Three reasons to consider allocating to Chinese A-shares
While some investors already have limited exposure to China’s large and fast growing economy through emerging market (EM) equity strategies, the most compelling investment opportunities are increasingly to be found in the onshore A-share market. Drawing on the framework from our Long-Term Capital Market Assumptions (LTCMA), a collection of long-term insights from J.P. Morgan Asset Management’s investment professionals, we explore three key reasons why investing in China A-shares could help improve returns.
1. We see onshore Chinese equities delivering high single digit annual returns over the next 10 to 15 years
In our 2022 LTCMA, we lifted our long-term annual returns forecasts to 6.6% in local currency terms and 8.2% in US dollar terms (6.9% in euro), up from 6.3% and 7.5% (6.1%) respectively last year. These are considerably higher than our developed market equity return assumptions.
The upgrades to our forecasts were driven by a greater rotation towards new economy sectors and the expectation for significant international and domestic investor flows.
Among the key factors that could further affect our long-term assumptions for Chinese assets are: the pace of structural reforms; policies seeking to rebalance efficiency and equality in the economy; liquidity; and the external environment.
2. Onshore Chinese equities offer clear diversification benefits
Chinese onshore equities have historically had a low correlation to other assets, offering investors potentially attractive portfolio diversification opportunities. Correlations will likely rise as foreign investor participation in the Chinese market rises however, we believe they will remain low relative to developed market assets, given China’s distinct economic and policy cycles.
Many investors do not differentiate between offshore (Chinese stocks listed on international exchanges, mainly in Hong Kong and New York) and A-shares, which trade in mainland China. 2021 was a stark reminder that that these markets can diverge. Offshore equities were hit by government regulatory changes that targeted technology and real estate sectors. While offshore Chinese stocks struggled, onshore equities delivered positive returns, albeit more muted than global equities, as China tapered its stimulus. With China now set to ease monetary policy at the margin, while the Federal Reserve is raising interest rates, we think China could once again diverge from the global business cycle.
We modelled Chinese equities’ return projections, their correlation to other markets and volatility risk based on historical data. We found that having a dedicated allocation to A-shares of up to 10% above the current benchmark index weights would result in a more optimised portfolio with an improved ‘efficient frontier’ — which means A-share investors can potentially expect higher returns for each given level of additional risk. Put another way, with global equity markets largely moving together, and although diversification does not remove the risks altogether, not having adequate onshore exposure may represent an opportunity cost in terms of portfolio diversification.
Exhibit 1: China A shares offer investors diversification opportunities
3. Onshore equities provide exposure to China’s increasingly consumer-led economy
China’s equity market is shifting towards sectors that are benefiting from its transition to a more consumption and innovation driven economy, and away from sectors that are more reliant on investment and exports. The beneficiaries of China’s economic transformation include consumer goods, technology, health care and high end manufacturing. We expect these shifts to continue, potentially offering China A-share investors more exposure to these high growth sectors compared to emerging markets overall.
The MSCI China A Index also gives considerably greater exposure to small and mid-cap stocks that typically service the domestic economy, with close to 26% in companies under $10 billion market cap at 31 January 2022, compared with 15% and 20% in the MSCI China and the MSCI EM respectively (source: J.P. Morgan Asset Management, FactSet, IBES). That has meant they are more sheltered from US-China tensions, and less subject to Chinese regulatory interventions which have targeted mega-cap companies that are generally listed offshore.
The onshore Chinese equity market continues to become increasingly accessible to international investors, offering a deep pool of investment opportunities and significant diversification benefits. However, it’s crucial that investors choose an investment partner with the local knowledge and proven active research expertise required to uncover the most attractive opportunities in this under-researched market. At J.P. Morgan Asset Management, our experienced team of China experts have been managing A-shares for over 15 years with offices in mainland China. Our extensive research capabilities can help unlock the compelling prospects of the A-share market.