MSCI inclusion will bring more scrutiny for China’s stock market but investors may benefit

China’s flabby stock market is set for a workout, as inclusion in MSCI’s influential indexes brings extra foreign scrutiny. While some money will simply track the benchmark, active investors will arrive too. That should mean that prices better reflect fundamentals, and bosses feel increased pressure to shape up.

More than 200 A shares will join major MSCI indexes on Friday. The initial impact will be modest, with about $8.5 billion of passive funds flowing into Chinese equities, reckons JPMorgan Securities – equivalent to a trivial 0.1 percent of an $8.5 trillion-plus market. In many cases, companies have already courted overseas shareholders through Hong Kong listings.

However, this should be the start of something much bigger. For a start, active investors may contribute as much as five times again, or about $42 billion. Then, the index compilers will gradually increase China’s presence over the next decade or so, bringing in much more capital.

That will help make Shanghai and Shenzhen increasingly professional and international. While institutions dominate most developed bourses, individual retail investors account for more than 80 percent of trading in China, calculates UBS. And foreigners held less than 3 percent of stocks at the end of last year, compared to 30 percent in South Korea and 25 percent in India, according to BNP Paribas.

Throw in regulatory meddling and the result could be inefficiency. Prices often swing wildly in line with shifting sentiment and there is relatively little trading in large-capitalization stocks, as opposed to smaller companies.

Change could be gradual, since outsiders will be minor players. But compared to mercurial retail punters, these buyers are likely to nudge prices into line with underlying corporate fundamentals. The effect could be especially pronounced for mainland-only stocks, a contingent that includes Hikvision, a specialist in digital surveillance, and Kweichow Moutai, a liquor distiller, among many others.

At best, the newcomers could prod private Chinese companies into better corporate governance. The result should be a more robust market for international and domestic investors alike.