Accessing world's second-largest stock market

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<p><strong>Glenn Freeman</strong>: I'm talking with Eng-Teck from Nikko Asset Management about the opportunity that Asian markets present for Australian investors, particularly China and the A shares which are now increasingly available to investors offshore.</p> <p><strong>Eng-Teck Tan</strong>: So, to start with, China is already now the second-largest stock market in the world if you include the Shanghai and the Shenzhen Stock Exchange. So, historically, a lot of investors had problems getting into the Chinese market because up to like three years ago they were on, what we call, the qualified foreign institutional investors license. So, to get the license, you have to apply to the Chinese government through the central bank and eventually if you get approved, most of the time you don't get the full quota. But if you get approved, then you have to put the money in immediately. Chances are that your money will be stuck there for a couple of weeks up to a few months.</p> <p>That was a very cumbersome process for most institutional investors. About three years ago, the Chinese started a pilot program, what we call, the Stock Connect program. So, practically, in this Stock Connect program, there's a group of approved stocks, almost like 80 per cent of the stock market in Shanghai and since last year, also, 80 per cent of the stock market in Shenzhen. Through this program what happens is that instead of having to apply for a quota you actually trade to the Hong Kong Stock Exchange and you get your money back almost like within three days following the Hong Kong system.</p> <p>To us, this year, it's really the MSCI China inclusion. Although very minuscule, and China is probably like the most underrepresented MSCI country in the whole index. Of course, on the other side, you have U.S. which is the most over-represented. China is about almost five times under-represented relative to its GDP. So, I think, it's a matter of time before China get full inclusion.</p> <p>So, what does that really mean for global and financial investors? I think even with the full inclusion China will get to maybe between 8 per cent to 12 per cent of the global index. It's probably not enough to move the needle for investors to really separately allocate to China from a global investors' asset allocation perspective. But from a global emerging market investors' perspective that's where we have to rethink our traditional way of investing. Because when a full inclusion happens, China potentially accounts for between 60 per cent to 90 per cent of the global emerging market. So, I think, from that perspective, from global emerging market investors and also from Asia ex-Japan investors, eventually, we could end up with global emerging market index that is ex-China and Asia ex-Japan ex-China index. So, I think, that's a consideration that asset allocators in Australia need to consider when a full inclusion happens.</p> <p><strong>Freeman</strong>: So, what are China A shares and what does their growing availability mean for investors?</p> <p><strong>Tan</strong>: China A shares is just one asset class. China, unfortunately, is quite a complicated animal. There's A shares; there is what we call the U shares which is the U.S.-listed shares. So, what typically people separate to in China is what we call offshore and onshore. So, the offshore is what you have, the A shares, the U.S.-listed shares. So, when you invest in that, which is currently the bulk of the composition of the MSCI China, more than 40 per cent is actually in the internet-related stocks. And then you have another 25 per cent to 28 per cent of that in the financials.</p> <p>So, in onshore shares there's hardly any U.S.-listed stocks, because believe it or not, listing on the Shenzhen and the Shanghai Stock Exchange is actually far more difficult than Hong Kong and the U.S., because they don't allow nonprofitable company to be listed and a lot of internet companies weren't exactly profitable when they listed in the U.S.</p> <p>So, they have very few internet-related stocks. What they have is a huge amount of consumer brands that you probably have never heard before in Australia but is extremely popular in China. Now, if our thesis is correct, and it has been correct for the past three years, where China is actually rebalancing its economy from a fixed asset dominant economy towards a more consumption-based economy. That has happened actually at increasing rate. Then what foreign investors are getting from the MSCI China is not exactly representative of the where the future of the Chinese economy is going. And the A shares actually can balance that out, because you get a huge proportion of the index that is quite heavily tilted towards the domestic economy.</p> <p><strong>Freeman</strong>: Eng-Teck, can you talk us through the process that Nikko follows in selecting assets for its Asian portfolio?</p> <p><strong>Tan</strong>: Yeah. So, Nikko follow a very rigorous process in terms of how we are selecting stocks. We start with idea generation where various offices are involved in terms of what we call idea triangulations. We try to absorb ideas from other offices, whether it's in Australia, whether it's in Edinburgh and Japan. And then from there, we try to see how it reimpose into Asia. On top of that, of course, we do very intense company visits, company management contacts, suppliers contacts. We do a lot third-party expert network. So, once these ideas are generated, then we prioritize ideas based on when we think that the timeframe is going to happen. If we think that it is very urgent, then we would either put the analyst on a plane to visit the companies and expect the research to be out within one to weeks. If we think that this is more of a secular trend, then we might have a bit more time to do more research.</p> <p>Now, once the analysts are churning out their research, they have to present to investment committee within the team and then we will put a rating on the stocks. And this rating, if it's a positive rating, go into a pool of stocks where all the portfolio managers within Nikko can select at them. So, we are quite segregated in terms of duties. The portfolio managers cannot buy any stocks they want. So, we are not like a star portfolio manager kind of concept. And the analyst role is really to find the best stocks for the portfolio managers to invest in.</p>

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