Gauging China’s dynamic economy with a broad-based index
Mar 16, 2022
Co-Head of Equities Product Development, Markets, HKEX
 
 

China’s economy is undergoing rapid transformation. An objective and representative benchmark is key for investors to grasp the growth opportunities in this market. Given the importance of Stock Connect as the main gateway for foreign investors to enter the A-share market, an ideal China investment benchmark should take into account Stock Connect eligibility while reflecting China’s economic development.

 

Sector-balanced exposure to China A-shares

While there are several existing A-share indexes in the market, such as the CSI 300 Index, MSCI China A Index and FTSE China A50 Index, these indexes may not be perfect gauges for investors who invest through Stock Connect as the investment universe of these indexes differs from the scope of Stock Connect eligible stocks. In view of this, MSCI has launched a new A-share index constructed on Stock Connect, namely, the MSCI China A 50 Connect Index. The new index was designed to achieve a diversified sector allocation of the China A-share market, providing investors with a new benchmark for investing and managing risks in A-shares.

The new index comprises 50 Stock Connect eligible A-shares and its sector weights are adjusted to mirror those of the parent index to achieve sector neutrality. While the new index emphasizes a sector-balanced exposure, a pure top 50 index (that selects the 50 largest stocks in terms of market cap), by contrast, often skews towards certain sectors. The index construction process of the MSCI China A 50 Connect Index begins with selecting the 2 largest securities by free float-adjusted market capitalisation from each of the 11 sectors of the parent index. After that, the largest securities from the investment universe are included until the number of constituents reaches 50. The resultant index portfolio will have a balanced sector composition and prevent stocks with smaller market cap (such as healthcare and tech stocks) from being excluded.

 

Highly correlated to the broad A-share market

Index futures that have a broad sector exposure enable investors to invest in a basket of constituent stocks in one trade; these futures can also serve as hedging tools for diversified portfolios. The MSCI China A 50 Connect Index has a high correlation (0.96) to the CSI 300 Index and thus can be an ideal benchmark for hedging instruments of broad-based China portfolios. In addition, the sector-diversified index can also reduce the impact of a particular industry sector on index performance.

In summary, investor demand for a representative A-share benchmark is growing as foreign ownership of A-shares continues to increase. The Stock Connect compatible MSCI China A 50 Connect Index represents a balanced mega-cap approach to invest in the China A-share market, thus preventing sectoral biases. The MSCI China A 50 Connect (USD) Index Futures are constructed on the new index, providing international investors with a new risk management tool that can fulfil their hedging needs.

Similar to all investments, futures products involve risks and A-share futures are closely associated with the risks of China’s stock market. Investors should understand the risks involved before entering into any futures contracts.

 

Credits: Content based on an article published in HKET on 8th March 2022