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 have lifted our return estimations for Chinese equities for the next 10 to 15 years
In our 2023 LTCMA, we lifted our long-term annual returns forecasts to 9.5% in local currency terms and 11.8% in US dollar terms (9.7% in euro), up from 6.6% and 8.2% (6.9%) respectively last year. These are generally higher than both our emerging and developed market equity return assumptions.
We made the adjustments to reflect the improving sectoral mix of China’s equity market towards technology and consumer sectors, with higher margins. But this boost was offset by a valuation penalty, given ongoing risks of regulation in the country’s corporate space. Currency is also a notable tailwind this year, particularly in USD terms.
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. With Chinese growth likely to accelerate into 2023, we think China could once again diverge from the global business cycle.
Many investors do not differentiate between offshore (Hong Kong-listed H-shares and US-listed ADRs) which are more correlated to global markets and onshore A-shares. 2021 was a stark reminder that these markets can diverge. Offshore equities were hit by concerns over forced delisting of ADRs – onshore equities rarely have ADRs – and regulatory change that primarily impacted mega-cap offshore stocks. In contrast, onshore equities delivered positive returns, albeit more muted than global equities, as China tapered its stimulus. Then in the final quarter of 2022, onshore China lagged the MSCI China by close to 10% as offshore equities responded more positively to policy support for the real-estate and tech sectors, and the prospect of an end to zero-Covid.
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 over 20% of companies under $5 billion market cap compared with less than 10% for MSCI China and the MSCI EM respectively, as of end January 2023. 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.