World Markets

Why the inclusion of China A-shares in the MSCI emerging markets index may not help investors

Key Points
  • MSCI says it plans to add mainland Chinese A-shares to its benchmark EM index
  • But this may not help investors, analysts say, citing issues in governance and regulation
  • EM indexes are also becoming too concentrated in economies with decelerating growth
Why MSCI China inclusion might not be good
Why MSCI China inclusion might not be good

MSCI unveiled plans to gradually add mainland Chinese shares to its benchmark emerging markets index, injecting buzz into the market, but the stamp of approval may not help investors, say critics.

The index giant will add 222 China A Large Cap stocks — including Bank of China and Tsingtao Brewery — on a gradual basis beginning next year. The review is the fourth straight year MSCI has considered adding the mainland-traded stocks, known as A-shares in China.

Corporate governance is a particular bugbear as many of the 222 companies are large state-owned enterprises, said Kevin Carter, CEO of Big Tree Capital and founder of the Emerging Markets Internet and Ecommerce ETF.

"You have all of these enormous state-owned banks, the four big policy banks, the oil companies, and these are really not run like traditional Western companies," Carter said.

"These companies are filed with inefficiencies, they are filled with conflicts of interest and they are frequently filled with fraud. Adding more of that, even though it's just a small amount, I don't think it helps helps investors," he said, adding that it was not a problem unique to China but also to markets dominated by such mega companies, like Brazil.

MSCI had previously left the A-shares out of the EM (emerging markets) index but it relaxed its investment criteria in March in a bid to address concerns on capital repatriation and suspended stocks.

China MSCI inclusion: Not a 'gamechanger on any front'
China MSCI inclusion: Not a 'gamechanger on any front'

Michael Every, head of Asia Pacific Financial Market Research at Rabobank said "there are so many things to be negative about rather than positive" about the MSCI decision.

"It's a pattern we've seen in recent years of China managing to shoehorn itself into various different benchmark indicators like becoming an IMF reserve currency in 2015, but (that) has actually proved to be meaningless in reality because China doesn't meet the ... meat of what needs to be addressed in that particular area," Every told CNBC's "Street Signs."

The only upside for investors is that Chinese stocks look relatively cheaper compared to their peers globally.

"And the only reason that's true is because China had its bubble in 2015 and it burst horribly with all manner of very ham-fisted, heavy-handed government crackdown as a result. Why should we forget about that and put our money in now?" Every added.

MSCI decisions: How should you invest?
MSCI decisions: How should you invest?

For Jay Jacobs, director of research at Global X Funds, the ship may have already sailed.

"One of the bigger things investors have to look at in the next decade is how much concentration is in these emerging market indexes," Jacobs told CNBC's "Squawk Box"

Three-quarters of MSCI's emerging market index is now dominated by BRIC (Brazil, Russia, India and China) countries, as well as South Korea and Taiwan—which are all decelerating economies, he noted.

"People looking for that growth really need to shift their line of sight further down the developing market spectrum" he added, citing Indonesia, Malaysia, Mexico and Argentina as potential bets.

"Don't get too caught up in the MSCI announcement. Just recognize that concentration issue really is going to get worse as you start to include more of China in there" Jacobs said.