CONTRIBUTORS
Dina Ting
Head of Global Index Portfolio Management
Index provider MSCI’s decision to include a number of domestic Chinese equities in several of its benchmark indexes was seen as a milestone for the China market. Dina Ting, our head of Global Index Portfolio Management, discusses the MSCI inclusion and what it means for our LibertyQ smart beta exchange-traded funds.
The recent inclusion of China A shares in MSCI indexes represents an important milestone for Chinese equities. Traditionally, investors’ exposure to China came largely through Chinese companies listed outside the mainland, for example in Hong Kong, Singapore or the United States.
In our view, foreign investors’ increased ability to access a market that was previously restrictive will have a lasting impact going forward in various fronts, including governance, correlation and performance.
MSCI Inclusion: The Details
Index provider MSCI announced the addition of 226 large-cap China A share names that trade via the Stock Connect program to its Emerging Markets Index, All Country World Index (ACWI) and China Index.1 A shares (also called domestic shares or stocks) represent companies incorporated and listed in mainland China. These shares are quoted in renminbi and traded on China’s two mainland exchanges, located in Shanghai and Shenzhen.
An initial 5% inclusion is being implemented in two phases, with 2.5% effective June 1, and 2.5% on August 31.2 You can read more about the details of the inclusion here.
The Implications for Exchange-Traded Funds (ETFs)
The MSCI development has important implications for ETFs that closely track these MSCI indexes or otherwise aim to provide exposure to China’s equity market. Considering the entire universe of Chinese equities (estimated at more than 3,000), the number being added is relatively small. However, ETFs that track these MSCI indexes will also need to purchase A shares to keep performance in line with the indexes.
Franklin Templeton’s LibertyQ Emerging Markets, Global Equity and Global Dividend Indexes went through their semi-annual reconstitution on May 30, at which time the China A shares security inclusion was also determined. From the starting universe, the LibertyQ indexes apply the factor scoring to select only names with what we believe to be the most attractive characteristics based on quality, value, low volatility and momentum scores to be included in the index. The table below lists the inclusions per investment universe and LibertyQ indexes.
China A Shares Inclusion: By the Numbers
| INDEX NAME | # OF CHINA A SHARES ADDED | WEIGHTING OF CHINA A SHARES IN RECONSTITUTED INDEX | |
| Investment Universe | MSCI Emerging Markets Index | 226 | 0.40% |
| Underlying Index for FLQE | Franklin LibertyQ Emerging Markets Index | 16 | 0.19% |
| Investment Universe | MSCI AWCI Index | 226 | 0.05% |
| Underlying Index for FLQG | Franklin LibertyQ Global Equity Index | 27 | 0.20% |
| Investment Universe | MSCI ACWI ex-REITS Index | 226 | 0.05% |
| Underlying Index for FLQD | Franklin LibertyQ Global Dividend Index | 2 | 0.01% |
Overall, the China A Shares inclusion went smoothly, and the additions into MSCI indexes expanded investors’ exposure to market sectors that previously have been underrepresented, such as consumer staples and consumer discretionary, both of which allow investors more direct participation in the growth of local Chinese demands. We think this is important to emphasize—as the range of investment opportunities China’s market represents is vast.
This event marked the beginning of a foray of a broader set of foreign institutional investors into the previously limited markets, which we think will likely drive a higher correlation of A shares to the broader market going forward. And, we think it will also likely drive further improvements in corporate governance in China.
Dina Ting’s comments, opinions and analyses expressed herein are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.
This information is intended for US residents only.
To comment or post your question on this subject, follow us on Twitter @LibertyShares and on LinkedIn.
1. Source: MSCI, as of May 24, 2018. The MSCI Emerging Markets Index captures large- and mid-cap representation across 24 emerging-market countries. The MSCI All Country World Index captures large- and mid-cap representation across 23 developed markets and 24 emerging-market countries. Indexes are unmanaged and one cannot directly invest in them. Past performance is not an indicator or guarantee of future performance. MSCI makes no warranties and shall have no liability with respect to any MSCI data reproduced herein. No further redistribution or use is permitted. This report is not prepared or endorsed by MSCI. Important data provider notices and terms available at www.franklintempletondatasources.com.
2. Source: Ibid.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. ETFs trade like stocks, fluctuate in market value and may trade at prices above or below the ETFs’ net asset value. However, there can be no guarantee that an active trading market for ETF shares will be developed or maintained or that their listing will continue or remain unchanged. While the shares of ETFs are tradable on secondary markets, they may not readily trade in all market conditions and may trade at significant discounts in periods of market stress. Brokerage commissions and ETF expenses will reduce returns.
Generally, those funds offering potential for higher returns are accompanied by a higher degree of risk. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments; investments in emerging markets involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. To the extent the fund focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a fund that invests in a wider variety of countries, regions, industries, sectors or investments.
There can be no assurance that a fund’s multi-factor stock selection process will enhance performance. Exposure to such investment factors may detract from performance in some market environments, perhaps for extended periods.
Franklin LibertyQ Emerging Markets
The Franklin LibertyQ Emerging Markets ETF is designed for the aggressive portion of a well-diversified portfolio.
Franklin LibertyQ Global Dividend
Companies that have historically paid regular dividends to shareholders may decrease or eliminate dividend payments in the future. A decrease in dividend payments by an issuer may result in a decrease in the value of the issuer’s stock and less available income for the fund.
Franklin LibertyQ Global Equity
Performance of the Franklin LibertyQ Global Equity Fund may vary significantly from the performance of an index, as a result of transaction costs, expenses and other factors.
Franklin LibertyQ International Equity Hedged Index
The Franklin LibertyQ International equity fund will attempt to hedge the currency exposure of non-US dollar denominated securities held in its portfolio by investing in foreign currency forward contracts. Foreign currency forward contracts do not eliminate movements in the value of non-U.S. currencies and securities but rather allow the fund to establish a fixed rate of exchange for a future point in time. Investments in derivatives involve costs and create economic leverage, which may result in significant volatility and cause the Fund to participate in losses (as well as gains) that significantly exceed the Fund’s initial investment. Currency management strategies could result in losses to the Fund if currencies do not perform as the investment manager expects.