Despite years of economic growth, it is only recently that investors outside China have begun to gain access to the country's red-hot stock market. Shares in companies that trade on the mainland, also known as A-shares, currently have a float market capitalization of $5.443 trillion -- nearly three times the size of the Canadian market, which stands at approximately $2 trillion, and over five times the size of the Hong Kong market's $1 trillion capitalization (all figures are in U.S. dollars). The mainland dominates the Chinese market overall, with over 2,700 A-share companies out of a total of 3,655 companies listed. And the Chinese government is eager to open markets further, opening free trade zones, cutting red tape and clarifying investment rules for foreign-owned businesses.
Yet the excitement may have come at a risky time. The Shanghai Composite Index, which tracks China's largest companies -- many of them state-owned -- is up 149% over the past year. The riskier and tech-heavy Shenzhen Composite Index, which tracks smaller and privately owned companies, is up 190%. Many financial observers have described the China market as a bubble, some comparing it to the dot-com boom of the late 1990s.
That worry hasn't stopped fund companies from moving forward in adding A-shares to their products. Earlier this month, MSCI announced that A-shares were "on track" for inclusion in its Emerging Markets index, potentially as soon as next summer. Vanguard has already announced its inclusion of A-shares in its Emerging Markets Stock Index Fund, and 6% of that fund is scheduled to be comprised of A-shares later this year.
At Excel Funds, a Mississauga, Ont.-based company that focuses on emerging markets, the attitude toward A-shares is cautiously optimistic. The company manages its Excel China Fund through two asset managers: China AMC, which manages over US$90 billion in A-shares, and Barings, which manages over US$40 billion in Hong Kong-listed stocks, known as H-shares.
Nan Bai, vice-president of international business at China AMC, notes three factors that make A-shares attractive: investment reforms under Chinese President Xi Jinping, the growth of China's domestic consumer market, and the low rate of current foreign and institutional ownership.
"The investor base in mainland China is more idiosyncratic than the rest of the world," Bai says. "But we do see the institutional ownership has been increasing year over year. Foreign ownership in mainland China is very low compared to more mature Asian markets like Japan and South Korea. So we do see significant room for growth in foreign ownerships, as well as institutional ownerships, in this part of the market."
For now, though, Excel's approach is not to invest too heavily in small- and mid-cap China A-shares, says William Fong, head of the Asian equities team at Barings.
"If you look at some small to medium enterprises, especially technology companies, I think the share price is very hard to justify by fundamentals," he says. "For those specific stocks or sectors, we are talking about very high valuations, but the visibility for earnings growth is not too good. We continue to be very careful in this space."
Fong agrees that the market for small- and mid-cap A-shares is showing characteristics of a bubble. However, he says, that should not dissuade investors from China A-shares as a whole.
"If you look at the overall A-share market, the valuation is still below 20 times P/E (price/earnings ratio). I think compared to the historical peak, we are not there yet. So there's still upside in A-shares overall."
Fong points to the consumer and financial sectors as the best sources for investment opportunities in mainland China.
"We think there are many consumer stocks in A-shares, particularly the big cap, blue-chip companies within the consumer sector. Most of them are trading at below 20 times P/E, but with good earnings growth. Other than that, we also look at some financials in A-shares, because some financial companies have very good growth potential."
Excel has seen plenty of demand for Chinese stocks in Canada, particularly among large institutional investors such as pension plans, says head of sales and business development Michael Annis.
"China is a world market, and they're chomping at the heels of the U.S. for the economic powerhouse, and I think the rest of the world recognizes this," Annis says. "And their population growth and GDP numbers year-over-year have been incredibly beneficial to investors of the past, and most likely investors of the future."
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