With a market capitalisation of over USD 4 trillion, Hong Kong's stock market is the world's fourth largest and accounts for about 6% of the total market value of stocks traded globally (Bloomberg, data as of 13 December 2016). Investors in this market will often watch the benchmark Hang Seng Index to gauge the overall performance of the Hong Kong stock market. In this article, we take a closer look at the Hang Seng Index and discuss whether Hong Kong stocks warrant an allocation in your portfolio.
Making Sense Of The Hang Seng Index
The Hang Seng Index is a free-float adjusted market capitalisation weighted index that tracks the performance of the largest and most liquid stocks listed on the main board of the Hong Kong stock exchange. The index has a total of 50 constituents that account for about 60% of the exchange's total market capitalisation, making it fairly representative of the overall performance of the stock market. The index is calculated in Hong Kong dollars (HKD) and disseminated at two second intervals. It is also reviewed and rebalanced quarterly or at other times in order to adjust for the impact of corporate actions. Since its inception in November 1969, the index has moved from its base value of 100 points (backdated to July 1964) to more than 20,000 points (Chart 1).
Chart 1: Performance Of The Hang Seng Index Since Inception
The Hang Seng Index provides investors with diversified exposure to Hong Kong listed companies across nine different sectors (Table 1). However, it is important for investors to note that the index is primarily made up of companies from the financials sector, which constitutes about 47.5% of the index. In addition, the top ten constituents make up 61.1% of the index, with companies such as HSBC Holdings (HKEX.5), China Construction Bank (HKEX.939) and AIA Group (HKEX.1299) amongst the major constituents of the index. The rest of the index is made up by a handful of well-known technology, property, telecommunications and consumer stocks, some of which may be familiar to Singaporeans, such as Cheung Kong Property Holdings (HKEX.1113), the property developer helmed by business magnate Li Ka-Shing. Then there is Internet giant Tencent (HKEX.700), which owns instant messaging services QQ and WeChat, computer manufacturer Lenovo Group (HKEX.992) and the city's subway operator MTR Corporation (HKEX.66).
Table 1: Sector Weightings Of The Hang Seng Index and Straits Times Index
Sector |
Index Weighting |
|
|---|---|---|
Hang Seng Index |
Straits Times Index |
|
Financials |
47.5% |
36.7% |
Real Estate |
11.0% |
18.1% |
Information Technology |
11.0% |
- |
Telecommunication Services |
7.7% |
11.4% |
Energy |
7.1% |
- |
Utilities |
5.6% |
- |
Industrials |
5.6% |
20.2% |
Consumer Discretionary |
2.9% |
6.3% |
Consumer Staples |
1.7% |
7.4% |
Source: Bloomberg, Nikko Asset Management, iFAST Compilations
Data as of 13 December 2016 |
||
Diversification Value In Portfolio
Local stock investors often have the tendency to focus on stocks listed on the Singapore Exchange, and understandably so because they are more familiar with domestic companies. The additional associated transaction fees and currency risks also serve as deterrents to foreign stock investments. However, having foreign securities in our stock portfolios can help to spread the investment risk among international markets. Given that the five-year correlation of the Hang Seng Index and the Straits Times Index is about 0.66 (as of 13 December 2016), Hong Kong stocks certainly provide diversification value, especially to a Singapore-centric equity portfolio.
While the sector weightings of the Hang Seng Index are similar to that of the Straits Times Index, with both indices heavily weighted in the financials and real estate sectors, they have their differences as well. For instance, the Hang Seng Index has a sizable exposure to the information technology, energy and utilities sectors, but investors are not able to obtain these sectoral exposures with the Straits Times Index. Furthermore, more than half of the Hang Seng Index is made up of mainland Chinese companies, while Singapore stocks dominate the Straits Times Index, although some of these companies derive a part of their revenues from China.
Hong Kong Stock Market Down But Not Out
The Hang Seng Index has been beaten down severely from its peak in April 2015 amidst a slowdown in China's economy, catalysts are emerging for a rebound in the Hong Kong stock market. To put things into context, the Hang Seng Index has a long-term historical average of 13.6X over the period from 1993 – 2016 (Chart 2). The index hit its lowest PE ratio of 6.6X in June 1998 and at its highest, the index went all the way up to a PE ratio of 31.7X in December 1999. It is currently trading at a forward PE ratio of 12.3X that is below both its long-term historical average, as well as the 15.0X PE ratio which we think is fair for the market, and has an estimated dividend yield of 3.7% in 2017. Given these numbers, we believe that the Hong Kong stock market is undervalued and offers tremendous upside potential for investors. As highlighted in one of our articles, we think that the Hang Seng Index will hit 32,000 points by the end of 2018, supported by upward revisions in earnings forecasts for Chinese companies and recent improvements in economic indicators.
Chart 2: Valuations Of The Hang Seng Index
Getting Your Feet Wet In The Hong Kong Stock Market
A journey of a thousand miles begins with a single step, but this first step can be a challenge for the average investor given the plethora of investment options available in the Hong Kong stock market, which has close to 2,000 listed companies. The easiest way to obtain exposure to the Hong Kong stock market is through the Tracker Fund of Hong Kong (HKEX.2800), an exchange-traded fund (ETF) that aims to replicate the performance of the Hang Seng Index. Managed by State Street Global Advisors, the ETF is rather cost-efficient with a low expense ratio of 0.10%. It adopts a direct replication methodology, which involves the buying and managing of the underlying constituents of the index being tracked. Its rolling one-year tracking error of only 0.0302% (as of end October 2016) is also a reflection of the ETF's ability to closely track the Hang Seng Index.
For the stock pickers, a good starting point will be the 50 blue-chip stocks listed on the Hang Seng Index. These companies are some of the largest and most established companies in Hong Kong and China. As they tend to have sound business models, strong balance sheets and cash flows, and have historically shown to generate consistent growth, they are generally believed to be safer investments as compared to smaller and unproven companies. For income investors who may be enticed by the estimated 3.7% dividend yield, these are the biggest dividend payers on the Hang Seng Index. Of course, investors need to carefully consider the risks, future business prospects and valuations of these blue-chip stocks before they actually make the investment.
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