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How Ordinary U.S. Investors Own a Piece of China

How Ordinary U.S. Investors Own a Piece of China

(Bloomberg) -- China’s enormous stock market, long off-limits to international investors, is now part of many a mom and pop investor’s portfolio outside the country. That’s because the world’s major equity index compilers began including Chinese stocks in their gauges. As a result, funds that track those indexes -- for instance, the $51 billion Vanguard FTSE Emerging Markets exchange-traded fund -- have loaded up on so-called A-shares that trade in Shanghai and Shenzhen. Now, U.S. President Donald Trump’s administration is examining whether to keep government pension funds from investing in Chinese equities.

1. How much do international investors own?

About 1.89 trillion yuan, or $265 billion, of mainland equities as of March, according to the People’s Bank of China. Cash has poured into the $7.4 trillion market over the last few years as China moves to open up its capital markets, with overseas accounts now holding almost as big a stake as China’s own mutual funds. One big driver: Passively managed investment strategies, which have become some of the most popular ways to get exposure to global stocks and bonds. Funds that seek to replicate an index now oversee about $8 trillion in the U.S., ceding control over where they put this money to work to the companies behind their benchmarks. The decision by three big indexers -- MSCI Inc., S&P Dow Jones Indices and FTSE Russell -- to add A-shares to their flagship benchmarks has given many investors their first exposure to China.

2. Why was China for so long a pariah?

New York-based MSCI rejected China’s bid for inclusion in its emerging-markets index for three straight years though 2016, citing investor concerns. Those included the government’s control over financial markets (including heavy interventions during turmoil), accessibility, tax treatment and worries about the ability to move funds in and out of a country that controls capital flows.

3. What changed?

In granting approval in June 2017, MSCI said China had adequately improved market access for global asset managers by letting foreigners buy shares on the Shenzhen Stock Exchange, its version of the Nasdaq Stock Market. FTSE Russell and S&P have since added China to their gauges, with all three boosting the nation’s share within their indexes in stages to minimize market impact. MSCI said in February it would quadruple the weighting of A-shares in its indexes by November, yet that will still mean only 3.3% of its emerging-markets index is allocated to China.

4. Why was this such a big deal?

MSCI is one of the world’s biggest index compilers, with roughly $12.3 trillion in assets benchmarked to its products. Its embrace of China is expected, over time, to send billions of dollars flowing into the world’s second-biggest equity market. For China, there were the kudos of taking another step into the mainstream global financial community. Investment from international fund managers also helps China balance its capital account and reduces the market’s reliance on unpredictable retail investors.

5. And for investors?

Global money managers had long invested in Chinese stocks listed in New York and Hong Kong -- such as Alibaba Group Holding Ltd. and Tencent Holdings Ltd. -- but China’s domestic market offers exposure to a wider group of companies that benefit from an increasingly consumer-led economy.

6. How many Chinese companies are involved?

There are 472 large- and mid-cap China A share companies in the MSCI Emerging Markets Index, including heavyweights Alibaba, Tencent, Kweichow Moutai and surveillance camera maker Hangzhou Hikvision Digital Technology -- which was blacklisted by the U.S. in October. They’ve also been added to the MSCI China Index and the MSCI All Country World Index. Meanwhile, FTSE Russell added more than 1,000 Chinese firms to its global equity indexes last June, while S&P added more than 1,200 A-shares to its global benchmarks in September 2019.

7. Which funds are big China buyers?

Indexed funds that track emerging markets are among the biggest. For example, 39% of Vanguard Group’s emerging-markets ETF -- the largest tracking developing economies -- is made up of Chinese securities, data compiled by Bloomberg show.

8. So why the political attention?

As the U.S. and China continue to negotiate over trade issues, officials in Washington are looking for new tools to pressure Beijing. The Trump administration is considering ways to prevent U.S. government retirement funds from investing in China, Bloomberg reported, citing people familiar with the matter. In the latest move, Trump is considering blocking the Thrift Savings Plan -- the federal government’s retirement savings fund -- investing in Chinese equities considered a national security risk. The fund is scheduled to transfer about $50 billion of its international fund to mirror an MSCI All Country World Index, which includes China. In 2019, two senators criticized the Federal Retirement Thrift Investment Board, which runs a $600 billion plan over a 2017 decision to switch the benchmark of one of its funds to a gauge that includes China.

9. What impact would that have?

Preventing or reducing the flow of international money into the world’s second-largest economy would hurt a stock market that’s alone among the world’s biggest in not falling into bear market territory this year. It would also pose a major headache for providers of indexes and the funds that track them.

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