China – Too big and inefficient to ignore

Read­ing time: 3 mins

The Life Insur­ance and Wealth Man­age­ment has put togeth­er the first instal­ment of their Chi­na Series. This arti­cle is an intro­duc­tion to the series, high­light­ing the eco­nom­ic envi­ron­ment in Chi­na and some impli­ca­tions for the future. 

Since Chi­na joined the WTO in 2001, and opened up its econ­o­my, it has expe­ri­enced strong growth over the last decade. China’s GDP is now the sec­ond largest in the world, and it is antic­i­pat­ed to grow at a rate between 6 – 7% over the next 5 – 10 years. It has become one of the most influ­en­tial mar­kets in the world.

The fast grow­ing econ­o­my also breeds a large finan­cial mar­ket. Cur­rent­ly, the Chi­nese list­ed equi­ty mar­ket is the sec­ond largest in the world, and it is antic­i­pat­ed to grow much big­ger in the future. Across the glob­al exchanges, there are more than 4,000 Chi­nese list­ed com­pa­nies. The breadth and depth of this mar­ket presents a great invest­ment oppor­tu­ni­ty.

In Chi­na, the com­pa­ny needs to be approved by the reg­u­la­tor before it starts its IPO process. Every year there are about 600 com­pa­nies in the pipeline who are wait­ing to be approved and list­ed on the onshore ‘A share mar­ket’. This sug­gests the invest­ment uni­verse is still tran­si­tion­ing to be big­ger and broad­er.

As of today, China’s onshore equi­ty mar­ket is not part of the MSCI glob­al index, how­ev­er the index provider is close to mak­ing the deci­sion regard­ing inclu­sion of Chi­na A stocks. At full inclu­sion, Chi­na rep­re­sents about 40 – 50% of the EM index, which could rep­re­sent 6 – 10% of the ACWI index. The poten­tial flow into Chi­nese onshore equi­ties could be mate­r­i­al.

Apart from its sheer size, the Chi­na onshore mar­ket is prob­a­bly the most inef­fi­cient mar­ket ever seen in the glob­al cap­i­tal mar­ket. A few forces are behind this phe­nom­e­non.

In Chi­na, approx­i­mate­ly, 85% of the mar­ket par­tic­i­pa­tion is retail invest­ment. Being a typ­i­cal retail dri­ven mar­ket, this mar­ket is very often mis­priced which offers more room for alpha gen­er­a­tion, for long term fun­da­men­tal mind­ed insti­tu­tion­al investor.

More inter­est­ing­ly, the stock mar­ket par­tic­i­pa­tion rate is about 9% of the pop­u­la­tion in Chi­na (source SWUFE). And stock is only 15% of aver­age householder’s finan­cial asset and we all know Chi­nese com­mu­ni­ty likes to save (about 60% sav­ing rate).

As result, this high retail par­tic­i­pa­tion rate is going to stay in the mar­ket, which dri­ves the mar­ket away from its fun­da­men­tal fair lev­el.



The mar­ket inef­fi­cien­cy can also attribute to the lim­it­ed cov­er­age by the bro­ker and sell side ana­lyst. There are more than 4000 stocks list­ed which about 3000 are in the Chi­na onshore mar­ket. Rough­ly, the ana­lyst cov­er­age of the stock is very lim­it­ed. The ban­ning of short sell­ing in Chi­na also ampli­fies it as the ana­lysts have lim­it­ed incen­tive to issue neg­a­tive rat­ings, thus the research fails to reflect the fun­da­men­tal risk.

In Chi­na, the insti­tu­tion­al investor is a small part of the mar­ket, the lack of knowl­edge and stock assess­ment skill of the non insti­tu­tion­al investors makes it one of most inef­fi­cient mar­kets. Par­tic­u­lar­ly, the for­eign investor is about 2.5% of the mar­ket. Also the lan­guage bar­ri­er is anoth­er lim­i­ta­tion for for­eign pro­fes­sion­al investors to exer­cise the stock selec­tion skillset, anoth­er typ­i­cal exam­ple of infor­ma­tion asym­me­try.

The his­to­ry has shown the intra-sec­tor return dis­per­sion is tremen­dous­ly high, as shown in two charts below. The Chi­na A share intra-sec­tor return is mate­ri­al­ly high­er than equiv­a­lent US equi­ty.

The dis­per­sion also implies anoth­er inter­est­ing point: grow­ing diver­gence. As we stand here out­side Chi­na, we nor­mal­ly gen­er­alise things for Chi­na by assess­ing the head­line num­ber e.g. GDP. With the ongo­ing pro­found tran­si­tion of Chi­nese econ­o­my, the head­line aggre­gate num­ber becomes less impor­tant for equi­ty invest­ment because the econ­o­my size is so big and com­plex in struc­ture, and more impor­tant­ly, the great diver­gence is hap­pen­ing for dif­fer­ent sec­tors.

One pro­found evi­dent rep­re­sent­ed with Chi­na CSI300 index (a com­mon equi­ty index for Chi­na). Over the last six years, it was almost flat, but the sec­tor per­for­mance shown in the below bar chart diverged tremen­dous­ly.

Over­all, Chi­na is a very inter­est­ing and dynam­ic mar­ket. We are going to dis­cuss a series of hot issues about the Chi­nese mar­ket, with a focus on list­ed equi­ty mar­kets over a few pub­li­ca­tions about Chi­na on the Actu­ar­ies dig­i­tal, so please keep an eye on our Chi­na series.

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About the author

Hui Henry Zhang FIAA

Henry is the Senior Investment Analyst within Investment Strategy team. His main responsibility includes daily tactical asset allocation, quantitative/systematic equity portfolio, real return strategy and overarching portfolio construction. Prior to joining FSS in 2012, Henry worked at Snowy Hydro Limited as a quantitative analyst. Before Snowy Hydro Limited, he also worked in Investment team oversees the portfolio for CommInsure, the insurance division of Commonwealth Bank of Australia. Henry earned B.S. in Actuarial Science with honours and Commerce from The Australian National University. He is a qualified Actuary and earned fellowship in Institute of Actuaries of Australia. Also, Henry is now undertaking his PhD through University of Sydney.

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