Shenzhen Connect And Its Impact On China ETFs

Chinese regulators are opening the Shenzhen exchange to more foreign investments, a move some market observers believe could prompt index provider Msci Inc MSCI to reconsider its classification of China's onshore equity markets.

The Connect

The Hong Kong-Shenzhen connect was expected and follows the Hong Kong-Shanghai connect unveiled several years ago. While investor enthusiasm for the Hong Kong-Shenzhen connect is currently seen as muted, China's latest effort to liberalize its mainland financial markets, where A-shares equities trade, could have an impact on some U.S.-listed exchange-traded funds.

“Why Is Shenzhen Connect important in one word? MSCI,” said KraneShares Chief Investment Officer Brendan Ahern in a note out Tuesday.

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New York-based KranseShares sponsors the KraneShares Bosera MSCI China A ETF (KraneShares Trust KBA), the only U.S.-listed A-shares ETF tracking an MSCI Index. In June MSCI opted against the stocks trading on mainland China to widely followed indices such as the MSCI Emerging Markets Index.

One of the reasons MSCI gave for continued exclusion of A-shares from its international indexes is an issue schemes such as the Hong Kong-Shenzhen connect are aimed at improving: market accessibility.

“But the $3.2 trillion Shenzhen market, already the world’s seventh largest, could prove attractive to foreign investors because it is where fast-growing Chinese companies that operate in sectors such as technology, pharmaceuticals and clean energy often list,” according to the Wall Street Journal.

The Issue, Boiled Down

In other words, the comparisons many make to the Shenzhen and the Nasdaq are accurate, meaning increased access to Shenzhen-listed names for foreign investors could benefit tech-laden ETFs such as the KraneShares China Internet ETF (KraneShares Trust KWEB).

“Everyone will talk about exposure to Shenzhen's private companies versus Shanghai's SOEs which is true. Approximately 75 percent of Shenzhen companies are private/non-gov't affiliated versus just 40 percent on the Shanghai. P/Es on these companies are HIGH. One reason I like KWEB is because it provides growth exposure but at much more reasonable valuations versus Shenzhen,” added Ahern.

Timeline Remains Questionable

It is not clear exactly when the Hong Kong-Shenzhen connect will be operational, but it could happen in November, which marks the two-year anniversary of the Hong Kong-Shanghai connect.

Foreign investors will be able to access nearly 900 stocks on the Shenzhen exchange with a combined market value of over $1 trillion, according to the Journal.