Two decades of reform and the recent inclusion of A shares in benchmark MSCI indices have made China’s onshore equity market more accessible and more visible to non-Chinese investors. We can now all appreciate that this market is too big to ignore and diversifying enough to consider a distinct asset class in its own right. The potential excess returns available to quantitative investment strategies are less obvious, but very real. For example, the historical outperformance of non-momentum factors such as size, value and reversal has been strong in A shares, but close to non-existent in the U.S. over the same period. By contrast, momentum was not a useful factor in A shares, but performed well in the U.S. except for 2009. The uniquely strong performance of a “turnover” factor in A shares indicates the scale of the profits being left on the table by overactive, short-term, trend-following investors. The analysis shows that the China A shares opportunity set is arguably as rich as that of the developed markets 20 years ago, in the heyday of quant investing—but that success is not a matter of simply transporting U.S. equity factor models to this new market.
- China’s A-share market is too big to ignore: with some 3,500 listed companies across all 11 Global Industry Classification Standards sectors and an end-2018 market capitalization of over $8 trillion, it is the second-biggest equity market in the world, representing the second-biggest economy.
- Two decades of reform and the recent inclusion of A shares in benchmark MSCI indices have made China’s onshore equity market more accessible and more visible to non-Chinese investors.
- As well as its size, A shares’ low correlation with other equity markets, including other Asian and emerging markets, makes a strong case for considering it as an asset class and a portfolio allocation in its own right.
- We believe that part of that allocation could be managed with quantitative strategies, as certain characteristics of the A-shares market make it well suited to this approach.
- The A-shares market has excellent infrastructure to support quantitative portfolio management.
- A-shares trading and investment is dominated by small retail investors, revealed in regular survey evidence to be poorly informed about company fundamentals and significantly biased toward short-term herding; these investors contribute to over 80% of the total trading volume, but receive just 10% of the profits.
- Analysis of factor performance in A shares and the U.S. markets since 2006 reveals that factor performance has varied drastically between the two markets.
- For example, simple factors like size, value and reversal performed strongly in A shares, despite not working at all in U.S. markets over the same period.
- By contrast, momentum performed poorly in A shares and better in U.S. equities.
- The uniquely strong performance of a “turnover” factor in the A-shares market indicates the excess returns potentially available to those systematically taking the other side of retail over-trading.
- A simple composite strategy that equally invests in size, value, reversal and turnover factors delivered very strong results.
- The analysis shows that the China A-shares opportunity set is arguably as rich as that of the developed markets 20 years ago, in the heyday of quant investing—but that success is not a matter of simply transporting U.S. equity factor models to this new market.
Three Simple Factors That Continue to Perform Well in China, Despite Fading in the U.S. Market
Cumulative and annualized returns and risk for the size, value and reversal factors in the China and U.S. equity markets, 2006 – 2018
Source: Juyuan, Kenneth R. French (http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/index.html), Neuberger Berman. Data as of December 31, 2018.
The size factor is created by going long companies with low market capitalization and short companies with higher market capitalization; the value factor is created by going long stocks with low price-to-book ratios and short stocks with high ratios; and the reversal factor is created by going long stocks with the worst one-month returns and short those with the best. Annualized return and volatility data are calculated based on historical returns of respective portfolios from 2006 to 2018, using monthly returns. The China market includes substantially all A shares, excluding only those with the lowest liquidity. The U.S. market includes all of the stocks in the Center for Research in Security Prices (CRSP) database. All portfolios are hypothetical long-short portfolios gross of transaction costs. For illustrative and discussion purposes only. While these data series are not reflective of actual investment returns, they are factors constructed using a disciplined methodology and, in our view, can be used as proxies for Alternative Risk Premia. The performance shown does not represent the performance of any Neuberger Berman product or strategy and does not reflect the fees and expenses associated with managing a portfolio. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results. See Hypothetical Backtested Performance Disclosures for more information on Fama/French Factors.