Chinese equities see highest foreign inflows since November 2024, Morgan Stanley reports

Foreign funds injected US$4.6 billion into Chinese equities in September, marking the highest monthly inflow since November 2024, largely driven by US$5.2 billion from passive funds. This significant capital influx pushed year-to-date passive inflows to US$18 billion, exceeding the full-year 2024 level, and prompted global funds to reduce their underweight positions in China to 1.2 percentage points. While Asia ex-Japan funds increased their overweight, Emerging Market funds expanded their underweight to 3.0 percentage points, indicating a divergence in institutional sentiment despite the overall passive flow.

Analysis

Foreign capital inflows into Chinese equities showed significant momentum in September, with a net injection of US$4.6 billion marking the highest monthly figure since November 2024. This surge was driven almost entirely by passive strategies, which contributed US$5.2 billion, offsetting a minor US$0.6 billion outflow from active funds. The strength in passive allocation is a year-to-date trend, with cumulative inflows reaching US$18 billion, more than double the entire 2024 total of US$7 billion. Concurrently, the pace of active fund outflows has decelerated, with US$12 billion in year-to-date redemptions compared to US$24 billion for all of 2024, suggesting that while active managers remain net sellers, their bearish conviction is waning. However, investor positioning reveals a critical divergence: while global funds reduced their underweight stance on China to 1.2 percentage points and Asia ex-Japan funds increased their overweight, dedicated Emerging Market funds expanded their underweight to 3.0 percentage points. This indicates that China is gaining allocation from generalist funds but losing share among EM specialists. At the sector level, active managers are rotating towards Capital Goods and Semiconductors and away from Insurance and Consumer Durables, signaling a preference for industrial and technology-related themes over consumer and financial sectors.

Key Decisions for Investors

• Investors should recognize the strong technical support provided by accelerating passive inflows into Chinese equities, but remain aware that this trend is not mirrored by active managers, whose conviction remains muted.
• Monitor the significant divergence between generalist global funds adding China exposure and specialist Emerging Market funds increasing their underweight positions, as this may signal a rotation out of China in favor of other emerging markets.
• For targeted exposure, consider mirroring the sectoral shifts of active funds, which are increasing allocations to Capital Goods and Semiconductors while reducing positions in Insurance, Banks, and Consumer Durables.
• The key indicator to watch for a more fundamentally-driven rally will be a reversal in active fund flows from net outflows to inflows, which would confirm broader institutional conviction beyond the current passive momentum.