Early in 2014, we penned a commentary on A-shares to discuss the merits of China’s domestic A-share stock market as a long-term investment opportunity for global investors.
In the first quarter of that year, the local CSI300 Index (which tracks some of the biggest Shanghai and Shenzhen-listed companies) was trading at around 2,100. In hindsight, it would appear that it was a good call to pay more attention to that market in 2014, as it quickly began its first rally in five years—reaching an index high of 5,335 on June 12, 2015. However, things also turned suddenly. Liquidity-driven events that supported the rapid appreciation of the market proved to be unsustainable and things started to unravel. Over a span of just about three months, from June to October 2015, the domestic index declined by nearly 40% in local currency terms. And after a seeming recovery in October 2015, the A-share markets again gave back gains and fell sharply in the first few months of 2016. For the most part of 2016, the A-share market has remained in the doldrums, and has fallen by approximately 11% year-to-date in local currency terms with the index hovering close to the 3,200 level since the start of the year.
The A-share market is marked by its high level of retail participation with over 80% of its trading volume controlled by such investors. This volatility can also be seen from the rotation of sectors that such local investors have preferred over the past 18 months. The three top-performing industries in 2015, highlighted below, have thus far ranked in the bottom quartile by year-to-date performance. This rotation is a function of many things—slower growth prospects, already high valuations, lower risk appetite and a shift toward more defensive names in light of a slower growing economy.
At Matthews Asia, we are still attracted by the fundamentally sound merits of many local companies listed in China. Our long-term challenge, however, comes from the struggle that many good quality A-share companies in growing industries are priced at very rich valuation multiples. Such a market correction therefore provides us, as long-term investors, access to good quality firms at more reasonable levels. We continue to tread carefully in this market, however, and realize that perhaps only a handful of companies in this large universe are worthy long-term candidates for our portfolios.
Over the past 18 months, the A-share market has proven to be a challenging market. Investors were shaken by the government’s implementation of circuit breakers, and were put off by widespread arbitrary trading suspensions local authorities had tolerated. Nevertheless, there continue to be longer-term positive developments that warrant ongoing global attention to China’s A-share markets. The relaxation of rules surrounding the QFII (Qualified Foreign Institutional Investor) scheme promote more relaxed quota control, shorter lock-up periods and investor-friendly policies around remittance of capital. The establishment of the Shanghai–Hong Kong Stock Connect, and the soon to be, Shenzhen–Hong Kong Stock Connect aim to facilitate more global participation in the A-share markets. Finally, the continued review of the inclusion of the A-shares into the MSCI indexes, all works to promote longer-term global access to domestic Chinese firms.