Quantitative Analysis of Chinese Equities Diversification Benefits

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Bit of a shorter and informal post today, but I've done some work since my last post on Chinese equities. At the end of my last post, I made the point that China is becoming more economically independent, both in terms of its future growth and risks. From the rolling correlation graph between MSCI China and MSCI USA since 2007, we observe a decline in the correlations between the equity markets of the two countries since 2018. I evaluate diversification benefits relative to a US equity portfolio because even many Australians have outsized exposure to US equities. Many superfunds set their global equities benchmark as MSCI ACWI World Index which has a 63% weight on MSCI US. 

If we optimise a portfolio of MSCI China and MSCI USA to maximise Sharpe ratio based on the last 20 years of returns, the optimal allocation is 30% MSCI China and 70% MSCI World. As mentioned by my last post, Chinese businesses' risk profiles have changed drastically over the last 3 years, so going forwards, this optimal weight may very well be different. I hypothesise that the optimal weight could have decreased, given the increase in risk factors. The focus of my next article will be about exploring the arguments for and against geographic diversification. I will go deeper into examining the potential of MSCI China as a diversifier.

Efficient Frontier A Portfolio Consisting MSCI China and MSCI USA 

From the figure below we see an increase in Sharpe ratio when China's weight in a portfolio is increased (over the last 20 years).  

Spreadsheets:
Correlation
Python Code for Efficient Frontier
Varying Weights ---
lost the sheet for this one but here is the raw data, methodology is similar to the one drawing out efficient frontier

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