Lyxor ETF China Enterprise (HSCEI)

Un ticket pour le marché chinois, avec un fort biais sectoriel.

Alastair Kellett 30.07.2012

Suitability

The fund provides exposure to many of the largest and most liquid components of the Chinese equity universe, which has quickly gone from emerging market to global titan and as such has become an important part of a globally balanced portfolio. The Chinese economy now ranks third in the world, behind only Europe and the United States. The Hang Seng China Enterprises Index (HSCEI) contains companies from a number of industries but is heavily tilted towards the Financials sector, which makes up 57.5% of the total. Diversification at the security level is also limited, with close to 70% of the portfolio within the top 10 names.

Returns from the HSCEI have been extremely erratic, exhibiting annual volatility north of 40% since 1993. An investment like this therefore requires a lengthy time horizon and a very strong stomach to handle the swings. It has been a good diversifier, though: since mid-2005 it has shown a correlation to the local currency price returns of the S&P 500 Index, the MSCI World Index, and the MSCI Europe Index of 64%, 69%, and 67% respectively.

The fund does not distribute any dividends; therefore it may not suit an investor looking for regular income.

Fundamental View

In June 2012 the People’s Bank of China cut interest rates by 25 basis points, the first rate cut in the country since December 2008, when the world was in the throes of the global financial crisis. Less than a month later, it cut rates again. These moves have raised fresh concerns about China’s much-vaunted growth story. The monetary easing represents a stark departure, coming after a couple of years of policy tightening, including rules designed to curb home-buying. China’s GDP grew at an annualised rate of 7.4% in the first quarter of 2012; still robust on an absolute basis but less than had become customary. The Chinese government earlier this year targeted a 7.5% growth rate for all of 2012. One of the major factors contributing to China’s slowdown is that its economy is largely built on exports, and with many parts of the developed world spiralling back into recession, the demand for those exports has begun to dry up. As the beleaguered developed-world consumer continues to pare back, China will have to rely more and more on domestic demand from its own burgeoning middle class. Another major pillar of the economy is investment, and as we saw in 2008 the government has shown the willingness and ability to inject the economy with massive amounts of stimulus to buoy the economy.

The perceived undervaluation of China’s currency, the Renminbi, has been a perennial boon to the country’s exports. Since it became unpegged from the U.S. dollar in 2005, the Renminbi has appreciated by roughly 23%, but the slow rise has not been enough for many who still claim it is well below fair value. Indeed, the currency has weakened, not strengthened, in the first several months of 2012. The United States has thus far avoided labelling China a currency manipulator, but Republican candidate Mitt Romney, for one, has indicated it would be among his first orders of business should he claim the White House at the next general election. Such a labelling could prompt sanctions and lead to a full-blown trade war that would likely be detrimental to the global economy. Since 1994, the HSCEI has returned 0.69% per year, as measured in Hong Kong dollars, substantially less than the local currency price returns on developed markets over the same period. But its results have been highly volatile, and the picture can change dramatically depending on the time period. Its trailing 10-year annualised return is 16.02%, versus 3.24% for the S&P 500 and -0.04% for the MSCI Europe.

Portfolio Construction

The Hang Seng China Enterprises Index is a free float market capitalisation-weighted index of 40 of the largest H-share companies listed on the Stock Exchange of Hong Kong. H-share companies are incorporated in the People’s Republic of China and listed in Hong Kong. Unlike China-listed A-shares, there are no restrictions for international investors trading in H-shares. The HSCEI is a price index, meaning that it does not take into account the return from dividends paid by the underlying stocks. This fund uses as its benchmark the Hang Seng China Enterprises Gross Total Return Index, which assumes that dividends are reinvested. Stocks are screened for minimum listing period and trading volume, after which the largest companies are chosen for the index. The weight given to any individual name is capped at 10%. The index is reviewed quarterly and changes made as needed. To limit turnover, there are buffers around the levels at which companies are added and deleted from the index. New stocks are added if they rise to 32nd or higher in a ranking by free float capitalisation, and existing constituents are removed if they fall to 49th or lower. Financials make up by far the largest sector of the index, representing 57.5% of the total as of May 2012. The other significant sector weight was Energy, at 23.5%. The top holdings were Bank of China, Industrial and Commercial Bank of China, and PetroChina, at weights of 10.3%, 10.1%, and 10.0% respectively.

Fees

The fund’s total expense ratio (TER) is 0.65%, which is pricier than some of the alternatives offering exposure to Chinese equities. Other costs potentially borne by the unitholder but not included in the TER include swap fees, bid-ask spreads on the ETF, transaction costs on the infrequent occasions when the underlying index holdings change, and brokerage fees when buy and sell orders are placed for ETF shares.

Alternatives

There are other ETFs that track the HSCEI, including the Hang Seng H-Share Index ETF (02828, listed in Hong Kong and Taiwan), the Samsung KODEX HSCEI (A099140, listed in South Korea), the ComStage HSCEI (C023, listed in Germany and Switzerland), the Listed Index Fund China H-share (Hang Seng China Enterprises) (1548, listed in Japan) and the XACT Hang Seng China (XACTKINA, listed in Sweden). Amongst these alternatives, the Hang Seng H-Share Index ETF is the largest as measured by AUM. This Lyxor and ComStage ETFs use synthetic replication to track the HSCEI.

Investors may also consider ETFs that track other non-domestic Chinese market indices, e.g. the FTSE 25 Index, MSCI China Index and MSCI China H Index.

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A propos de l'auteur

Alastair Kellett  Al Kellett is an ETF analyst with Morningstar Europe.