Why Deutsche Asset Management Is Bullish On China

From Rob Bush: So, the door has been opened. Just a crack to be sure, but opened nevertheless. We refer to Morgan Stanley Capital International’s (MSCI’s) recent decision to re-label the onshore Chinese A-share market as an emerging market, and therefore include a sliver of these stocks in its main indexes.

Getting up to full weight will be a long process but, in making their decision, MSCI is recognizing something that we at Deutsche Asset Management have long been arguing – that the Chinese A-share market is simply too important to ignore.

MSCI’s vote of approval aside, there are a number of reasons why we think China may deserve consideration in a portfolio. Let’s look at the macro, the markets, and the metrics.

The Macro

As a firm we remain positive on China. We forecast the economy to grow at 6.3% this year, and next, marking a continuation of the stellar growth that has defined the Chinese economy for much of the last two decades. And it’s not just the headline number itself, rather the composition of the economy is also changing with encouraging shifts towards services and infrastructure. Throw into the mix a forecast for reasonable consumer price inflation of 2-3%, unemployment at about 4%, a fiscal deficit that we forecast will shrink from 3.4% this year to 3.2% in 2018, and a combined monetary policy rate of 4.35% and gross government debt-to-gross domestic product (GDP) of around 50%, and it seems like China has plenty of ammunition to weather any future economic storms. Of course, we’re not claiming the economy is without its problems but, let’s be frank, this is a macro palette that many developed nations would love to paint from.

The Markets

Whatever your view of investing in Chinese equity markets, you surely have to agree that the direction that policymakers have headed in over recent years is positive – the intent seems to be increased liberalization, easier access, and improved regulation. We tend to think of the US equity markets as a gold standard for how a well-run capital market should look, but let’s give China credit where it’s due – there is a determination to continually improve their market microstructure. And who can blame officials for trying to get there incrementally?

Issues remain, but the introduction of the Connect markets which link the exchanges in Shanghai and Shenzhen to Hong Kong are encouraging, as are a reduction in trading suspensions. Certainly, MSCI seem to agree, they cited access and suspensions as two of the hurdles that China had to leap and their announcement alluded to sufficient progress on both these fronts.

The Metrics

If you’re not convinced by the subjective nature of the arguments so far, then consider the following. We took the monthly returns of the CSI 300 (the main Chinese benchmark of A-shares) and the S&P 500 from early 2002 to May 2017 and calculated the returns, risks and correlation of these two markets, as well as a 90%/10% combination of the two (assuming monthly rebalances).

The results are shown in the table in Figure One. Note the incredibly powerful result of adding a clip of a relatively uncorrelated asset class to a US portfolio. Despite having a considerably higher volatility, the low correlation of Chinese and American stocks (at 0.30 over this period) resulted in a portfolio with higher return and lower risk. In our opinion, this evidence alone makes China a very compelling market to consider.

Source: Deutsche Asset Management as of 5/31/17. Past performance may not be indicative of future results.

Ultimately, whether you invest in China or not, we’re firmly of the view that, as the world’s second largest equity market, the decision demands careful scrutiny. Clearly, MSCI is now of the opinion that China has come far enough to justify the relabeling of the onshore market, and allocation in some of its key indexes should follow as a result.

However, be aware that the proposed allocation is not likely to transpire for nearly a year and, when it does, it will still only account for a small proportion of the far larger onshore market. But that doesn’t mean that wider access is impossible. Indeed the Chinese A-share market is more widely available to investors through various means (including, full disclosure, via a number of ETFs offered here at Deutsche Asset Management).

But, the recent decision aside – and, to be clear, we welcome it – we were already positive on the Chinese macro picture, its market reforms, and the profound impact that it can play in a portfolio – we’re bulls on a China shop.

The Deutsche X-Trackers Harvest CSI 300 China A-Shares ETF (NYSE:ASHR) was trading at $26.41 per share on Thursday morning, down $0 (0.00%). Year-to-date, ASHR has gained 12.62%, versus a 8.68% rise in the benchmark S&P 500 index during the same period.

ASHR currently has an ETF Daily News SMART Grade of A (Strong Buy), and is ranked #4 of 32 ETFs in the China Equities ETFs category.

This article is brought to you courtesy of Deutsche Asset Management.