In Bob Doll’s view of 2020, active managers and Donald Trump will win. “Our view is a more mediocre view, with a lot of frustration,” he mentioned during his yearly outlook while recommending to “focus more on alfa, own more high quality value vs expensive growth, have diversification both in terms of asset clases and geography, raise quality of the cash flow character, and watch wage rate increases to monitor inflation.”
In 2019, the chief equity strategist at Nuveen, made his predictions saying it was a tough year to forecast but that he was leaning towards a bullish view on stocks. He was mostly right, getting eight out of 10 correct.
Here are his top 10 predictions for 2020:
The world avoids recession in 2020 as U.S. GDP grows over 2% and global GDP grows over 3%.
Inflation and the 10-year U.S. Treasury yield end the year above 2% as the Fed stays on hold through the election.
Earnings fall short of expectations, partially due to rising wage rates.
Stocks, bonds and cash all return less than 5% for only the fourth time in 25 years.
Non-U.S. stocks outpace U.S. stocks as the dollar retreats.
Value and cyclicals outperform growth and defensive stocks.
Financials, technology and health care outperform utilities, real estate and consumer discretionary.
Active equity managers outperform their indexes for the first time in a decade.
The cold wars within the U.S. and between the U.S. and China continue.
The U.S. concludes a tumultuous political year with a status quo election.
For the full version of Bob Doll’s Ten Predictions for 2020 follow this link.
2019 has been a challenging year where our readers’ focus has been on how to better manage and diversify portfolios. This shows in the most read stories of the year, which have a tilt towards alternative investments and benchmarking. Our top 5 is comprised of:
The CERPI Boom in Mexico Should Continue in 2019 | This column by Arturo Hanono talks about a considerably new investment vehicle that allows global companies to co-invest along with the Mexican Pension Funds. It was published in February and took January’s numbers into consideration to present a rosy outlook for the asset class. Uncertainty in the country made both the amount of issues and the money invested to drop considerably this year, however CERPIs did outnumber CKDs, which was the author’s point in the most read piece of 2019.
We Currently Have a Robust M&A Market | This column by Michael Gabelli, from Gabelli Funds, also presented a positive outlook for 2019. It focused on specific deals and potential deals for the year.
Funds Society Presents its 2019 Asset Manager’s Guide NRI | The news about the release of our Asset Manager’s Guide NRI, a comprehensive list of asset management firms providing UCITS investment solutions to investment professionals in the wealth management non resident industry, was a very popular piece. It presents information on almost 60 international asset management firms who do business in the NRI market through their UCITS range of products, and their contacts.
RIA Leaders Are Becoming Younger, Average Age Goes From 52 to 49| A piece about research from TD Ameritrade Institutional which finds the leadership of registered investment advisor firms is passing the torch from the Baby Boomer to Gen X. The report found that the advisory community as a whole is getting younger, reversing a graying trend that had many advisors worried about the sustainability of the industry.
Frontier markets are often attractive to investors as they include countries or economies that are underdeveloped. In this Q&A, Matthews Asia Portfolio Manager Robert Harvey discusses his current views on investing in frontier markets.
What is the current outlook for frontier markets?
It’s important to remember that not all frontier markets are created equal. Some countries have better demographics, better positioning regionally or globally and better political systems, infrastructure and legal framework. A deficiency in any of these areas is a challenge, but opportunities arise when you see positive change. In my view, Asian frontier and smaller emerging markets overall have been out of favor for a while and valuations are now attractive, especially when compared with their growth potential.
When are frontier markets most attractive for investment?
Frontier markets are often attractive to investors as they include countries or economies that are underdeveloped. This means they have the potential to grow, although this potential often is not yet realized. Frontier markets are usually most attractive to invest in when they are most out of favor. Pessimism means you can often buy attractive shares in companies at low prices. When investors become pessimistic, when media reports are largely negative, that is the time to invest in my opinion.
What is the difference between frontier markets and emerging markets?
There is no real difference between the two. At a basic level they are definitions created by benchmark providers. If you compare Sri Lanka (a frontier market) with India (an emerging market), for example, you will see Sri Lanka is much more developed by most economic metrics. For 2018, India had per-capita income of approximately US$2,000, for instance, while Sri Lanka had per-capita income of around US$4,200. Broadly speaking, the definitions are a convenient suggestion or indication of how underdeveloped a country might be.
What is the typical profile of a frontier market investor?
Frontier markets offer huge potential, but it is a complex segment. Investors must have time on their side. Complexity in frontier markets comes from many areas: domestic politics, global commodity prices; domestic economies; foreign exchange movements and domestic business cycles. Their small relative size can also result in a magnified impact on stock prices by changes in investor sentiment. These markets are mostly not suitable for investors who have a shorter time horizon. I think frontier markets are also more suited to investors who are looking for low correlations against developed market indices and who are looking for lower overall volatility. That being said, the complexity of these markets requires a good active manager who understands these complex markets and can discover opportunities for investors.
What are the risks that frontier markets investors should assess before entering a market?
Risks include high oil prices that can materially impact emerging and frontier markets, but the impact differs by country. In the Middle East, high oil prices are a big positive and can help boost both the external accounts and the investment and spending within a country and the region. High oil prices are a negative for oil-importing countries such as Sri Lanka and Pakistan. High oil prices can result in higher import bills, a weaker currency and ultimately higher inflation and interest rates. Therefore, we believe investors should have a long-term time horizon and be prepared to endure volatility. Try not to invest when frontier markets are making news. Just because a market moves up or down, it is not a reason to sell it—only sell if the fundamentals change.
Can you share your investing strategy for frontier markets?
Our approach to emerging and frontier markets is no different than how we look at Asia’s developed markets. We use on-the-ground, bottom-up fundamental analysis to select stocks with a long-term time horizon, mainly focused on the growing consumer demand in these underdeveloped countries. We believe in on-the-ground research and meeting management teams face to face.
111 North Orange Courtesy photo, taken by Costar. Black Salmon Acquires Office Tower In Downtown Orlando
Black Salmon announced the acquisition of 111 North Orange in Orlando for $67.75 million. The 245,201-square-foot, ‘Class A’ office building is considered one of the most sought-after towers in the city’s central business district.
Set in downtown Orlando, the 21-story building is ideally surrounded by more than 500,000 square feet of walkable, street level retail, as well as new multifamily development, creating a true live-work-play environment. Ninety-four percent leased, notable tenants include Regions Bank, UBS, Geico,and co-working space provider Regus.
According to the Bureau of Labor Statistics, Orlando has led the nation in job growth for the past four years, a testament to its strengthening economy. While the region is often most associated with its robust tourism sector, job growth stemmed primarily from professional and business services, which accounted for more than 20,000 new jobs this year.
Black Salmon’s portfolio includes assets in major markets throughout the U.S., such as the San Francisco Bay Area, Phoenix, and Indianapolis. The firm’s investment strategy continues to focus on acquiring stabilized assets in high grow markets with an educated workforce, robust technology industry, and strong market fundamentals.
“Downtown Orlando has been on our radar since the firm’s inception, and we are so pleased to have identified this rare opportunity to own a landmark office tower in the area,” said Grant Peterson, Vice President of acquisitions with Black Salmon. “As we look to 2020, we aim to continue expanding our footprint with similar deals for our select group of investors.”
The expansion of high-speed rail service Brightline, soon to be Virgin Trains, to Orlando’s international airport is expected to further bolster the city’s already booming economy by facilitating new business growth and adding regional transportation options. Orlando is also home to the University of Central Florida (UCF), the largest university in the nation, and the Central Florida Research Park (CFRP), the fourth largest in the country.
Banco Santander International (BSI) is carrying out a series of changes in the organizational structure of BPI, its international private banking business, which is led by Jorge Rossell.
Under the helm of Alfonso Castillo -who is adding the area of Products and Investments to his current responsibilities over Commercial and Global Private Wealth-, there are new appointments to these three areas, Funds Society was able to learn from sources familiar with the matter.
The former Products and Investments area, which was led by Javier Martín Pliego, is being divided into two units: the Products area which will be led by Isidro Fernández, who will also continue serving as Head of Alternative Investments and Funds; and the Investments area, led by Manuel Pérez Duro, until now responsible for AIS at BSISA (Switzerland and Bahamas). Martin Pliego will remain in Santander Group but is leaving the unit.
Within the internal structure of the Investments area, Carlos Ruiz Antequera is to become Chief Investment Officer, incorporating the investment stragegy team. Verónica López-Ibor will lead the Discretionary Portfolio Management team andMiriam Thaler will take on the role as new head of Investments in BSISA (Switzerland and Bahamas).
The Commercial area, under the new leadership of Eugenio Álvarez, will also experience some notable changes: Juan Araujo will be the new Regional Director for Venezuela. He will be based in Geneva. In addition, Yolanda Gargallo and Borja Echanove are to become BSI Branch Managers in New York and Houston, respectively.
With these changes, which will become effective on January 1, the entity will seek to continue growing in the European and Latin American markets. Since the beginning of 2019, Rossell – head of BPI and CEO of BSI- has been looking to boost the group’s business. He reports to both Victor Matarranz, Head of Santander Wealth Management, and to the recently appointed, Tim Wennes, CEO of Santander in the US. Wennes took on the position at the beginning of this month, after Scott Powell left the firm to become COO of Wells Fargo.
Foto cedidaAlberto D'Avenia, Managing Director y Head of US Non-Resident Business (NRB) y Latam Retail en Allianz Global Investors.. Alberto D’Avenia (Allianz Global Investors): “Para 2020, desplegaremos nuestro negocio y profundizaremos en nuestro enfoque de asesoramiento”
Alberto D’Avenia, Managing Director and Head of US Non-Resident Business (NRB) and Latam Retail at Allianz Global Investors, makes a positive balance of 2019. Throughout the year investor’s main concern has been to achieve returns, and preserving capital. D’Avenia considers that that objective has been fulfilled at Allianz GIobal Investors, where the work they do together with private bankers and financial advisors has been fundamental. This and more in the following interview with Funds Society.
What were the main worries that the investors had this year?
Generating income with capital preservation are in general the 2 main features that non-resident private client in the non-resident business require. The year has been positive even for moderate balanced portfolios, and the average low volatility has had the risk management component take a back seat like it always happens in those occasions, but risk management must keep playing a crucial role in a 2020 year that has the making of a more complex financial scenario.
And how did you manage it?
We have seen favour from clients in our more traditional fixed income and balanced solutions like Income and Growth built to this aim, but we have also worked with our distribution partners to introduce diversification solutions in the liquid alternative space, like our option-based Structured return, providing a favourable decorrelation from traditional markets and absolute return, all weather approach, that we believe will come in handy once volatility spikes.
For the next year (2020), what do you think that will be the principal events to consider? How can you take advantage of it or transform into an opportunity?
We position a trio of major economic and political factors as key events to monitor: US elections, trade developments and central banks liquidity – on a lesser extent, but still significant, we have a second trio made of oil supply, food-security fears and growing US-China competition which could create additional risks for portfolios. This in a 2020 that we see characterised by a deceleration in global growth (triggered by slower US and Chinese economies) and continued uncertainty about how monetary policy and politics will move markets.
These factors will offer a number of “risk-on/risk-off” movements, especially in an era where a single tweet can determine significant volatility shifts; in these occasions, beta returns are normally flat. Hence, risk management will be paramount. In this environment, investors should aim to keep their portfolios allocations consistent to their convictions and actively manage risk – not avoid it. These are, in fact, moments where Money weighted return (what clients are getting out of each own’ s investments) tend to differ from Time weighed returns (returns of investments “on paper”) because of trades dictated by fear and greed. The support of the private bankers and advisers will be paramount to consistent investment approach in those volatile phases, and this is why we keep investing in significant communication on topics like behavioural Finance and risk advisory with our dedicated unit risklab.
Investment opportunities in highly valued markets will be rarer and searching for cheaper ones that also generate return potential from dividends or income might be the right approach. Attractive returns can be pursued from less volatile dividend-paying stocks in value sectors such as energy and from themes that capture global, disruptive trends.
We will keep pursuing the benefit of alternative investments such as private credit, infrastructure debt and equity, and absolute-return opportunities tend to be less correlated to fixed income and equities over time, offering an additional source of diversification potential.
AllianzGI is also a recognised leader in ESG informed and integrated investments; we believe in the merits of long-term sustainability of companies that can be best assessed when incorporating ESG factors into investment decisions.
Choose carefully among over-owned US equities; consider undervalued European stocks and emerging-market debt; look to alternative investments for less correlated returns; keep up the hunt for income against a backdrop of low yields.
Finally, careful on passive investment – their backwards looking nature (indexes and funds tracking them are determined in the past) can be significantly tested by news headlines. They can be part of a general portfolio allocation, but in the light of an actively managed strategy set to invest with conviction
During 2019, which were the most popular funds or demanded by the investors?
As said before those favouring a more cautious approach to high yield like Allianz Short Duration High Income and Global Selective HY, those clearly aimed at a risk managed process to ensure a consistent income, like Income and growth and finally thematic investments, offering access to stories with long-term global growth potential, like Allianz Global Artificial Intelligence.
In this way, what do you think that will be the trend in 2020?
We do not believe private clients (and hence, our distribution partners) needs will change dramatically – probably, after 2019 good results, a more cautious approach will be required but still with income generation at the helm. Diversification and risk management will become even more important going forward.
During this year, did you implement some new services or solutions for the investors?
2019 has been a seminal year, after all our office in Miami has been up and running around summer, so we have invested in establishing our brand and its core value proposition: partnership approach oriented to advisory and consultative partner relationships, risk management support with our dedicated unit risklab, ESG integration in our investment process. As far as investment solutions go, we have positioned Allianz Structured Return (it is more a suite of solutions than just one fund, that is the pure portable alpha strategy) and we believe it will be a real game changer especially in high volatility scenario going forward. Same for our socially responsible solutions (SRI) which are available by the main platforms our partners work with, Pershing and Allfunds bank.
Do you have any plan or idea to develop new services for the clients?
If 2019 has been the year of fitting in the market, 2020 will see full deployment of our service model. We have ambitious plans of investing with our partners in our advisory approach, putting risklab, our ESG research and behaviour finance at the core of our offer, together with our best investment solutions.
As a company, what have been your main successes this year?
Our main goal this year has been positioning our brand in the full US non-resident and Latina America Wealth management markets, and our decision to open an office in Miami has been crucial to that. We have signed a number of new distribution agreements with US local independent and Latin America partners, and we have been able to increase the level of cooperation with those we were already working with. Due to our physical absence from the market, we were being looked at in terms of “best of” investment opportunities in our Ucit and while we are obviously thrilled to be able to provide the market with best in class funds, our partnership approach and the richness of above described solutions is now fully available to our partners, getting our relationships to the next level.
Younger, wealthier, and coming from Asia. The profile of typical buyers in the premium second home resort market is dramatically changing. According to the latest Luxury Portfolio International research, while the baby boomers are traditionally buying second homes more often, the new group under 40 is fueling the premium market, creating a spotlight opportunity for sellers. That younger crowd accounts for almost half of interested buyers or at least half of those looking.
“We believe the demand for premium units in the domestic and international resort market will continue to get stronger. We already see an influx of demand for branded residences with value-added services such as building maintenance, housekeeping, concierge facilities, etc.,” shares his insights on the research Daniel Kodsi, CEO of Royal Palm Companies, a leading South Florida developer. “As individuals increasingly become global citizens with diverse business interests, time is becoming a rare commodity. They want the most amenities in the world in one place.”
Another advantage of ownership resort property is holiday rental and investment yield potential. Now, 60-80% of buyers put their property in the rental pool, which is double what it might have been ten years ago. These rental programs tend to be a bigger driver in resort locations as those buying in cities tend to use them more regularly. It’s the right time to take advantage of this need by investing in mixed-use products providing the services and amenities of a full luxury hotel to the vacation residence users.
According to the latest report compiled by UBS and Campden Wealth Research, premium real estate gained the greatest traction in family offices portfolio this year, with allocations rising more than any other asset class, by 2.1 percentage points. That dynamic signals that most of these buyers are beginning to inherit substantial amounts of money from their parents and invest in real estate.
Where do millennial millionaires want to buy? In Florida, of course. The ‘sunshine’ state ranks among the top seven states (after California and New York) where young and wealthy buyers look for property, based on the most recent “A Look at Wealth” study by Coldwell Banker Global Luxury and data surveyor WealthEngine. Downtown Miami is a rising star on a global map. While New York and Los Angeles are stagnant, the Downtown population has increased by 40% since 2000, according to the local authorities. Last year, Miami broke tourism records – 16.5 million overnight visitors and 6.8 million day-trippers came through – and 2019 is likely to top those. All of this bodes well for the city’s hospitality industry.
The $4 billion mixed-use Miami Worldcenter is underway on almost 30 acres that are poised to become a magnetic destination for tourists and business visitors in the heart of Downtown Miami, with its impressive collection of historic landmarks, world-known museums, and waterfront parks. This is the most significant mixed-use development in the U.S. after New York’s Hudson Yards.
This year, PARAMOUNT Miami Worldcenter, a condo tower designed with a “residential Skyport” for a future of flying cars, has been completed and already roughly 90% sold to buyers from around the world – from Turkey, China, the UAE to Brazil, Venezuela, and Sweden. The next global debut at Miami Worldcenter is Legacy Hotel and Residences, with 278 branded condos above 255 hotel rooms, the city’s first enclosed rooftop atrium, and a first-of-its-kind medical and wellness center. Royal Palm Companies’ plan is to break ground in June and complete the building within almost three years. The tower will join a wave of new projects with rental options for buyers.
Peter Stockall, courtesy photo. Peter Stockall se une a iM Global Partner, fortaleciendo su plataforma de distribución internacional
iM Global Partner, a leading investment and development platform focused on acquiring strategic investments in best-in-class traditional and alternative investment firms in the U.S., Europe and Asia, appointed Peter Stockall to lead sales in the US Offshore and Latin America region.
Peter, based in Miami, will enhance iM Global Partner’s international expansion, spearheading the business development efforts in this very important region within the Americas. He will offer US Offshore and Latin America investors access to a wide range of strategies managed by the outstanding partners of iM Global Partner, ranging from US equities to liquid alternative strategies. Peter will report to Jose Castellano, Deputy CEO and Head of International Business Development.
Castellano said: “I am delighted to welcome Peter to our international sales team to support our rapidly developing Latam and US Offshore platforms, which have already been in place for more than a year. His experience covering the Americas will be a valuable asset in helping to develop the operational distribution capability of our current and future U.S., European and Asian Partners.”
Peter has 16 years of experience working for leading asset managers. Before joining iM Global Partner, Peter was responsible for sales of the Carmignac Mutual Fund range in the US. He spent four years, between 2012 and 2016, as Offshore regional Sales Consultant for Pioneer Investments, where he was responsible for sales of offshore mutual funds and alternative investments to financial advisors across all channels in the Southeast, Caribbean, and Panama territories. Peter started his career at Merrill Lynch providing Financial Advisors with sales support and investment guidance in both New York City and Asia regions. Peter has also been part of the Oppenheimer Funds and Capital Group sales teams.
Courtesy photo. Los diferenciales de los bonos híbridos y subordinados pueden estrecharse más durante el primer semestre de 2020, según Nicoló Bocchin de Azimut
A year ago, when Nicoló Bocchin, Head of Fixed Income of the Italian manager Azimut, started to manage the AZ Multiasset Sustainable Hybrid bonds fund, one of the main changes he introduced was to add subordinated bonds of financial companies, especially insurance companies, to its portfolio of corporate hybrid bonds.
“Hybrid bonds allow European issuers to finance themselves without jeopardizing their rating, if they follow the methodology established by the rating agencies, while insurance companies issue subordinated bonds for solvency reasons, but have features in common”, explains Bocchin in an exclusive interview with Funds Society.
Thus, by introducing insurance subordinated bonds, they enhance diversification thanks to instruments “that have almost the same structure as a corporate hybrid bond and provide the same spread,” explains the manager.
For this same purpose, the manager explains that recently they have also added AT1 instruments, known as CoCos in the portfolio, because it is “an asset class that we use tactically to enhance the return of the portfolio and that we like a lot. It is more volatile that hybrid and insurance but again it provides us with diversification nad coupon flows that are very helpful for the time being,” explains Bocchin.
Currently, the portfolio of the AZ Sustainable Hybrid fund is composed of 45% corporate hybrid bonds, 27% subordinated bank bonds and 24% insurers. Bocchin explains that there is generally one or two notches difference between the hybrid or subordinated bond rating and the issuer’s rating, depending on the degree of subordination and that in this type of asset “the investor is rewarded for the subordination, in a title with greater volatility, but with a spread similar to that of the High yield segment and an investment grade default risk.”
Short on underlying interest risk
Another characteristic of its investment style is that it is managed based on spreads, not yield, which implies that the two components that make up the total yield are broken down. The quality of the issuer and the macro environment and the impact on the government yield are analysed separately. Consequently, based on this approach and its current outlook for interest rates, they have recently reduced the sensitivity of the portfolio.
“In Europe we are in negative yield environment in the German curve which we think is not fully justified. We have mid to long term view in the way we manage our portfolio,we think that negative rates is a distortion of the market and perhaps in 2-3 years’ time with a bottoming out of growth and a pick up in inflation, which can occur, interest rates will slowly go from negative back to zero,” says the manager.
Consequently, its current position is that they have a long credit portfolio and short underlying interest rate risk Bocchin explains, “the current duration of our portfolio is 4.5 years, but the interest rate sensitivity of the portfolio is less than 3 years because I am almost 2 years short in futures both in the German curve and the small component in the Italian curve.“
Implementation of ESG Criteria
Another differentiating aspect of his management style is the application of ESG criteria in selecting the securities that are part of the portfolio. “Since we started managing the fund, the percentage of issuers that meet ESG criteria has increased from 75% to 95%,” says the expert, who applies this filter based on the criteria established by his external provider Vontobel.
In the same line the manager adds that, although these types of instruments are mostly issued by European entities, he predicts a great development of ESG issuers in emerging markets in the coming years and confirms that Azimut has the necessary resources and experience to take advantage of this opportunity.
2020: A year to Benefit from the Carry
In terms of return of this type of assets, the fund has had a very significant one during the year, although Bocchin points out that the profitability of the year 2019 has to be seen together with that of 2018 due to the strong spread widening at the end of 2018 and its subsequent recovery during 2019. Based on this good performance, in July 2019 they slightly reduced the risk of the portfolio by decreasing its exposure in AT1 and reinvesting in corporate hybrids and some insurers.
With respect to 2020, the manager points out that the profitability of 2019 will be very difficult to replicate. However, although the spreads are at levels close to 200 basis points, the manager believes that there is still room for further reductions, especially during the first half of 2020.
“With the QE the ECB is buying Investment Grade credit so investors see a squeeze in spreads and yield among IG, and they need to look for yield in the lower part of the capital structure,” explains the manager.
In short, by 2020 they expect a return between 2-4% in euros (that is, between 4.6% and 6.6% in dollars) under optimistic scenarios, although they do not rule out periods of volatility caused mainly by disappointment regarding Chinese growth .“2020 is the year where you should appreciate the fact that this type of instruments have a carry. We don’t expect a big spread compression, although there will be some, and the performance will be basically the yield of the portfolio”, concludes the manager.
Since 2018 China A-Shares have been included in MSCI Indices. Improvements in accessibility are expected to accelerate further inclusion of the China A-Shares in the near term. In this Q&A, Matthews Asia Portfolio StrategistJeremy Murden offers his views on this and China’s motivation to increase accessibility.
What Changes have been made to the MSCI Indices?
With the rebalance on November 27, 2019, index provider MSCI has completed the planned increase of both the weighting and breadth of China A-shares exposure in its emerging markets index as well as its China index and other regional indices.
In 2019, the inclusion factor rose to 20% from 5% through a three-step implementation process of 5% increments that began in May. In addition to the increase in allocation to the existing securities, MSCI also increased the breadth of the securities by including ChiNext shares as well as mid-cap stocks. Following the rebalance, Chinese A-share securities now make up approximately 4.2% of the MSCI Emerging Markets Index, an increase from 0.72%, and China exposure including A-shares now makes up approximately 33.6%.
Why were these changes made?
The move follows the successful implementation of the initial 5% inclusion of China A-shares in 2018 and wide support for the weight increase from international institutional investors. MSCI consulted with a large number of international institutional investors, including asset owners, asset managers, broker/dealers and other market participants worldwide as part of its review process.
Additionally, there was significant growth in the adoption of A-share investment by international investors as the number of northbound Stock Connect accounts grew from 1,700 before the June 2017 inclusion announcement to over 7,300 in February 2019. The Stock Connect programs in recent years linked the Shanghai and Shenzhen stock exchanges to the Hong Kong Stock Exchange and enabled foreign investors to buy A-shares with fewer restrictions.
Are further increases expected?
Yes. While no future increases are currently scheduled, MSCI is in regular contact with the China Securities Regulatory Commission (CSRC) regarding the proposed improvements in market accessibility that would lead to an increase in the inclusion factor.
What are key improvements the CSRC would need to make before inclusion is increased?
A key driver of the increase to 20% from 5% inclusion was the significant advancements in accessibility, including a tightening of the trading suspension rules and a quadrupling of the daily Stock Connect quota in 2018. MSCI highlighted nine potential improvements as a road map to a potential 100% inclusion.
The four areas that MSCI views as most pertinent to increasing the inclusion factor beyond 20% are:
Access to hedging and derivatives as the lack of listed futures and other derivatives products hamper investors’ ability to implement and risk-manage a large-scale inclusion
Change the current settlement cycle of T+0/T+1 to the emerging market standard of T+2 as the current short settlement period presents operational risk and tracking challenges
Align the trading holidays of onshore China and Stock Connect as the misalignment creates investment frictions
Create the availability of Omnibus trading mechanism in Stock Connect to better facilitate best execution and lower operational risk.
The next tier of improvements that MSCI communicated to the CSRC are:
Further reduce trading suspensions. There have been visible improvement lately, but trading suspensions in the China A-shares market remain unique when compared to other emerging markets
Improve access to the Chinese renminbi for stock settlement as direct access to the renminbi for stock settlement could represent a more-efficient foreign-exchange option for global investors
Improve access to IPOs and ETFs as both remain outside the scope of Stock Connect.
Open stock lending and borrowing. While short-selling is technically allowed, there currently is no functioning stock lending and borrowing market
Improve the stability of the Stock Connect universe as changes can create turnover issues in the maintenance of indexes.
What are potential next steps?
According to Sebastian Lieblich, MSCI’s Global Head of Equity Solutions, MSCI has been pleasantly surprised by the pace of accessibility improvements that have been implemented by the CSRC over the past 12 to 18 months. Beijing has indicated that access to derivatives and the alignment of holiday schedules are likely to be addressed in the near term. The change in settlement time is more complex, but still could be implemented swiftly. If the present momentum continues, “in a relatively short time frame, the launch of a public consultation on a major change could be announced.”
While the 2019 increase has been a move from 5% to 20%, Mr. Lieblich felt that given the pace of improvements, moving forward there is no need to grow the inclusion factors in 15% to 20% increments. He stated there is no prescribed path from here and the timing and extent of further inclusion will be directly driven by the timing and extent of accessibility improvements. While nearly all of the second-tier steps would need to be completed to reach 100% inclusion, incremental improvements will accelerate inclusion in the near term.
In addition to an increase in the inclusion factor, MSCI could continue to broaden the universe of A-shares to include the small-cap universe in indices to align China A-shares with the global standard of 85% of adjusted free float market cap. Beyond that, the securities trading on the new Shanghai Stock Exchange’s Science and Technology Innovation Board (STAR Market) could be included if they meet requirements of the MSCI GIMI Methodology and the eligibility of the stock connect programs linking the mainland markets and Hong Kong.
Finally, the exposure of Chinese A-shares in MSCI indices is still limited by the current 30% foreign ownership limit. Any opening from that limit would result in an increase to the adjusted free float market cap of all A-shares at the next index rebalance without any action by MSCI. Depending on the scale of the increase, it could have a multiplicative effect on the increase in A-share inclusion.
What is China’s motivation to increase accessibility?
China is primarily driven by a desire to draw institutional assets into its domestic market, according to our MSCI source. While many developed equity markets are 80%+ institutionally owned, China remains the inverse with only 20% institutional ownership. That has led to higher volatility as annual turnover in the A-share market in 2017 was 222% versus 116% for the U.S. Access to a larger pool of institutional capital, which tends to be more stable and long term in nature, would help reduce volatility in the market.
What would a move to 50% inclusion and beyond mean for the MSCI emerging market index?
Holding all other factors constant, a move to 50% inclusion from 20% inclusion would increase the exposure of A-shares in the MSCI Emerging Markets Index to 9.8% from its current level of 4.2% and increase China exposure to 37.5% from 33.6%. At full inclusion, China would represent 43.1% of the benchmark, 17.8% of which would come from A-share exposure. Looking ahead further, if South Korea and Taiwan, which are already considered to be developed economies, were to graduate to developed- market status per MSCI, China would make up 48.2% of the index at 50% inclusion and 54.0% at full inclusion.
How could this benefit investors?
The current Chinese exposure within the MSCI Emerging Markets Index and other indices is heavily weighted to mega-cap internet companies and large Chinese banks. This and future increases in A-shares exposure, and a further broadening of the universe to include small-cap stocks, will allow the indices to better reflect the opportunity set within Chinese equities.
Additionally, there was an estimated $1.9 trillion in assets that track the MSCI EM Index as of March 2019. While flows into A-shares from active managers are difficult to predict, the growth of the benchmark weight is likely to translate to inflows to the space and larger exposure from active managers who track the index.
Will pressure from U.S. politicians affect A-share inclusion?
While there has been pressure from U.S. policymakers, led by Florida Senator Marco Rubio, to remove Chinese stocks from indices, MSCI remains focused on the needs of global investors. Per MSCI, all indices use a fully transparent rules-based methodology. MSCI stated it will not make changes to existing indices or delay a planned allocation due to political pressure, only to changes in market access.
Additionally, the U.S. Thrift Savings plan at the center of the political pressure recently announced its decision to maintain its current benchmarks and China exposure after its board and consultant concluded maintaining the exposure to China was in the best interest of plan participants.
How much experience does Matthews Asia have with China A-shares?
Matthews Asia has extensively studied and invested in China’s domestic A-share companies for many years. In 2014, our firm was awarded a Qualified Foreign Institutional Investor (QFII) license and quota that enabled us to invest directly into China’s domestic securities market, including the market for China A-shares. We also have participated in A-shares via the Stock Connect programs.
We continue to be attracted by the fundamentally sound merits of many local companies listed in China. We realize that many quality A-share companies in growing industries can be priced at rich valuation multiples, however, which makes our experience of carefully vetting them critical. We believe long-term investors can benefit from exposure to A-shares.
At Matthews Asia, our focus has always been on taking a fundamental approach to finding leading A-share companies that are poised to benefit from the country’s structural shift toward its domestic economy.
