While recognising the growing importance of China in the global economy, ERI Scientific Beta, a smart beta index provider, has taken the decision not to add China A-Shares to its universe at present.
The company has, however, taken the following actions in this area:
• The creation of a dedicated and independent Chinese geographic basic block made up of 100 liquid constituents to ensure proper representation of the Chinese equity market within the Scientific Beta Emerging Universe. Multi-regional indices offered by ERI Scientific Beta are built by aggregating the strategies constructed at the geographic basic block level based on the total free-float-adjusted market capitalisation of each geographic basic block in the reference capitalisation-weighted index of the global universe. This approach ensures proper exposure to each geographic basic block and avoids taking geographical risks, which correspond to deviations from the weights of economic regions expressed by their market capitalisations.
• The addition of Chinese ADR (American Depositary Receipts) to the list of eligible securities for inclusion in the Scientific Beta Universe. Chinese ADRs offer a level of reassurance for investors, since they are not directly subject to Chinese market regulations while offering exposure to the Chinese economy.
Scientific Beta has noted the efforts made by the Chinese authorities to open Chinese equities to institutional investors and align its accessibility with international standards. Nevertheless, some accessibility issues that Scientific Beta considers to be a penalty for its clients remain:
• Derivatives products linked to China A-shares need to be pre-approved (in particular index-linked investment products) and can be restricted by the exchange.
• Large number of suspensions affecting China A-shares when compared to other emerging equity markets.
• Stock Connect daily limit: Even if in April 2018, the daily quota of both Northbound stock-connect programs (Shanghai and Shenzhen) between Hong Kong and mainland China quadrupled to RMB52 billion, the risk of breaching it during index rebalancing still exists.
• Limited securities lending and borrowing market.
Ultimately, the China block, thanks to the inclusion of the American Depositary Receipts, provides exposure to China while ensuring a good level of liquidity. The investment capacity and liquidity of the China block is comparable to that of the whole emerging universe and of the global index.
Noël Amenc (pictured), CEO of Scientific Beta, says: “An investment universe that is dedicated to smart beta needs not only to be representative, but also to be investable and liquid. The exposure to China in an index can be controlled by creating a China block, but not necessarily through an inordinate increase in the number of Chinese stocks, to the detriment of their liquidity.”