China has finally made it past the bouncers and granted entry to an exclusive club. The club’s ‘pass’ literally means investors have to hand over hard earned dollars.

Historically, investors preferred to pick stocks or give their investments to managers to make these decisions. This is called active management, and the idea is that the decision is better than the average company (or return as measured by an index). But then these fund managers charged exorbitant fees for this service, and investors questioned whether the manager was actually doing better than a standard basket of shares (index). Enter the ‘index fund’ or passive management, with low fees and giving investors access to this basket of shares with little or no decision making process.

China has historically had immense capital controls on foreign investment. But over the last decade, these have been wound back (to some extent) allowing foreigners to invest in local stocks (these are called A-Shares). One of the main global stock indices is run by MSCI, and in the past they have refused China’s entry based on the capital controls, poor governance, and lack of transparency. However this has just changed.

With MSCI granting inclusion of Chinese stocks, this has effectively given China a gold pass to the VIP room. It is estimated that the global index-linked investor market has around $US1.6 trillion funds under management will now have to invest directly in Chinese A shares. An estimated $US20bn will flow in over the next 12mths, and this could rise to $500b over the next 8 years.

Initially 222 companies (or less than 1 per cent of Chinese listings) will receive a boost. There is no stock picking to decide if one company is better than another… and that is why it could be a real concern for pensioners or SMSF trustees. If this is a concern, perhaps it is time to consider whether index investing (especially in emerging markets) should form part of your portfolio.