Investors from Hong Kong and mainland are eyeing investment opportunities in both stock markets through ETFs. Provided to China Daily

Exchange Trade Funds (ETFs) that track Hong Kong and mainland market indices reciprocally are now increasingly popular. Oswald Chan tells how compilation of various indices can boost growth in both markets.

Amid the growing popularity of index investing, the Hang Seng Indexes Company Ltd (HSIC) pledged to design more Hong Kong share market-related market indices, and vowed to work closely with mainland fund managers to satisfy the growing mainland investor demand for ETF products tracking Hong Kong share market-based indices.

"The HSIC can launch three to five indices in the financial market every year based on its normal work schedule and it is currently studying a batch of indices. The index product variety will be very rich in the future," HSIC Director & General Manager Vincent Kwan told China Daily in an interview.

Kwan said the market index products development is getting more diversified from the traditional general indices to specialized sector indices, and even exotic strategy indices that can provide more ideas for issuers to design 'satellite (ETF) products' for investors to satisfy their different investment needs.

ETF investment is gaining more popularity recently as global investors, including even hedge fund managers, are increasingly interested in this type of passive investing, in the hope of obtaining the highest absolute returns by the combination of passive index investing and active stock picks.

Financial integration

The Hong Kong and mainland share markets are fostering a greater degree of financial integration whereas ETFs tracking reciprocal market indices are getting more listings on their own share market.

Kwan expected that more mainland-based fund managers will adopt HSIC's flagship indexes or sector indexes to formulate ETF products tracking Hong Kong share market-based indices, thus providing more investment opportunities for mainland investors to invest in the local equity market.

"The mainland fund manager companies should be aware of their market positioning to launch the appropriate ETF products that fit their investment styles and niches," said Kwan. "I expect the future market potential will be enormous."

QDII quota

The Chinese central government launched the qualified domestic institutional investors (QDII) in 2006, allowing mainland financial institutions to invest in overseas financial products through the QDII quota. According to China's State Administration of Foreign Exchange data, the total QDII investment quota reached $862.97 billion as of October 2012.

Vice versa, the HSIC will also be proactive in designing more mainland-related A share indices to cater to the increasing market needs of overseas investors to invest in the mainland asset market.

"Overseas investors have been vehemently interested in the mainland asset markets and it is very important for Hong Kong to extend the coverage of the A-share market indices. HSIC will gradually launch different indices that include different mainland business sectors or different enterprises of various capitalizations, probably next year, in order to expand the investment choices for overseas investors," Kwan told China Daily in the interview.

The Qualified Foreign Institutional Investor (QFII) was launched in 2002 on the mainland to allow licensed foreign investors to buy and sell yuan-denominated A shares on the mainland stock exchanges. In April, 2012, the QFII quota was increased from $30 billion to $80 billion.

The mainland government then expanded the QFII quota into RQFII, allowing the Hong Kong-based subsidiaries of mainland brokerage firms and fund companies to invest the yuan currency in mainland stocks and bonds.

The China Securities Regulatory Commission (CSRC) in November decided to raise further the RQFII quota by 200 billion yuan, boosting the total RQFII quota to 270 billion yuan. CSRC has previously raised the RQFII quota to 70 billion yuan from the original 20 billion yuan in April this year, of which the new 50 billion yuan quota are allowed to be invested in Hong Kong listed ETFs tracking A-share indices for the first time.

According to HKEx data, there are 28 ETFs listed in Hong Kong that track various A share indices, of which there are four yuan-denominated RQFII A share ETFs.

"Looking ahead, Hong Kong is the best experimental market to launch A share related index trading products although there are other competitors who will snatch the business from us," Kwan concluded.

CES China 120 Index

The Hong Kong Exchanges and Clearing Ltd (HKEx), Shanghai Stock Exchange and Shenzhen Stock Exchange in late November announced that it will jointly launch the CES China 120 Index - the first ever cross-border equity stock index that will combine A share and H share in the compilation of one index.

HSIC had complied eight A-share market indices, of which two indices are used to launch two index funds that are both offered in Hong Kong and on the mainland.

Regarding the Hong Kong index compilation, HSIC had compiled 49 Hong Kong-related market indices, of which two indices are listed on the Shenzhen and Shanghai share markets, involving two ETFs and one listed open-ended fund (LOF) with a total capitalization of $348 million as at October 31.

Of the total 49 Hong Kong-related market indices, four of them are listed in Hong Kong and 16 others on the mainland and overseas stock markets, involving15 ETFs and one LOF with a total capitalization of $15.5 billion as at October 31.

Despite the rosy market potential offered to the local index compilation, Kwan said that the future market development will be restricted by the relative small market size of the local ETF market.

"Because of the relatively thin market turnover of the index trading, it may pose difficulties for HSIC to launch some other exotic strategy index products," Kwan said. "It still needs time for the Hong Kong market to enhance its trading volume to support the index trading market's development."

For example, the launch of the volatility index in early 2012 was not well received because of the thin turnover of the index trading in Hong Kong compared to the huge turnover registered in the US and European markets.

The local ETF market started with the launch of the Tracker Fund in 1999 that tracks the price movement of the underlying Hang Seng Indexes. However, even after the Tracker Fund has been trading for more than 10 years, the local ETF market size is still relatively small compared to other ETF markets.

According to HKEx data, there are currently 100 ETFs listed on the local bourse. ETF trading however just accounted for about 3.49 percent of the total market turnover in the first 11 months of this year.

HSIC, a wholly-owned subsidiary of Hang Seng Bank, was established in 1984 and is the city's index complier covering Hong Kong and mainland markets.

(HK Edition 12/22/2012 page2)