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Proposed Reform of
Hang Seng Index –
A Bless or A Curse?

Gain Miles agrees that reform of Hang Seng Index could be beneficial.
However, it is still worth to consider the degree of regulation strictness and sustainability while improving its flexibility.

Hang Seng Indexes Company Limited has released a press release on 22 Dec 2020 to seek market views on the potential changes to the Composition of Hang Seng Index (HSI). There are 5 proposed changes on the rules of composition and its eligibility. In this research paper, Gain Miles shares its view on the proposed reform of HSI.

1. Expansion in Industrial Representation

 

Hang Seng Indexes Company Limited has proposed to select constituents by industry group (e.g. consolidate the 12 industries into 6 groups); and based on a target coverage for each industry group (i.e. in terms of market capitalisation, turnover etc.) to select.

In respect to this, Gain Miles disagrees to focus on the coverage of each sector, instead, HSI should focus on the market coverage, which means the stocks listed in the Main Board or in the market. We suggest that the coverage for each sector should be determined by the market, instead of confining it with a minimum level to manually define the coverage in a particular sector. Otherwise, the proposal to introduce target coverage within an industry group may increase the representativeness of each industry by sacrificing the focus on the overall market.

 

2. Enlargement in Market Coverage

Hang Seng Indexes Company proposed to increase the number of constituents to between 65 and 80.

Gain Miles agrees to increase the number of constituents with the aim to reach higher market coverage as the current market capitalization and turnover is decreasing over the years (i.e. from 65.0% and 57.4% in 2016 to 57.6% and 50.5% in 2020, respectively). The lack of market coverage may not be suitable for HSI to serve as the market benchmark of the Hong Kong stock market.

As of 13 January 2021, there were 2,175 companies listed in the Main Board. Keeping 52 companies as the constituents would no doubt introduce gap to conclude the performance by all companies listed in the Main Board. Gain Miles believes that increasing the number of constituents is a good action to increase representativeness and strongly suggest to increase to 80 to achieve the objective.

 

3. Prompt Inclusion of Sizeable New Listing

Hang Seng Indexes Company proposed to remove the minimum listing history requirement for eligible candidates to enhance the flexibility for HSI Advisory Committee to include new listing as a HSI constituent.

Gain Miles disagree to remove the minimum listing history requirement for eligible candidates. Although the removal of this requirement increases the flexibility for the HSI Advisory Committee, this may allow speculators to take advantage to the lack of reinforcement / governance for HSI to include new listing into the index. The stability of HSI will be harmed and lead to the potential situation where the constituents switched too frequently by the newly listed companies.

The involvement of newly added shares will cause a rise to the P/E ratio of HSI. For illustration, based on Jun 2020 to Nov 2020 data , the below table comparison demonstrate the P/E ratio between the top 10 market cap newly listed shares and the HSI. It is noticeable that the P/E ratio of the newly added shares were much higher than HSI. Few shares were more than 10-times higher than the HSI P/E ratio. If there is no governance on the minimum listing requirement, the stability of HSI will be jeopardised.

 

4. Representation of Hong Kong Companies to Remain Intact

Hang Seng Indexes Company suggested to maintain around 25 Hong Kong companies under the current situation or a certain amount to sustain the level of representation of Hong Kong portion in the index.

Gain Miles is neutral to this proposal but would like to suggest to refer to maintain a certain percentage of market representation instead of number of companies. Keeping the number of Hong Kong shares does not mean that Hong Kong companies will have a certain weighting in the HSI as it is about the asset size instead of the number of shares. Currently, 79% of the assets listed in the Main Board belongs to Mainland company and only 21% are Hong Kong company. Thus, Gain Miles can only say that keeping 25 Hong Kong companies (around 42.2%) as constituents will keep HSI being an index with its own characteristics.

 

5. Enrichment in Constituent Weighting Distribution

Hang Seng Indexes Company is willing to lower the weighting cap of individual constituent from 10% to 8%’ and align the weighting cap of all shares to be 8%.

Gain Miles agrees that this could help including more WVR/ Secondary listed companies with higher weighting into the index. WVR/Secondary listed are common practice for technology and multinational enterprise on well developed markets like in US and EU. In Hong Kong, it is foreseeable that more secondary listed with large market capitalization will be listed in Hong Kong. Therefore, to more accurately report the situation in Hong Kong, it is better to align the weighting cap of every share.

All in all, Gain Miles agrees the reform of Hang Seng Index is a good thing. Yet, there are points that need to be considered. The minimum listing history requirement is vital and worth to consider again. As a representative and important investing index in Hong Kong, the regulation should be strict enough while considering the flexibility.

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