• Having decided against it over the last three years (due to issues such as the 20% monthly repatriation limit and abuses on stock trading suspensions), MSCI has finally decided to include China's A-shares in its Emerging Markets index. Recall, at present, China stocks included in the index are traded in either Hong Kong or the United States.
   
• However, the inclusion, which will take effect in June 2018, comprises 222 mainland Chinese stocks with an initial total weighting of only 0.7% – which means its dilutive impact on other emerging markets, including Malaysia, is fairly muted.

• Nonetheless, we remain mindful that given the growing breadth and depth of China stocks, it is inevitable that the weighting of other emerging markets in the index, including Malaysia, will be repeatedly tweaked down in favour of China in the coming years.

• Over the longer term, the full inclusion of A-shares should bring the weight of Chinese stocks in the index from about one-fourth to more than one-third. Based on our calculation, ceteris paribus, the full inclusion of A-shares would dilute the weighting of existing constituents by 11% across the board.

• Meanwhile, a supposedly nail-biting event, the MSCI EM index rebalancing exercise in May 2017 came and went without inflicting any visible damage in the local stock market. This was unlike a year ago when a cut by MSCI of Malaysia’s weighting in the MSCI EM Index from 3.43% to 3.09% actually triggered a major sell-down of the local market.

• MSCI has yet to officially disclose Malaysia’s weighting before and after the latest rebalancing exercise. However, if data provided by BlackRock’s iShares MSCI Emerging Markets ETF and SPDR MSCI EM UCITS ETF is a guide, we estimate that Malaysia’s weighting stood at about 2.47% before the rebalancing exercise (a decline from 3.09% from May 2016 generally due to the weaker performance of the local stock market and the ringgit against the USD, versus their peers in the index), falling only marginally to 2.41% (Exhibit 1) following the rebalancing exercise.

• Apart from the relatively insignificant cut in weighting this time around, we believe the local stock market was also helped by the low base effect. We gathered that, for a start, many actively managed emerging-market funds had underweighted Malaysia, i.e. below the weighting recommended by MSCI, prior to the rebalancing exercise.

• We remain positive on the equity market outlook in Malaysia, although we do expect volatility over the immediate term as the market has moved a little further ahead of its earnings. We maintain our end-2017 KLCI target of 1,745pts and end-2018 KLCI target of 1,900pts, based on 17.5x 2017F and 2018F earnings respectively.

Source: AmInvest Research - 21 Jun 2017