Investors in China weigh MSCI part 2, armed with wishlist
Investors stand at trading terminals in front of an electronic stock board at a securities brokerage in Shanghai, China, on Wednesday, May 30, 2018.

The inclusion of Chinese stocks in MSCI's benchmark indexes this year has made mainland equities more attractive to foreign buyers, but exposure to global investment has also revealed some rough edges around corporate China's governance standards.

Global index publisher MSCI adds another tranche of Chinese stocks to its emerging markets index, which follows the milestone debut inclusion in June, and foreign investors are queuing up to get into the asset class.

Since the first tranche, the number of foreign investors in China has jumped about 30 percent, according to exchange data, despite the market volatility triggered by worsening Sino-U.S. trade relations.

Still, global asset managers say Chinese companies leave a lot to be desired, including some basic practices such as making disclosures in English and shorter share trading suspensions.

"It's pretty obvious some companies are not ready to have interactions with an investor base outside mainland China," said Zhang Jin, a New York-based portfolio manager at Vontobel Quality Growth Boutique.

Zhang complained that most Chinese companies don't publish financial reports in English, making it difficult for such stocks to pass Vontobel's rigid stock-screening process.

Zhang's fund recently bought Chinese stocks such as liquor heavyweight Wuliangye and is looking for other opportunities.

MSCI's unofficial estimates indicate the two-stage inclusion will see inflows of roughly $17 billion into Chinese shares.

But after the second tranche next week, Chinese A-shares will still only comprise a tiny 0.8 percent of its emerging market index.

While active fund managers have leeway in allocating funds to China, whose main index is down 17 percent this year, managers of passive portfolios that track the MSCI indexes will have to include the roughly 230 Chinese companies in the benchmark.

China's securities regulator has said it is working toward giving local stocks greater index weightings and supports a potential China accession into FTSE Russell's global share benchmarks.

The country has been gradually opening its markets to global investors. However, only around 5 percent of the stock market is currently held by foreigners.

Eugenie Shen, head of the asset management group at the Asia Securities Industry & Financial Markets Association which represents over 100 global financial institutions, said it has been lobbying Beijing for more transparency and efficiency.

Shen said investors needed hedging instruments, such as securities lending and stock index futures, in a volatile market but not "window guidance", which refers to the informal way Chinese regulators often try to sway market participants.

"Market fluctuations are normal. Foreign investors don't want to see government intervention in the market as this brings uncertainty," she said.

Foreign investors also worry about the shareholding structures at many China-listed companies, where the interests of controlling and minority shareholders are not sufficiently aligned, according to Charles Sunnucks, a fund manager at Jupiter Asset Management, which holds stocks in three A-share firms.

He said retail investors' particular focus on growth over income in many Chinese small-cap firms can sometimes lead management teams to make bad capital allocation decisions.

Stephane Loiseau, Societe Generale's APAC head of cash equities & global execution services, believes MSCI could triple A-shares' inclusion factor in its EM index to 15 percent over the next six months.

Despite the trade war, the message foreign investors get is that "China is very serious about the opening of its market, that the roadmap is very firm over time, and the pace of opening is accelerating", he said.

