Key Broad Indices to Watch in Volatile Markets
The market's rapid rise has sparked a surge in investor sentiment. The trading volume in the A-share market skyrocketed from under 600 billion to a historic high of 3.45 trillion on October 8. Once again, we are witnessing signs of a bull market after many years.
In contrast to previous market rebounds, this time the catalysts for the A-shares are substantial policies, including liquidity easing, interest rate cuts, and relaxed real estate regulations. Even today, we continue to see a stream of favorable policies being rolled out.
During this rapid market rebound, many have noticed that some actively managed equity funds have failed to outperform broad market index ETFs. This mirrors the scenario in December 2014 when the bull market began, with undervalued high-quality blue chips taking the lead in the surge.
Moreover, during the press conference held by the State Council on September 24, it was explicitly stated that there would be a vigorous push for innovation in index products, including broad-based ETFs. As market enthusiasm quickly returns and volatility begins to increase, how should investors select worthwhile broad-based ETFs?
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For investors, we believe that the core broad-based ETFs of the new era should not only reflect the competitiveness of the Chinese economy but also extend beyond borders to form international influence.
In recent years, an increasing number of Chinese companies have gone global, gradually becoming firms with global competitiveness and production advantages. In the future, our capital markets will also evolve alongside the enhancement of national competitiveness, creating index products with global influence.
Globally, most countries and regions that rank high in GDP have at least one globally recognized index product that investors can allocate to, whether it's the S&P 500 or Nasdaq in the U.S., the Nikkei 225 in Japan, or the FTSE 100 in Europe, to name a few.
So, will global investors truly consider allocating to broad-based indices in the Chinese market? Let's explore this from both a change and a constant to discuss the underlying reasons.
First, let's discuss a change. The policy punches launched before the National Day holiday, combined with the cyclical nature of the stock market, suggest that stock performances among countries may exhibit tendencies toward mean reversion and cyclical patterns.
From this perspective, the Chinese market, which is currently at the bottom of its cycle, is likely to outperform overseas markets in the coming years. Furthermore, compared to the recent 50 basis point rate cut by the Federal Reserve, the strength of our current policy measures may be considerably more impactful.
Now, let's explore a constant. From the perspective of global asset allocation, incorporating Chinese assets significantly enhances the risk-return profile of an investment portfolio.
The soon-to-be-listed A500ETF (159339) is an innovative broad-based index. From the optimization of the index design to the trading rules, it not only has the potential to become a Chinese index with international outreach but, more importantly, this innovative broad-based index can create a globally influential Chinese index, thereby better helping holders benefit from economic growth.
Chinese Companies Going Global Achieve New Heights
As the economic growth dynamics transform, Chinese enterprises are gradually shifting from catering to domestic needs to exporting their competitiveness globally.
Today, the scale of Chinese companies venturing abroad has also reached a historic high. According to the 2023 annual reports of publicly listed Chinese companies, overseas revenue for A-share companies has surged from over 4 billion after joining the WTO to 8.5 trillion by the end of 2023, with a remarkable compound annual growth rate of 38%.
Compared to ten years ago, the dynamics of Chinese companies going abroad have undergone fundamental changes. Firstly, the proportion of large companies venturing abroad has significantly increased. According to data from Wind, by the end of 2023, 24.15% of overseas listed companies had assets above 10 billion, a 13% increase compared to the end of 2013, and 3.94% of overseas companies had 100 billion in assets, doubling since the end of 2023.
Secondly, the production model of companies going global has shifted from merely exporting labor advantages and supply chain resources to achieving a new form of globalization. These companies have transformed Chinese manufacturing into global manufacturing, showcasing management capabilities. For instance, in the manufacturing sector, Chinese enterprises have today strengthened their manufacturing advantages.
Thirdly, an increasing number of overseas consumers are embracing Chinese brands. During this past Spring Festival, while vacationing in Thailand, I observed a plethora of domestic car brands on the streets. Furthermore, during this year's U.S. Super Bowl, which featured prominent advertisements, one of the leading Chinese e-commerce platforms made a stunning appearance, leading to an overseas backlog of orders. In Singapore, domestic hot pot and tea drink chains have rapidly occupied prime locations in major malls. Even in New York’s most expensive Hudson Yards mall, Americans lined up for Chinese milk tea.
The Value of Chinese Indices in Global Allocation
Many may question whether Chinese indices can achieve global influence. For global investors, it seems sufficient to simply "win" with stocks like the S&P 500 and Nasdaq in the U.S.
To comprehend the global allocation value of Chinese indices, we need to examine this from two more professional perspectives.
First, there is the inevitable mean reversion, or the notion that every type of asset has its own cycle of excess returns.
Historically, in the 80s, the best-performing countries were Sweden, South Korea, Japan, and Spain, achieving excess returns of 503%, 354%, 310%, and 188% respectively. By the 90s, Switzerland, the U.S., Sweden, and France surged to the forefront with returns of 231%, 217%, 190%, and 117%. The 2000s saw China, Norway, Brazil, and Canada topping the list, with excess returns of 76%, 48%, 45%, and 42%. Starting from 2010, the leading countries became the U.S., New Zealand, Sweden, and Japan, with returns of 182%, 149%, 146%, and 105% respectively.
As the saying goes, no flower blooms for a hundred days; it is evident that a country's stock market will find it difficult to sustain excess returns over a long period. This includes changes in relative advantages and valuation corrections, which have been clearly observed in the A-share market as well. Historical data shows that robust industries tend to shift every few years. Wind data indicates that from 2007 to 2009, cyclical commodities in non-ferrous metals and coal led, while from 2013 to 2015, software services in the ChiNext took the spotlight, and from 2016 to 2019, it moved onto food and beverage and home appliances. Research from Shenwan Hongyuan's strategy group shows that very few sectors consistently rank in the top five for three years; in fact, sectors performing well in one year often fall to the tail the following year.
Secondly, there is the negative correlation in asset allocation. Today, we all understand that the core of asset allocation is not about how many types of assets to hold, but rather the negative correlation between assets within the portfolio. The following chart shows the correlation analysis between various assets and U.S. stocks conducted by Bridgewater; the further up, the higher the return and risk ratio. The gray assets represent U.S. assets, with the larger shapes corresponding to higher risk associated with U.S. stocks.
We see that the correlation between Chinese stocks and U.S. stocks is not high, and adding Chinese assets to a portfolio helps to diversify risks while optimizing returns after adjustments for risk.
Investing in Chinese assets carries risks, but all global assets are associated with certain risks. From today’s standpoint, undervalued Chinese assets potentially correspond to higher expected returns. Furthermore, by incorporating Chinese assets into the portfolio, one could significantly enhance the portfolio's risk-return ratio.
Whether from the perspective of cyclical reversion or the optimization of portfolio configuration, there is a global demand among investors for allocating to Chinese assets.
A500ETF: The Core Broad-Based of the New Era
Having understood the significance of Chinese indices in global asset allocation, let’s discuss what kind of Chinese indices can better internationalize. We believe that a core broad-based index capable of forming international influence should possess two characteristics:
1) A strong market representation across different economic development stages. After all, investing is about buying the future; a good index should showcase both past economic characteristics and evolve with changes in economic development patterns.
2) The formulation philosophy must align with international characteristics, incorporating new concepts from global index compilation.
We have observed that the recently launched A500ETF meets both of these criteria as the core broad-based index for the new era.
First, the construction approach of the CSI A500 index selects 500 securities based on free float market capitalization while striving to maintain consistency in the primary industry market cap distribution within the sample space. This construction approach is similar to that of mainstream global core broad-based indices.
Taking the well-known S&P 500 index as an example, its compilation process accounts for the sample index's GICS industry distribution in alignment with the overall market index (S&P Total Market Index). This methodology ensures higher market cap coverage and better reflects industry characteristics across different periods.
In comparing several mainstream broad-based indices regarding free float market capitalization coverage, we find that the CSI A500 offers significant coverage, facilitating a better representation of the A-share market.
Through its comprehensive coverage in index construction, the CSI A500 better reflects changes in the growth patterns of Chinese enterprises. For example, the previously mentioned trend of companies going global is likely well represented within the CSI A500 index.
Secondly, the CSI A500 index incorporates ESG ratings in its compilation. Over the past decade, one of the largest shifts in the global asset management industry has been the increasing importance placed on ESG. The focus has evolved from shareholder returns to stakeholder returns, where companies must generate cash flow for shareholders while also creating societal value. Compared to the CSI 800 and CSI 500, the proportion of A-rated ESG companies in the CSI A500 is considerably higher.
Finally, for an index to maintain international competitiveness, its constituent stocks must be accessible for investment by global funds. The CSI A500 index mandates that all constituent stocks fall within the connectable scope, thus enabling global funds to allocate to these stocks.
Due to its internationally minded construction methodology, the CSI A500 has demonstrated remarkable vitality. From 2014 to present, the CSI A500 has outperformed the CSI 300 and CSI 500 by 7.85% and 16.93% respectively, benefiting from differentiation in index construction. Furthermore, during this period, the CSI A500 has shown a high degree of correlation with the latter two indices’ performances, indicating that excess returns are likely not solely derived from excessive exposure to any specific style or industry.
Focus on the Leading Broad-Based Indices of the New Era from Low Points
We see that the Chinese stock market, currently in a low valuation zone, has experienced a much-welcomed resurgence following the policy punches on September 24. In fact, after the Federal Reserve’s 50 basis point rate cut, Chinese assets like A-shares, Hong Kong stocks, and the RMB exchange rate have all shown significant recovery. Hong Kong stocks, which are more affected by foreign investor allocations, exhibited strong elasticity in the short term, suggesting that global allocation funds are actively positioning themselves for the revaluation of Chinese assets.
For domestic investors, the recently listed A500ETF (159339) offers an innovative broad-based index that could assist in capital market recovery efforts. In the short term, this product meets the innovative criteria for broad-based ETFs; in the long term, the A500ETF may have the potential to evolve into an index product impactful on the global stage.
Yin Hua Fund has been awarded the Golden Bull Fund Management Company title ten times. In terms of ETF products, the fund has demonstrated excellent portfolio management and index tracking abilities.
For instance, on the innovation front, Yin Hua Fund has launched several unique ETFs for niche segments, including high dividend ETFs, Hang Seng Hong Kong Stock Connect ETFs, and Hong Kong tech 30 ETFs. In their selection of broad-based beta assets, Yin Hua Fund consistently aims to provide holders with optimized core broad-based investments. This year, in the first half alone, Yin Hua Fund has laid out the large-cap broad-based CSI A50 index, and now, they are focusing on the core broad-based CSI A500 index, which features more internationalized construction methodology and is poised for an international presence.
We also believe that core broad-based indices like the A500ETF (159339) can accompany China’s rising national power and become a calling card for the Chinese stock market on the global stage.
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