment for Chinese equities overall ( and EM ) is enhanced by this vote.  Saudi Arabia actually gains more than China in the short term.

What does the China A Share inclusion mean?

  • Technically:
    • MSCI Inclusion of 0.7% into the MSCI EM, and it will be 2.6% of MSCI China,  0.8% of MSCI Asia ex-Japan Index
    • 222 stocks will be included which is slightly higher than the 169 guided in March
    • A Shares could be 20% of MSCI EM index by 2030 and China overall therefore could be 40% of the index….
    • The announcement has little actual flow impact from the passive index tracking community ($14Bn of $2Trn tracking, $595m will be outflow from other markets…) but will lead to more active allocations from opportunistic players dedicated to EM
  • Symbolically:
    • Yes, MSCI is saying China is doing better on their market friendly policy improvements but irony is they are doing this in 2-stages because of liquidity issues still inherent in this market
    • But this event along with the Bond Connect recently announced is very important for giving global investors access to China in the medium term
      • Investors are looking for better yields – and Bond Connect gives global investors and opportunity to pick      up yield and opportune time
  • Bottom Line:  Get China right and you get EM right.  China is 28% of index now…and Asia is 63% of the Index overall, so make you wonder whether EM is really all about Asia?
  • Brazil, SA, RU, MX <20% ; All others (including Turkey, Most of Latam) 15%

The MSCI news is more significant for Saudi despite Saudi having more questions to answer.

  • MSCI will consider Saudi Arabia for entry in the June 2018 review, and it appears this is a rubber stamp barring a major fallout in the economy or the policy towards reform.
  • if accepted would enter MSCI EM in May 2019. Would also be significant – a lot of moving parts here with Saudi ownership limits, the potential Aramco IPO, etc. but our clearly Saudi would quickly be on a par with Russia in its weighting around 2.5% to 3%
  • Saudi still has major questions on free-float size  but mkt rallied hard today in advance of next June which is what the trading call is for countries who are short listed for MSCI inclusion (See Pakistan, Vietnam…frankly, makes you want to own Frontier stocks $FM)
  • Best Saudi plays right now are SABIC (Basic materials ) and SAMBA ( financial group )

Also, Argentina consideration for EM is put off another year, and consideration of removing Nigeria from MSCI Frontier is delayed until (at least) November this year.  Where do you go after being thrown out of Frontier?  We save that question for another day…

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