Bloomberg Barclays Fixed Income Indices yesterday announced new parallel global indices that include China RMB denominated securities.
Take two influential indices: MSCI Emerging Market Index in stocks and the Bloomberg Barclays Global Aggregate Bond Index for bonds, each comprising nearly 25 countries. Both are typical to the universe of indices and as such are systematically underweight in China. For although China dominates the EM space (with the second largest stock and third largest bond market in the world) its capital mobility restrictions, quotas and transparency hinder it from being included on a level proportional to its economic significance.
As we have previously compared: ‘China‘s GDP is over 7x larger than South Korea’s which currently accounts for over 15% of the MSCI EM Index’. Currently at 26.8% China’s weighting in the MSCI EM index could rise to 27.8% with a partial inclusion which was postponed last June. This may still be on the cards for this year but China’s recent increase in capital controls make it less likely. Further into the future it has the potential to reach over 40% will full inclusion of China A-Shares (alongside already included China and China overseas shares) should the quota systems and capital mobility restrictions ever be fully abolished. With around $1.5tn benchmarked to the MSCI EM Index and plenty more active and passive money influenced by this and similar indices this transitional trend could bump up international investment to both China’s stock and bond markets.
But whereas equity investors will have to wait a few more months for the MSCI decision, the Bloomberg Barclays Indices (which have become increasingly popular since acquired by Bloomberg in December 2015) have decided to create a parallel ‘Global Aggregate Index + China’ which would include onshore Chinese government bonds whilst keeping their Global Aggregate Index unchanged. This allows investors to decide to follow either or both going forward.
Such ‘transition indices’ should be seen as a positive step for the Chinese government who continue to suggest further key reforms are imminent. It also represents an opportunity for international investors who currently only hold around 2% of both the mainland stock market and onshore interbank bond market according to the Financial Times. Should other major index providers follow suit (JP Morgan, MSCI and Citigroup expected to make announcements in the next few months) investors should consider their allocation to China in general and make the necessary adjustments before passive investments are forced to follow any potential index adjustment. Even if China doesn’t make the cut this year its disproportional economic magnitude suggests that Chinese stocks, bonds and currency should eventually but inevitably constitute a greater proportion of international portfolios.