China’s stock market is one of the surprises of 2017. In early March developed market equities reached their highest point in euro terms but slipped thereafter, while stocks from emerging countries, especially from China, have continued to grow at a pace.

At the end of August, the MSCI China was up 41.69[1] percent since the start of the year, which is significantly better performance than other stock markets from industrialized countries as well as other emerging markets.

The China MSCI has also registered impressive long-term performance of 188 percent since August 2006 - albeit with very high volatility.[2]

Deutsche Asset Management has therefore, in its "Passive Insights" series, analysed in detail what underpins this impressive development, and what opportunities - but also what risks - investors may consider when investing in Chinese equities.

First, we look at the valuation of the Chinese equity market. Prices have recently risen strongly. The expected price-earnings ratio is currently 14.6. However, valuations in the US and Europe are in part significantly higher. [3] In addition, Chinese companies listed on the stock exchange can show strong growth in earnings. According to analyst estimates, earnings per share are up 14 percent in the current year and could increase to 15 percent in 2018. On the other hand, the markets for the US, Japan and the Eurozone are expected to see a decline in the profitability of listed companies in the coming year. [4]

Even if the status quo appears promising, investors may more importantly want to look at whether there are strong arguments for medium and long-term positive performance for Chinese stocks.

Here, two developments are particularly promising: the stabilization of the Yuan against the US dollar has ed to a decline in outflows of capital from China into the dollar area, thereby tempering fears of a "hard" landing for the Chinese economy.

On the other hand, the long-debated addition of the A-shares listed on the Shanghai and Shenzhen stock exchanges into emerging market equity indices could trigger a boost for the MSCI Emerging Markets Index. This is by far the most common index for emerging markets. Up to 450 Chinese large or mid-cap A-shares are included in the index. Investors with exposure to the MSCI EM Index could invest up to 340 billion dollars in these shares. This could lead to improved market efficiency, lower volatility and increased involvement of institutional investors in the Chinese equity market.[5]

ETFs could be a good option for participating in the opportunities the Chinese equity market provides. However, investors need to understand the unique aspects of the market. According to the index company China Securities Index Co., currently more than 3,300 shares are listed on the Shanghai and Shenzhen stock exchanges.[6] For a long time A-shares listed in the Chinese Renminbi currency were reserved for Chinese investors only. However more recently, at the end of 2011, with the launch of the Renminbi Qualified Foreign Institutional Investor (RQFII) program physical ETFs could be launched that provide foreign investors with direct access to Chinese equities. Deutsche Asset Management, with its Chinese partner company Harvest Global Investments, listed the first physical "A-shares" ETF in Europe on the German stock market in 2014.

In addition to A-shares, there are the much smaller H-shares listed on the Hong Kong Stock Exchange, which are hitherto more important for non-Chinese investors. Here, Chinese companies have traditionally listed stocks for international investors in Hong Kong dollars. Common indices such as the MSCI China Index - or the FTSE China 50 Index - still predominantly consist of Hong Kong shares and thus the smaller part of the Chinese equity universe. With the inclusion of A-shares by large index providers, however, this distinction could soon be a thing of the past.[7]