China A-Shares: Strategic Allocation to Market and Factor Premiums

Abstract

The authors investigate the added value of strategically allocating to the Chinese A-shares equity market. Their results indicate a positive contribution to a portfolio that only considers traditional developed and emerging equity markets and bonds. The authors find that a diversified A-shares portfolio based on value, quality, and momentum factors exhibits significantly better risk-adjusted performance than the passive A-shares market portfolio. Consequently, allocating to Chinese A-share factor premiums significantly improves the efficient frontier. The conclusions remain similar when incorporating conservative estimates of trading costs or when constructing value-weighted portfolios, which represent more realistic investor returns.

TOPICS: Fundamental equity analysis, emerging markets, analysis of individual factors/risk premia, portfolio construction

Key Findings

• ▪ Investors need to decide how much to allocate to the China A-share market now that the market is opening up.

• ▪ We find that a diversified A-shares factor portfolio based on value, quality, and momentum factors exhibits significantly better risk-adjusted performance than a passive A-shares market portfolio.

• ▪ Benefits from a factor portfolio in China A-shares remain when incorporating conservative estimates of trading costs, which are relevant in presenting realistic investor returns.