For professional clients only
A guide to passive fund management
More than simply tracking the market
2 More than simply tracking the market
Introduction 3
Building a passive fund 4
What should I look for in a passive 6 fund provider?
Why choose HSBC Global 8 Asset Management
Important Information 11
Over recent years, there has been a rapid growth in inflows into
passive investments, such as index tracker funds and Exchange
Traded Funds (ETFs). Passive funds aim to offer investors low-
cost, diversified and transparent market access.
The goal of passively-managed funds is to track a benchmark
index, which usually represents a broad market or a segment
within that market. However, the day-to-day management of
passive funds goes beyond merely buying and holding the
underlying securities. These daily tasks range from managing
corporate actions and dividend cash flows to implementing
index rebalances.
This document sets out the key responsibilities of passive fund
managers and how they run their portfolios on a day-to-day basis
to ensure that they track their benchmark in the most efficient
way possible.
More than simply tracking the market 3
IntroductionThe challenging market environment of recent years has led to
many investors moving into passive funds, as they seek more
cost-efficient market access.
Rising global demand for passive investments has led to the
development of a wide range of passive funds, covering a broad
spectrum of market areas, sectors and asset classes.
We expect investor demand for passive solutions to continue
growing, both as a result of recent regulatory changes (such as
those brought in by the Retail Distribution Review) and rising
interest in passive investments from investors looking to reduce
the cost of managing their investment portfolios. Subsequently,
we believe that passive funds are likely to play a greater role in
the core of investor portfolios over the coming years.
The many roles of the passive fund managerAs with any investment, the knowledge and experience of
the individual fund manager play a key role in the successful
running of a passive fund. Passive fund managers have to be
able to handle proprietary research and in-house models to make
their own informed decisions about the most efficient way to
manage cash flows and other corporate actions (such as index
rebalancing and dividends). At the same time, managers ensure
that the risk profile of their fund remains within the established
limits compared to the underlying benchmark. During falling
and difficult markets, the ability of a fund manager to navigate
these challenging market conditions becomes crucial for the
performance of the fund.
As such, passive fund managers have a variety of dynamic
operational roles to play in managing their investors’ money.
4 More than simply tracking the market
Building a passive fundHSBC Global Asset Management’s range of passive funds is
based on a robust investment process.
We start with what we call the “universe analysis” of the
underlying index, focusing mainly on FX allocation, rebalancing
costs, dividends and taxes. While defining the indexation
methodology, we consider client-specific requirements in relation
to the constraints of the fund. The objective of this exercise is to
minimise tracking error as much as possible.
In order to decide on portfolio construction, we then look at
the investable universe with respect to liquidity, volume, index
turnover and volatility, as well as the distribution between large
and small cap stocks within it and its composition at the country,
sector and industry level. A matrix approach is then used to
manage factor risk in the portfolio and to ensure that it has
a neutral position relative to the risk exposure implied by the
benchmark.
We then carry out pre- and post- trading analysis to ensure that
our portfolio is implemented in the most pragmatic and effective
way. Another part of this trading analysis, which is aimed at
minimising costs, is to estimate the actual costs, whether they
are explicit (taxes, custodian and execution) or implicit (market
impact).
Continuous fund monitoringAfter the launch of a fund, and throughout its life, passive fund
managers continuously monitor and analyse their portfolios, to
ensure that the fund closely tracks its benchmark.
The cost and risk management activities undertaken by passive
fund managers on an ongoing basis in the management of their
portfolios are outlined below.
Cost ManagementThe objective of a passive investment fund is to replicate the
performance of its benchmark index. However, the costs of
managing the fund will most likely prevent it from delivering the
exact benchmark return. This is because, unlike the fund, the
index itself does not incur any trading costs when it rebalances.
In practice, costs play a key role in determining portfolio
performance. Passive fund managers concentrate on minimising
the impact of a range of factors that drive fund costs, and
subsequently the fund’s tracking difference to the benchmark.
Key cost considerations include:
` Index rebalancing
When an index rebalances (i.e. when it goes through
regular review of its composition and constituent weights),
passive portfolio managers also need to rebalance the funds
tracking that particular index accordingly. They will therefore
buy and sell securities, so that the fund matches the new
composition of the benchmark. However, buying and selling
equities involves trading costs, which will have an impact on
the passive fund’s performance relative to the index.
` Corporate actions
Corporate actions (such as mergers and acquisitions, stock
splits, rights issues, spin-offs or the receipt of interest/
dividends) also need to be processed by a passive fund
manager, which may then generate trading costs or
other implicit costs related to the corporate activity in the
underlying investment.
For example, dividends paid by the underlying stocks of a
passive fund need to be reinvested, as keeping them in
the portfolio would create a ‘cash drag’. This refers to the
impact on the fund’s performance from being underexposed
compared to its benchmark due to cash accumulation.
` Taxation
Taxation can also add to the difference between the
performance of a passive fund and that of its benchmark.
A common example of such a difference would be the
More than simply tracking the market 5
A growing passive product rangeOver the past 25 years, there has been a significant
increase in the scale and scope of passive investment
products available to investors.
The first widely-used passive investment product was
the index tracker fund, which came to prominence in the
1980s and 1990s.
The next stage in passive investment in Europe was
represented by the emergence of Exchange Traded
Funds (ETFs) during the 2000s. ETFs added liquidity and
transparency to the index trackers’ core strengths of
cost-effective and diversified market access.
At present, a growing range of ‘smart beta’ solutions,
such as HSBC Alternative Indexation or RAFI*, is being
pioneered by many passive fund managers. Smart beta
uses quantitative analysis or other proprietary research
to come up with alternative investment strategies. These
include using alternative weighting methods to the
traditional market capitalisation approach, or constructing
new alternative market capitalisation based indices
that have a stronger grounding in actual economic
fundamentals.
Other methods of gaining index exposure include
segregated mandates.
Individual circumstances (such as tax eligibility or any
client restrictions) can help advisors to decide which
type of passive investment product is right for their
clients’ specific needs.
* In partnership with FTSE, Research Affiliates (RA) launched
a series of indices based on the Fundamental Index (FI) methodology developed by Research Affiliates.
withholding tax (WHT) rate paid on dividends. An index might
assume that the tax rate on a stock’s dividend is 30% for a
given country, while the fund, as a result of a favourable tax
treaty between the stock’s country and the fund’s domicile
country, might actually only pay a 15% tax rate. The reverse
is also possible and, in some instances, the fund might pay a
higher WHT rate than that assumed by the index.
Risk managementComprehensive risk management also forms a crucial part of
the passive fund manager’s role. This is not only key during the
portfolio construction process, but continues on an ongoing basis
over the life of the fund.
Passive fund managers carry out risk management analysis on a
daily basis. This starts with the verification of the net asset value
and performance attribution, which allows them to monitor how
closely the fund is tracking its benchmark.
Other factors, such as the fund’s current exposure to foreign
currency, sectors or countries, are also taken into account. In
addition, risk management monitoring considers the impact
of the treatment of corporate actions, index rebalancings and
exchange rate movements. This is done on an on-going basis.
Passive fund managers also need to be aware of changes to the
taxation or regulatory environment, to see what impact these
might have on fund performance. When considering global
portfolios, this includes keeping track of potential changes across
several regulatory regimes at once.
At a trading level, fund managers have to be aware of all the
different market holidays that occur around the world and how
these are handled by index providers, as well as the specific
trading and settlement rules on each exchange.
6 More than simply tracking the market
There are several key factors to consider when choosing the right
passive fund provider for your clients’ investment needs.
These include:
` Experience
` Scale
` Index methodology
` Tracking performance
` Costs
` Commitment to innovation
ExperienceAs with any investment decision, it is worth seeking out fund
managers that have a long track record in managing passive
investments if you are seeking to invest in a passive product.
Many leading fund managers, including HSBC Global Asset
Management, now offer over 25 years’ experience in managing
passive investments.
ScaleLarger passive fund managers are able to achieve greater
economies of scale, which can lead to lower costs for clients.
Global passive fund managers also need to maintain and develop
relationships with traders and brokers around the world, to
ensure best execution and low trading costs. It is also in passive
fund managers’ interests to have a local presence in key global
trading centres, so they can keep up to date with changing
regulations and understand exactly how local markets work.
HSBC Global Asset Management has extensive expertise and
a long track record in both developed and emerging markets
and we can offer direct market access on many local stock
exchanges. We are therefore able to go further than other
providers in offering full physical replicated passive investment
products. This long experience also supports our aim to keep
down our costs, which helps to both minimise fees and maintain
a strong tracking performance.
Index methodologyThere are several ways to construct a passive fund.
HSBC Global Asset Management believes that the full physical
replication approach to passive fund construction (i.e. buying all
of the stocks in the underlying index and in the same proportion
as the index) is the best approach to take, as it allows us to
construct funds with a high degree of transparency
and simplicity.
Where it is not cost-effective to buy all of the securities in
the underlying index (e.g. for broad indices such as the FTSE
All-Share or the MSCI World), we use a process known as
optimisation, where we own a proportion of securities in the
underlying index.
Although some studies have shown that synthetic funds (which
use swaps and other derivative products to obtain market
access) can offer a lower tracking error over time than full
physical replicated funds, we believe that the risks associated
with such synthetic funds – the most important of which is
counterparty risk – make them a less attractive investment
option.
Moreover, it is not always the case that synthetic funds provide
clear outperformance when compared to physical funds. For
example, HSBC Global Asset Management has developed a
range of physical ETFs (notably in Russia and Emerging Markets)
that offer very competitive tracking performance compared to
rival synthetic funds. This has been achieved by leveraging our
local expertise in these markets, enabling us to carry out direct
investment in local stocks wherever possible. This helps to
reduce the tracking error of our funds.
Tracking performanceAs we stated above, the full replication element to HSBC Global
Asset Management’s investment approach reduces the potential
for any significant divergence in tracking performance. When
deciding upon any investment in a passive fund, it is crucial to
consider its historic tracking performance.
In doing so, it is worth looking at both tracking difference
(the difference between the net asset value of a fund and
its benchmark) and tracking error (how consistent this return
difference has been over time, computed using the standard
deviation of the tracking difference).
If, over time, the tracking error of a passive fund relative to
its benchmark index increases disproportionately, the return
objective of the overall investment portfolio would not be met.
Consequently, HSBC Global Asset Management’s replication
approach across its range of passive investment products aims
to minimise tracking error as far as possible. A low tracking
error means that a passive fund is meeting its main investment
objective, namely matching the returns of its benchmark closely.
What should I look for in a passive fund provider?
More than simply tracking the market 7
CostsA commitment to competitive costs is essential for a passive
fund manager. Passive investments – such as index trackers and
ETFs – have historically tended to have lower costs than active
funds. This reflects the fact that passive funds do not require
large teams of active managers or stock-pickers to generate
outperformance, as the objective of a passive fund is only to
match the performance of its benchmark.
The key measurement of cost for both ETFs and index
tracker funds is the Ongoing Charges Figure (OCF). The OCF
incorporates elements such as the annual management fee
and a list of other operating costs carried by the asset manager;
these include administration, custody, trustee and audit fees,
as well as legal, regulatory and registration expenses. On the
other hand, corporate actions and index rebalancing - which both
generate trading costs - are not included in that figure. There are
also entry/exit fees to consider for index-tracker funds and trading
spreads and brokerage fees for ETF investments.
HSBC Global Asset Management is able to use its global
footprint and existing local expertise to devise cost-effective
passive investment products that offer a range of market
exposures, from global down to country-specific. Within
emerging markets, our trading scale often enables us to
negotiate attractive dealing costs on local exchanges, which we
can then pass on to investors via lower OCFs.
Our passive investment team is also able to call upon the full
infrastructure and expertise of the wider HSBC group in areas
such as global banking and markets, through to custodian and
administrative services. Moreover, our integrated IT systems
help us to achieve efficient execution and portfolio management.
Commitment to innovationPassive investments are currently experiencing a period of rapid
growth, with more and more fund managers looking to leverage
their own proprietary research to develop new ‘smart beta’
investment solutions. A commitment to innovation is therefore
another key strength that you should consider when choosing a
passive investment partner.
HSBC Global Asset Management remains committed to
innovation in smart beta and we have now enhanced our
passive range by offering investors Alternative Indexation
solutions. Alternative Indexation offers a complementary
option to commonly used benchmarks, whereby we use our
own proprietary research to develop traditional or alternative
weighting schemes.
8 More than simply tracking the market
Why choose HSBC Global Asset Management?HSBC Global Asset Management’s range of passive investment
products (index tracker funds, ETFs and Alternative Indexation)
has been designed with the investor in mind. To that end, we
have used our global presence to create a broad range of passive
funds across both developed and emerging markets that provide
exposures to the areas where our clients are looking to invest.
HSBC Global Asset Management is a leading global investment
manager with a long track record of providing sound investment
solutions to a wide range of investors around the world. We
have been managing passive investments for over 25 years. The
fact that we have a common investment management team
working across our global passive range ensures that portfolio
construction and risk management processes are consistent
across our range of products.
HSBC Global Asset Management has a long track record in
emerging market investment and we can subsequently offer
direct market access on many local stock exchanges. We are
therefore able to go further in offering passive funds based on
this fast-growing market sector than other providers.
HSBC Global Asset Management’s robust quantitative portfolio
management and trading processes ensure that our funds are
able to track their benchmark indices closely.
HSBC Global Asset Management also believes in high levels of
transparency across its range of passive investment products.
We provide a daily list of the securities held by each fund
(portfolio composition file) as well as monthly fund factsheets.
Moreover, our overall investment approach remains conservative.
We believe in strong levels of risk management and governance
for our passive funds, aiming to deliver minimum tracking error at
a competitive price to our clients.
We believe that HSBC Global Asset Management is now well
placed to take a leading position in passive investment, offering
investors a broad range of complementary passive investment
solutions that can work alongside the active portions of client
portfolios.
Index Tracker Funds range Exchange Traded Funds range
HSBC AMERICAN INDEX FUNDHSBC FTSE 100 INDEX FUNDHSBC FTSE 250 INDEX FUNDHSBC FTSE ALL SHARE INDEX FUND HSBC EUROPEAN INDEX FUNDHSBC JAPAN INDEX FUNDHSBC PACIFIC INDEX FUNDHSBC UK GILT INDEX FUND
HSBC ESI WORLDWIDE EQUITY UCITS ETFHSBC EURO STOXX 50 UCITSHSBC FTSE 100 UCITSHSBC FTSE 250 UCITSHSBC FTSE EPRA/NAREIT DEVELOPED UCITSHSBC MSCI AC FAR EAST ex JAPAN UCITSHSBC MSCI BRAZIL UCITSHSBC MSCI CANADA UCITSHSBC MSCI CHINA UCITSHSBC MSCI EMERGING MARKETS FAR EAST UCITSHSBC MSCI EMERGING MARKETS LATIN AMERICA UCITSHSBC MSCI EMERGING MARKETS UCITSHSBC MSCI EUROPE UCITSHSBC MSCI INDONESIA UCITS
HSBC MSCI JAPAN UCITSHSBC MSCI KOREA UCITSHSBC MSCI MALAYSIA UCITSHSBC MSCI MEXICO CAPPED UCITSHSBC MSCI PACIFIC ex JAPAN UCITSHSBC MSCI RUSSIA CAPPED UCITSHSBC MSCI SOUTH AFRICA UCITSHSBC MSCI TAIWAN UCITSHSBC MSCI TURKEY UCITSHSBC MSCI USA UCITSHSBC MSCI WORLD UCITSHSBC S&P 500 UCITSHSBC S&P BRIC 40 UCITSHSBC WORLDWIDE EQUITY UCITS ETF
HSBC Global Asset Management
Passive Investment Product Overview
HSBC Global Asset Management
More than simply tracking the market 9
Index Tracker Funds range Exchange Traded Funds range
HSBC AMERICAN INDEX FUNDHSBC FTSE 100 INDEX FUNDHSBC FTSE 250 INDEX FUNDHSBC FTSE ALL SHARE INDEX FUND HSBC EUROPEAN INDEX FUNDHSBC JAPAN INDEX FUNDHSBC PACIFIC INDEX FUNDHSBC UK GILT INDEX FUND
HSBC ESI WORLDWIDE EQUITY UCITS ETFHSBC EURO STOXX 50 UCITSHSBC FTSE 100 UCITSHSBC FTSE 250 UCITSHSBC FTSE EPRA/NAREIT DEVELOPED UCITSHSBC MSCI AC FAR EAST ex JAPAN UCITSHSBC MSCI BRAZIL UCITSHSBC MSCI CANADA UCITSHSBC MSCI CHINA UCITSHSBC MSCI EMERGING MARKETS FAR EAST UCITSHSBC MSCI EMERGING MARKETS LATIN AMERICA UCITSHSBC MSCI EMERGING MARKETS UCITSHSBC MSCI EUROPE UCITSHSBC MSCI INDONESIA UCITS
HSBC MSCI JAPAN UCITSHSBC MSCI KOREA UCITSHSBC MSCI MALAYSIA UCITSHSBC MSCI MEXICO CAPPED UCITSHSBC MSCI PACIFIC ex JAPAN UCITSHSBC MSCI RUSSIA CAPPED UCITSHSBC MSCI SOUTH AFRICA UCITSHSBC MSCI TAIWAN UCITSHSBC MSCI TURKEY UCITSHSBC MSCI USA UCITSHSBC MSCI WORLD UCITSHSBC S&P 500 UCITSHSBC S&P BRIC 40 UCITSHSBC WORLDWIDE EQUITY UCITS ETF
HSBC Global Asset Management
Passive Investment Product Overview
What to consider when investing in an index tracker fund and an ETF
Market risk
The value of investments and any income from them can go
down as well as up, and investors may not get back the amount
originally invested.
Currency risk
Where overseas investments are held, the rate of currency
exchange may cause the value of such investments to go down
as well as up.
Emerging market risk
Investments in emerging markets are by their nature higher
risk and potentially more volatile than those inherent in some
established markets.
Geographic risk
Some of the Index tracker Funds and Exchange Traded Funds
invest predominantly in one geographic area; therefore any
decline in the economy of this area may affect the prices and
value of the underlying assets.
Property risk
The value of interests in real estate companies may be affected
by changes in interest rates, tax laws and environmental laws
and regulations. While the value of interests in REITs may be
affected by the value of the property owned or the quality of the
mortgages held by the trust.
Russian risk
There are significant risks inherent in investing in Russia, which
could affect the value of investment. These include a lack of
clarity in laws and regulations in the following areas: investor
protection, banks and other financial services, the Russian
economic system, taxation, transaction settlement and fiduciary
duty and responsibilities of company management. Please see
the supplement for full information. Investors and potential
investors should read the relevant Key Investor Information
Document (KIID) and full prospectus and supplement for full
details of the risks involves prior to making a decision to invest.
If you have any doubt about the suitability of an investment you
should consult a financial adviser.
10 More than simply tracking the market
This document is intended for professional clients only and
should not be distributed to or relied upon by retail clients.
The material contained herein is for information purposes only
and does not constitute investment advice or a recommendation
to any reader of this material to buy or sell investments. Care has
been taken to ensure the accuracy of this document, but HSBC
Global Asset Management (UK) Limited accepts no responsibility
for any errors or omissions contained therein.
Fund information
The HSBC index tracker funds referred to are sub-funds of HSBC
Index Tracker Investment Funds, an Open Ended Investment
Company that is authorised in the UK by the Financial Conduct
Authority. The Authorised Corporate Director and Investment
Manager is HSBC Global Asset Management (UK) Limited.
HSBC ETFs are sub-funds of HSBC ETFs plc, an investment
company with variable capital and segregated liability between
sub-funds, incorporated in Ireland as a public limited company,
and authorised by the Central Bank of Ireland. The company
is constituted as an umbrella fund, with segregated liability
between sub-funds.
Shares purchased on the secondary market cannot usually
be sold directly back to the Company. Investors must buy and
sell shares on the secondary market with the assistance of an
intermediary (e.g. a stockbroker) and may incur fees for doing so.
In addition, investors may pay more than the current Net Asset
Value per share when buying shares and may receive less than
the current Net Asset Value per Share when selling them.
For investors in the UK
All applications are made on the basis of the current HSBC ETFs
plc Prospectus, relevant Key Investor Information Document
(“KIID”), Supplementary Information Document (SID) and Fund
supplement, and most recent annual and semi-annual reports,
which can be obtained upon request free of charge from HSBC
Global Asset Management (UK) Limited, 8 Canada Square,
Canary Wharf, London, E14 5HQ. UK, or from a stockbroker or
financial adviser. Investors and potential investors should read
and note the risk warnings in the prospectus, relevant KIID, SID
and Fund supplement. UK-based investors in HSBC ETFs plc are
advised that they may not be afforded some of the protections
conveyed by the Financial Services and Markets Act (2000), (‘the
Act’). The company is recognised in the United Kingdom by the
Financial Conduct Authority under section 264 of the Act.
Restrictions
The shares in HSBC ETFs plc have not been and will not be
offered for sale or sold in the United States of America, its
territories or possessions and all areas subject to its jurisdiction,
or to United States persons. Affiliated companies of HSBC Global
Asset Management (UK) Limited may make markets in HSBC
ETFs plc.
Index disclaimer
The EURO STOXX 50 is the intellectual property (including
registered trademarks) of Stoxx Limited, Zurich, Switzerland
and/or Dow Jones & Company, Inc., a Delaware corporation,
New York, USA, (the “Licensors”), which is used under license.
The securities based on the Index are in no way sponsored,
endorsed, sold or promoted by the Licensors and neither of the
Licensors shall have any liability with respect thereto.
All rights in the FTSE 100 and the FTSE 250 (the “Indices”)
vest in FTSE International Limited (“FTSE”). “FTSE®” is a
trademark of London Stock Exchange Group companies and is
used by FTSE under licence. The HSBC FTSE 100 UCITS ETF
and the HSBC FTSE 250 UCITS ETF (the “Products”) have
been developed solely by HSBC Global Asset Management
(UK) Limited. The Indices are calculated by FTSE or its agent.
FTSE and its licensors are not connected to and do not sponsor,
advise, recommend, endorse or promote the Products and do
not accept any liability whatsoever to any person arising out
of (a) the use of, reliance on or any error in the Indices or (b)
investment in or operation of the Products. FTSE makes no
claim, prediction, warranty or representation either as to the
results to be obtained from the Products or the suitability of the
Indices for the purpose to which they are being put by HSBC
Global Asset Management (UK) Limited.
Important Information
More than simply tracking the market 11
“FTSE®” is a trade mark of the London Stock Exchange
Group companies, “NAREIT®” is a trade mark of the National
Association of Real Estate Investment Trusts (“NAREIT”) and
“EPRA®” is a trade mark of the European Public Real Estate
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The funds or securities referred to herein are not sponsored,
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Standard & Poor’s and S&P are registered trademarks of
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The S&P 500 and the S&P BRIC 40 are products of S&P Dow
Jones Indices LLC, and have been licensed for use by HSBC
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such product(s).
HSBC Global Asset Management Ltd is the Sponsor for HSBC
Economic Scale Index - Worldwide and HSBC Worldwide Index.
As such, it maintains a segregation of duties from entities
acting as the calculation agent for the Index, and investment
manager for any products linked to this Index. HSBC Global
Asset Management Ltd maintains a Conflicts of Interest policy
to manage any conflicts of interest between HSBC Global Asset
Management Ltd and other members of the HSBC Group
or other affiliates. As the Index Sponsor, HSBC Global Asset
Management Ltd has policies and procedures in place to ensure
that it operates with transparency and accuracy in the Index
creation and management process.
This document is approved for issue in the UK by HSBC Global
Asset Management (UK) Limited who are authorised and
regulated by the Financial Conduct Authority. Copyright HSBC
Global Asset Management (UK) Limited 2014. All rights reserved.
www.assetmanagement.hsbc.com/uk
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HSBC Global Asset Management (UK) Limited provides
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26032/AS/1014/FP14-1573. Expiry 10/10/2015.
Notes
12 More than simply tracking the market
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Notes
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ContactFor more information, please contact us:
Email: [email protected]
Telephone: +44 (0) 207 024 0435
Website: www.assetmanagement.hsbc.com/passive
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