Analysts are reacting to the changes in the Hang Seng index in Hong Kong

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A person wearing a protective mask walks by the sign for Hong Kong Exchanges & Clearing Ltd. on Wednesday, August 19, 2020. (HKEX) on display in the Exchange Square complex in Hong Kong, China.

Roy Liu | Bloomberg via Getty Images

This week’s announcement of a move to the Hong Kong stock index is a “positive move” that could help diversify risk, according to Min Chen of Somerset Capital Management.

“We believe the new methodology (of the Hang Seng Index) is a great way to prevent overconcentration of risk and it is very effective in helping the passive investor,” said Chen, portfolio manager of the company’s China strategy , across from CNBC’s “Street Signs” Asia on Tuesday.

Passive investing is a long-term investment strategy that aims for minimal trading and often involves buying into funds that track market barometers.

His comments came after Hang Seng Indexes Company, the index’s compiler, announced on Monday that it was optimizing the main benchmark for stocks in Hong Kong. The decision was made after a month-long consultation with the stakeholders.

A press release described five major changes to the Hang Seng index in Hang Seng indices. The changes will be implemented from the index review in May:

  1. Increase components to 100: The aim is to increase the number of HSI components to 80 by mid-2022, with the aim of having 100 companies in the index. The index currently has around 55 components.
  2. Select components from seven industry groups: These range from finance to information technology to health care. The aim is to achieve a market capitalization of at least 50% for each industry group.
  3. Shortening the listing history requirement: This will be shortened to three months, which may make adding new entries to the index faster.
  4. Maintain representation of companies in Hong Kong: Approximately 20-25 components classified as Hong Kong companies are retained in the HSI, and the component component count is reassessed at least every two years.
  5. Lower the weight cap to 8%: All HSI components – including those with weighted voting rights or secondary listings – are subject to an upper weighting limit of 8%. Weighted voters or secondary listings are currently capped at 5% while others are capped at 10%.

“The new improvements to the HSI will further increase its representation and make the index more balanced and diversified,” said Anita Mo, CEO of Hang Seng Indexes, in the press release.

The Hong Kong benchmark index has gotten off to a good start this year, up more than 9% since Wednesday’s close of trading in January.

Chen, the portfolio manager, said the new changes would increase Hang Seng’s exposure to new economy sectors and maintain an appropriate level of diversification.

He pointed to the 8% decrease in the weight cap and said it was much lower than other indices. As an example, he cited the MSCI China Index, in which the tech juggernauts Alibaba and Tencent cumulatively account for more than 30% of the weighting.

How investors might react

Goldman Sachs indicated that investors are likely to reallocate their portfolios in light of the Hang Seng overhaul.

“With the HSI increasing the constituent count to 80 and applying an 8% weight cap to all constituents, the highest constituents in the index today could see outflows led by the reallocation as their index weights would be capped at 8%,” said Goldman analysts said in a Tuesday note.

… We believe the upgraded HSI index, with its expanded index coverage and higher exposure to New China, could attract more capital to track as a benchmark.

Meanwhile weighted voting rights or secondary listing companies – in addition to possible new entrants in the index – might see “big inflows” as their index cap is raised from 5% to 8%.

Companies that currently have a weighting of more than 8% for the Hang Seng include gaming giant Tencent and life insurer AIA, according to Hang Seng Indexes.

“In addition to portfolio redistribution flows, we expect the upgraded HSI index, with its expanded index coverage and greater exposure to New China, could attract more capital to track as a benchmark,” said Goldman Sachs analysts.

“Since the index cap could rise 25% when the number of constituents reaches 80, we predict that the tracking (managed) HSI could grow proportionally from around $ 20 billion now to $ 25 billion,” they said .

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