Morningstar Magazine - June/July 2018 - 49

Chinese economy. The information technology
sector went from representing just 2% of the index
in 2007 to becoming its largest sector by the
end of March-making up 41% of the benchmark's
value. Meanwhile, the telecommunications
sector has shriveled from 21% to 4% of the index's
value. This is, in part, evidence of the diminishing
footprint of the traditional telecommunications
industry and the rise of newer and more
innovative communication, commerce, and
entertainment platforms. Most notably, it reflects
the emergence of a pair of tech giants,
Tencent Holdings 00700:HK and Alibaba Group.
In June 2017, MSCI announced plans to include
222 China A-shares in the MSCI Emerging
Markets Index, in a two-step process commencing
at the end of May. Using June 2017 figures,
A-shares would make up 0.73% of the MSCI
Emerging Markets Index once they've been folded
in, and all remaining Chinese shares would
represent 28.5% of the index's value.
This is just the start. MSCI has provided a road
map outlining the next milestones for China
A-shares inclusion. While the timing is unknown,
it seems all but certain that China A-shares'
representation in the MSCI Emerging Markets
Index and MSCI China Index will increase.
Morningstar's reports on exchange-traded funds
with Chinese A-share exposures can help

investors navigate some of the nuances of this
asset class. Our equity research analyses on
specific A-share companies can also assist
investors in understanding the fundamentals of the
individual stocks as well as the relevant sector.
From January 2004 through March 2018, the MSCI
China Index averaged a 0.77 rolling three-year
correlation with the MSCI World Index.
Meanwhile, A-shares, represented by the MSCI
China A Index, have historically experienced
a lower level of correlation to the MSCI World, with
a rolling three-year average of 0.4 since
mid-2008. That suggests that the diversification
benefits of the China Index might increase
as more A-shares are included.
However, from a broader perspective, the further
opening up of the Chinese equity markets
as well as continued globalization and expansion
of trade between China and the rest of the
world, will make China ever more global. These
factors will likely serve to increase the
correlation of the MSCI China Index with the MSCI
World Index in the long run.
As Chinese stocks' footprint continues to expand
in equity indexes to more closely align with
the footprint of the nation's capital markets and its
economy, some investors may wonder how
large China's share of these indexes will become.
At present, China's 3.6% share of the MSCI

China Now Dominates the MSCI Emerging Markets Index
At Inception (Jan 1988)

Malaysia
Brazil
Thailand
Chile
Portugal
Mexico
Greece
Philippines
Jordan
Argentina

March 2018

3.1%
5.3%

2.9% 1.8%

33.8%

7.7%
8.5%
8.9%
9.1%

18.9%

2.4%
China
2.5%
9.6%
South Korea
2.9%
Taiwan
3.6%
India
6.7%
Brazil
South Africa
7.5%
Russia
8.1%
Mexico
11.8%
Malaysia
Thailand
Others

29.9%

15.1%

ACWI represents a large disconnect relative to its
14.8% share of global GDP (per 2016 data
from the World Bank). By way of comparison, U.S.
stocks make up 52% of the MSCI ACWI and its
share of global GDP is 24.6% (per 2016 data). Thus,
it seems that the best answer is "larger" and
potentially "much larger."
Jackie Choy is director of ETF research with Morningstar Asia.

Chinese Bonds Go
International
In March, Bloomberg announced that it will add
Chinese renminbi-denominated government
and policy securities to the Bloomberg Barclays
Global Aggregate Index, subject to planned
operational enhancements to be made by the
People's Bank of China and the Ministry
of Finance. These securities include debt issued
by the China Treasury and three policy banks:
China Development Bank, Export-Import
Bank of China, and Agricultural Development Bank
of China. Upon full inclusion, the index would
contain 386 Chinese securities, collectively
representing 5.49% of its value (using January
data). The change will be implemented over a
20-month period beginning in April 2019.
Other Bloomberg indexes will also add Chinese
renminbi-denominated debt at that time.
This marks a big step down the path toward
greater access to China's capital markets. From an
investor's perspective, it is important to understand
how these changes might affect the indexes
underpinning various bond exchange-traded funds.
Bond indexes have various nuances, and China's
weighting could be quite different across them. For
example, China's weighting could be around
40% in the Bloomberg Barclays EM Local Currency
Government Index, while a capped version of the
index would put the stake only at 10%.
Jackie Choy is director of ETF research with Morningstar Asia.

Source: MSCI, Morningstar. Data as of 03/31/2018.

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