MSCI announced it will include China A-shares in the MSCI Emerging Markets Index and the MSCI ACWI Index.“This decision has broad support from international institutional investors with whom MSCI consulted, primarily as a result of the positive impact on the accessibility of the China A market of both the Stock Connect program and the loosening by the local Chinese stock exchanges of pre-approval requirements that can restrict the creation of index-linked investment vehicles globally,” MSCI said in a statement.
As a result, $1.6 trillion from investment funds will be under heavy but informal pressure to start buying Chinese domestic stocks next year, leading to $17 billion in fresh money being pumped into the stock markets, according to MSCI.
China A-shares, which trade on the Shanghai and Shenzhen Stock Exchanges, account for roughly two-thirds of the market capitalization of Chinese stocks. Because most foreign investors cannot purchase China A-shares, investors in most existing China ETFs lack exposure to the majority of Chinese companies. As China opens up its economy, more investors are considering the risk/reward scenario of allocating to A-shares. Some say that Chinese A-shares have longer-term potential, yet may experience short-term volatility as the trading landscape evolves. What’s behind this sharp rise in interest in A-shares, and can it be sustained?
There are few options for mainland Chinese investors.
Since China’s economy is still quite closed, there are very few alternatives for local Chinese to invest. Since real estate and wealth management investments have soured, investors are returning to the stock market. There’s also been an increase in the amount of margin/leverage investors are using to amplify their exposure. In addition, hopes for continued monetary stimulus by the Peoples Bank of China, continue to stoke interest.
Foreign investors have been buying A-share ETFs in the U.S. market.
Foreign investors have piled in through A-share ETFs, since they offer a way to access this category without having to perform due diligence on individual companies and/or avoiding the operational issues of investing directly in the market through the Stock Connect.
Are Bulls Behaving Like Sheep?
However, this speculative sheep mentality may be just one of the catalysts for a run by the bears. For many, valuations are starting to appear extended. China A-shares may not be bubble territory just yet, but it takes little creative thinking to imagine it getting there if the rally gets overdone.
If you’re interested to learn more, check out our bull and bear China ETFs.
Direxion Shares Risks – There are special risk considerations relating to RQFII and QFII investors and the Chinese A-Share market. A-shares are issued by companies incorporated in the People’s Republic of China (“PRC”). The A-share market in China is made available to domestic PRC investors and certain foreign investors, including those foreign investors that have been approved as Renminbi Qualified Foreign Institutional Investors (“RQFII”) or as Qualified Foreign Institutional Investors (“QFII”). A Fund’s ability to achieve its investment objective is dependent on the ability of other ETFs and counterparties to obtain their QFII or RQFII quota. If a Fund is unable to obtain sufficient exposure to the Index due to the limited availability of necessary investments or financial instruments, the Fund could, among other things, as a defensive measure, limit or suspend creation units until the adviser determines that the requisite exposure to the Index is obtainable. During the period that creation units are suspended, a fund could trade at a significant premium or discount to its NAV and could experience substantial redemptions.
Risks associated with investments in Chinese companies include, among others (i) the small size of the market for Chinese securities and low trading volume, resulting in a lack of liquidity and in price volatility; (ii) currency devaluations and other currency exchange rate fluctuations or blockages; (iii) the nature and extent of intervention by the PRC government in the Chinese securities markets, whether such intervention will continue and the impact of such intervention or its discontinuation; (iv) the risk of nationalization or expropriation of assets; (v) the risk that the PRC government may decide not to continue to support economic reform programs; (vi) limitation on the use of brokers; (vii) higher rates of inflation; (viii) greater political, economic and social uncertainty; (ix) market volatility caused by potential regional or territorial conflicts or natural disasters and; (x) the risk of increased trade tariffs, embargoes and other trade limitations. These factors can directly affect A-shares, and may indirectly affect investments that derive their value from A-shares. Any reduction or elimination of access to A-shares will have a material adverse effect on the ability of a fund to achieve its investment objective.
Risks of each Fund include Effects of Compounding and Market Volatility Risk, Derivatives Risk, Counterparty Risk, Shorting Risk, Cash Transaction Risk, Intra-Day Investment Risk, Daily Inverse Index Correlation Risk, Valuation Time Risk; for the Bull Fund, Leverage Risk, Daily Index Correlation Risk and Other Investment Companies (including ETFs) Risk; for the Bear Fund, Shorting Risk, Cash Transaction Risk and Daily Inverse Index Correlation Risk, and Emerging Markets Risk. Please see the summary and full prospectuses for a more complete description of these and other risks of the Fund.