China shares have surged this year, but with active fund managers still underexposed to the market, the rally isn't over, Goldman Sachs said.
"Funds of various mandates are underweight the market in a range of 140-600bp, and thus have marked benchmark stress and a need to raise exposure to China," Goldman said in a note Monday, citing EPFR data. "If emerging market funds alone increase allocations in the largest underweight sectors in China to marketweight, inflows could be worth $26 billion."
China shares have already rallied strongly, with Hong Kong's Hang Seng Index up around 21 percent year-to-date to its highest levels since early 2008, while the Shanghai Composite jumped around 39 percent over the same period to its highest since late 2007. Shanghai A-shares price-to-earnings ratio rose to -five-year high of 15.5 times, according to data from Nomura.
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But despite the rally making China shares more expensive, pressure for active funds to add more mainland exposure is likely to build as so far this year, those funds have underperformed their benchmarks for their worst performance since 2009, Goldman noted. Only 20 percent of emerging market funds and 40 percent of Asia ex-Japan funds have beaten their benchmark this year, compared with a 60-70 average over the past five years, it said, reiterating its overweight call on China shares.
"Underexposure has directly led to underperformance," Goldman said, noting that China is now the largest market in both the Asia ex-Japan and emerging market indexes, contributed about half of their year-to-date performance. Almost all Asian markets outside Hong Kong and China have underperformed the MSCI Asia Pacific ex-Japan index and within emerging markets, Russia, China and Hungary are the only three, out of 23, which have outperformed, it noted.