A tweak to the Hang Seng China Enterprise Index that enables listing debutants to become eligible for fast-track inclusion has contributed to an 18.7 per cent decline in the index since February, leading to negative returns for some of the US$622 million worth of exchange-traded funds that track the benchmark.
Since a “fast entry rule” was introduced in October 2020 enabling sizeable new listings to fast-track their admission into the index on the 11th trading day instead of waiting till the index’s quarterly rebalancing, short video platform Kuaishou Technology was added to the benchmark that tracks 50 leading Chinese companies listed in Hong Kong. JD Health, also unprofitable, was added last December via the fast entry route.
But Kuaishou’s 73 per cent plunge since its inclusion has caused some fund managers to question whether the new rule has exposed investors to significant underperformance and higher trading costs.
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Given that many of the ETFs that track the index are backed by the retirement savings of the city’s residents, some fund managers are questioning whether further “hot” tech stocks slated for IPOs, especially those that are not profitable, should be eligible for fast-track inclusion. Other unicorns that could get listed in Hong Kong in the near future include ByteDance , Kuaishou’s bigger short-video rival.
“Kuaishou’s early addition to the benchmark means that all the portfolios that track the index had to buy the stock at a high level. Now, with the stock down around 70 per cent seven months later, its impact on the index will be mirrored directly by the performance of these funds,” said Govert Heijboer, co-chief investment officer of hedge fund manager True Partner Capital.
The IPO frenzy was highlighted by Kuaishou, which raised US$5.4 billion from its public offering ahead of its debut on the Hong Kong stock exchange in February, which valued it at HK$1.23 trillion (US$159 billion).
But the meteoric rise of the unprofitable company, which at one point more than tripled its IPO price, has now reversed and its 73 per cent slump has contributed 4 per cent of the index’s 18.7 per cent drop since its February inclusion, making it the biggest driver of the index’s overall decline. An ETF is designed to track the performance of its underlying index closely.
To be sure, shares of other tech companies such as social media giant Tencent Holdings, and food delivery-to-ticketing e-commerce giant Meituan, have also dropped amid a crackdown on Big Tech by Beijing, contributing to negative performance for the benchmark, commonly known as the H-share index.
But when they joined the index, they were already profitable companies. The H-share index, unlike the blue chip Hang Seng Index, does not require profitability as a criteria. The Hang Seng Index was down by 12.1 per cent for the same period.
Fund managers say they have also incurred higher trading costs as a result of the fast-track rule.
“With the fast entry rule, an index tracking fund needs to perform a higher number of rebalance trades than in the past, which leads to additional trading costs for the fund,” said Melody He, head of sales and product strategy at CSOP Asset Management, a Hong Kong-based ETF manager which manages over US$10 billion in assets.
The selection of index constituents is based on an objective methodology set by the index company after heeding market demand, said Daniel Wong, director and chief index officer at Hang Seng Indexes Co. Changes introduced to indexes often need to go through a market consultation process.
The “fast entry rule” was introduced amid feedback from market participants at the time that they wanted early exposure to China’s new economy and tech companies, said Wong. “Also, with more tech IPOs in Hong Kong than other sectors, the index has to reflect this market structure.”
Investors chased Chinese tech giants such as smartphone maker Xiaomi and Alibaba Holding Group, owner of the Post, after they were listed in Hong Kong in 2018 and 2019 respectively. But a regulatory clampdown in China has weighed on the sector this year.
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