China’s seemingly insatiable appetite for foreign assets has been a big focus in international business over the last several years.
However, this phenomenon isn't as new as it might feel, with the boom in China having started almost 40 years ago when longtime leader Deng Xiaoping took power and started introducing economic reforms.
The difference is that now China's rate of expansion has now become so important that it even appears on the financial calendar, with an army of investors around the world constantly monitoring how quickly China's GDP is growing.
And just as China’s economy has continued to grow, so has the world's interest in Chinese financial markets.
In the last several years, China has (almost begrudgingly) opened up access to its mainland financial markets through its most western-facing territory, Hong Kong.
Just last year, a connect that allows foreign investors to access the mainland was opened up between Hong Kong and Shenzhen, the latter being in my opinion "the most important mega-city on the earth that most have never heard of.” A similar connection had already been established between Hong Kong and Shanghai, which went live in 2014.
These actions, which allow for more diversified global ownership in Chinese stocks, have in turn catalyzed adjustments in some important emerging market benchmarks, and the products that track them.
As discussed recently on an episode of Options Jive, MSCI Inc. recently made the decision to include Chinese mainland shares (often called “A-Shares) in their emerging markets benchmark index. That landmark change means that many other financial products tracking the MSCI Emerging Market Index (EMI) will also need to be adjusted.
On a high level, that means that demand for A-Shares should pick up, as ETFs tracking the MSCI EMI and other global financial products/investors add these shares to their portfolios.
However, as outlined on Options Jive, there’s another dimension to consider - China’s representation in many of these financial products will also grow substantially. For example, in the iShares MSCI Emerging Markets ETF (EEM), exposure to China will grow from 27% to approximately 40%.
Certainly that’s nothing to sneeze at, especially for investors looking to spread risk across emerging markets without a high concentration in any single economy.
Considering the fact that A-shares have experienced significant volatility in recent years, it’s additionally important for options traders to keep track of how this MSCI decision could affect implied volatility. Using EEM as an example, this episode of Options Jive helps viewers better understand how the inclusion of A-shares could affect implied volatility going forward.
We recommend taking a few moments of your time to review the complete episode of Options Jive focusing on this important topic when your schedule allows. Heightened awareness of these changes to the MSCI EMI may help traders better manage risk in their existing portfolios, or even uncover new opportunities going forward.
Fortunately, this change won’t be happening until 2018 at the earliest, as the MSCI is planning to conduct additional reviews in May and August next year.
If you have any questions related to the MSCI’s recent decision to include A-shares in their emerging market index, we hope you’ll leave a message in the space below or reach out directly at email@example.com.
We look forward to hearing from you!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.