Tuesday, July 27, 2021

China decoupling in investment world


Chimerica no more? One of the great investment events for any country is the inclusion of your equity and debt in major global benchmark indices. Index inclusion is a game changer. You have arrived. Index inclusion means that every global investor must hold your assets in his portfolio. To not hold a position is a bet against the performance of that country. This index effect for China especially in fixed income over the last two years has generated significant foreign investment flow not just from China experts but from passive investors. There is a time delay between any announcement, the actual rebalancing, and the impact on financial markets, but the longer-term effects are real. 

The inclusion of China equites in benchmarks has been established for several years. The MSCI global equity index added Chinese A shares in 2018 and mid-caps in late 2019.  The inclusion of China debt in the JP Morgan EMB benchmark was announced in 2019 for inclusion in 2020. 

Firms have ramped up their equity and debt exposure, and now we are having a great decoupling of financial regulatory policies which has created a large disconnect country performance disconnect.

The difference between EEM and EEM x China is over 6% this year as of yesterday. The differential between the US and Chinese equity benchmarks is over 30% (SPY vs MCHI) this year. What should have brought the countries closer together is now having negative financial impact on global investors as the rules have the game change. Holding Chinese financial assets were considered a country and global trade play and was not viewed as a strong play on regulatory and political systems. The world has changed.

Hard to believe that terms like "Chimerica" - the Niall Ferguson and Moritz Schularick word for the symbiotic relationship between China and America seem so outdated.   

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