Investors across the globe are gradually moving along the ETF investing learning curve. For most, this process begins with learning what ETFs are and progresses towards how to invest with ETFs. Early in this process investors learn that most ETFs are designed to track an index. As an investor performs their due diligence, understanding the construction of an ETF’s benchmark index is crucial. To help facilitate this process, we have introduced this series to allow investors to get to know the nuts and bolts of the key indices tracked by ETFs in Asia.
The Hang Seng Index (HSI) is the one of the most widely used and quoted indices in Asia. It’s constituents have a total market capitalisation of HK$12.2 trillion (US$1.6 trillion), and the index includes ~60% of all securities listed on the Stock Exchange of Hong Kong.
ETFs Tracking the Hang Seng Index
There are five ETFs that track the HSI, namely the Tracker Fund of Hong Kong (02800), the Hang Seng Index ETF (02833, listed in Hong Kong and Taiwan), the Lyxor ETF Hong Kong (A9B, listed in Singapore, France, Italy, Germany and Switzerland), the GS Hang Seng BeES (HSBEES, listed in India) and the ComStage HSI (C022, listed in Germany and Switzerland). There is also an inverse ETF listed in Germany, Italy and the UK, namely db x-trackers HSI Short Daily Index ETF (DBZR, XHSS and XHSD), which provides the daily inverse performance of the HSI Total Return Index.
Index Construction
The Hang Seng Index is a free float-adjusted market capitalisation weighted index with a 15% cap on each constituent. Only companies with a primary listing on the Main Board of the Stock Exchange of Hong Kong (SEHK) are eligible for inclusion. Mainland China enterprises with an H-share listing in Hong Kong will also be eligible if (1) 100% of its ordinary shares are in the form of H-shares; or (2) H-share companies have completed Share Reform with no unlisted share capital; or (3) no unlisted share capital for new H-share IPOs. In addition, the companies must be among the top 90% of all listed firms in terms of total market capitalisation and total turnover, and must normally have over 24 months of listing history. Since the initial inclusion of H-shares as constituents in 2006, the representation of Chinese companies within the index has steadily increased and sits at 56% as of this writing.
HSI Weightings by Share Type
The index is fairly top heavy with the 10 largest constituents accounting for almost 60% of the index’s total market capitalisation. The index has a large degree of concentration in the finance sector, which comprises some 47% of its total value. HSBC (00005), one of the largest global banking franchises, accounts for 16% of the index’s value, and there are 4 Chinese banks amongst the top 10 constituents. Other major sector weights include energy (13%), telecommunications (9%) and properties and construction (8%).
HSI Industry Weights
There is also a cap on the number of constituents included in the index, being 50 stocks (the index had 48 stocks as of April 2012). The index is reviewed and rebalanced on a quarterly basis.
Fundamental Performance Drivers of the Index
Despite the fact that the index’s constituents are listed in Hong Kong, the split between Hong Kong based companies (which includes HSBC, headquartered in London) and China-based companies (including China Mobile and various Chinese banks) is around 44/56. As a result, investors should expect the index’s performance to be linked to the health of the Chinese economy.
HSBC (00005) accounts for 16% of the HSI. This banking giant is a truly global enterprise. As such, it has exposure to some currently troubled regions. While Eurozone members have taken drastic steps to reduce their government debt by cutting expenses and raising taxes, any further negative developments in the Eurozone debt situation may dampen the share price performance of HSBC, and hence the performance of the HSI.
Chinese banks account for 22% of the HSI. China has recently eased its tightening policy stances with the People’s Bank of China lowering the reserve requirement ratio (RRR) for banks in December 2011 and again in February 2012, providing additional liquidity to the market. This has generally been viewed as a positive sign, and the market reacted positively after the announcement that the RRR would be decreased. In particular, the lowering of RRR also means that Chinese banks will be able to offer more loans. More recently, Premier Wen recently cited in April 2012 that the current bank monopoly must be broken up. Investors should be aware of the potential for future changes in Chinese banking regulation and the effects it could have on incumbents’ market share.
The second largest sector exposure for this index is energy, accounting for 13% of the portfolio. This exposure consists solely of Chinese energy companies, comprised mainly of oil companies (11% - Sinopec (00386), PetroChina (00857) and CNOOC (00883)). These companies are not only exposed to fluctuations in oil prices but also to Chinese regulations affecting the energy sector and their overseas expansion strategies.
Overall, investors should be reminded that Hong Kong’s economy is driven largely by the Chinese economy which in turn could be affected by the global economy and local monetary policies.
Jackie Choy is an ETF Strategist with Morningstar.
