Ruffle believes MSCI's inclusion of A-shares into its emerging markets indices, to be announced June 21, is likely. But what matters is the long-term impact, he told FSA.
China now accounts for about 28% in the MSCI Emerging Markets Index, while A-shares are expected to add another 0.5% once included. However, because the A-share market is so large, the weighting of China could eventually grow to 50%, resulting in a single asset class too large to remain in the EM index, he said.
CIFM Asset Management estimated A-shares' weighting in the MSCI Emerging Markets Index will eventually rise to 18.1% from the 0.5% proposed by MSCI.
“I think in the 2020s China will emerge as a separate asset class, just like Japan did in the 1980s. And MSCI needs to find a new label [for the rest of the markets],” said Ruffle.
The fund house, with offices in Shanghai and San Francisco, only focuses on China equities, regardless of listing countries. Its China A-Share Fund, launched March 2005, is registered in Singapore for professional investors, according to FE. It had $146m of assets under management as of May-end.
He said the portfolio has already invested in about 17 out of the 169 A-shares potentially to be added in the MSCI EM indices, and the team has a debate on whether to take advantage of the potential entrance.
“We recently invested in some large banks, which is quite unusual for us. But they are cheap enough, and they have high dividend yields of 4-5%. With interest rates rising, the net interest margins for some of the big banks are actually improving.
“We have debated whether we could shift from the bigger ones to those to be included in the EM indices, such as Shanghai Pudong Development Bank, Ping An Bank and Industrial Bank. But we think the economic story will favour the big banks that have a huge deposit base, and it outweighs the short-term benefits of the index inclusion,” he explained.
Seeking 20% growth
For the overall portfolio, the team mainly invests in privately-owned small to mid- cap growth companies, he said. “Growth is the key over value. [The company] has to grow earnings by 20% or more in order to catch people’s eye. It is the rule of thumb for an inclusion or exclusion to the portfolio.”
Political stocks, such as the energy sector, are generally avoided as these state-owned enterprises might be forced to align with government policies, such as full employment and price cuts. It also tends not to invest in the real estate sector as the team finds it difficult to value these companies in the context of corruption scandals, he added.
“The biggest risk in China is usually politics. We spend time on what the government is trying to achieve, and what are the future policies, and we try to invest in the same direction as the government’s.”
Ruffle said the team missed out on China's boom in auto sale last year. “We were biased against the auto manufacturing industry as low value-added companies.”
But in fact the industry had launched new models of sport utility vehicles (SUVs) and increased capacity. He said it's too late to invest in the auto industry now, but his team tries to find companies that are expected to ramp up for the next big expansion.
The team has recently looked at stocks that might benefit from China’s one-belt-one-road initiative, beyond the state-owned construction firms. For instance, it has invested in a Xinjiang-based power transmission equipment maker.
Three-year performance of Open Door's China A-Share Fund, according to FE, with reference to the cateogy average of China equity funds available for sale in Singapore, and CSI 300 Index. The fund does not have a benchmark.
All fund NAVs have been converted to US dollars. Note that funds in this chart may be denominated in currencies other than the US dollar.