Indexing Strategies Asia 2007
Vincent KwanManaging Director
28 November 2007
China China ““AA”” Shares vs. Shares vs. ““HH”” Shares:Shares:Hedging ofHedging of
HH--share and Ashare and A--share Portfoliosshare Portfolios
1
Contents
1. The Risk of Different A-share and H-share Prices
2. Higher Volatility and Jumps in AH Price Differentials – Who Cares?
3. Hedging the Risk, or Arbitraging the Difference
2
Why A share & H share Price Diverge?Why A share & H share Price Diverge?Why A share & H share Price Diverge?
And the Risk of Such a PhenomenonAnd the Risk of Such a PhenomenonAnd the Risk of Such a Phenomenon
3
The A/H Price Anomaly
265.12%3.388.54天津創業環保Tianjin Capital
278.01%18.8049.81江西銅業Jiangxi Copper
250.93%
263.74%
276.15%
305.26%
6.77
8.16
4.40
8.0423.39中國南方航空China South Air
大唐發電
中國國航
北京北辰實業
16.19Datang Power
20.51Air China
11.58Beijing N Star
A shares(CNY)(As at 21 Nov 2007)
H shares(HKD)
A/H Price Ratio
CNY 100 = HKD 104.93
Hang Seng China AH Premium Index: 168.58
4
Possible Reasons for the A/H Price Differential
NOT convertible
HKD
USD
EUR
JPYCNY
Limited Convertibility
Hong Kong
LocalInvestors
IndividualPRC citizens
QDII
Int’lInvestors
QFII
Dom
estic
Inve
stor
s
Mainland China
Company
H shares A shares
5
Can We Accept This As Normal?… For Now
Nationalisation
TWOMARKETS
Hong Kong Mainland China
Internationalisation
ONE COUNTRY
TWOCURRENCIES
TWOPRICES
TWOSYSTEMS
6
Risk of the A/H Price Differential
Further Widening of A-share PremiumLiquidity in China push A-share prices further up
Sudden Narrowing of A-share PremiumPolicy changes lead to price equalisation
Increasing Price Fluctuation & Volatility
A-H Shares Move in Different Directions
Bubble
7
20 August 2007Announced the launch of Tianjin Pilot Program (“Through-train” Scheme)
Risk: Policy Driven
AHPI178.93
- 4.83 p.p.
< Impact >Investors expect to purchase H shares which trading at deep discount relative to A shares
HSI 5.9%
HSCEI 8.7%
AH (H) 8.4%
SSE 50 6.2%
SHCOMP 5.3%
AH (A) 5.5%
18 October 2007Rumor of arbitrage mechanism by swapping A & H shares was being studied by the China Govn’t
AHPI147.00
- 7.59 p.p.
< Impact >HSCEI went up 5% intraday and Valuation gap in dual-listed stocks narrowed
HSI 0.6%
HSCEI 1.0%
AH (H) 1.5%
SSE 50 3.7%
SHCOMP 3.5%
AH (A) 3.4%
5 November 2007Premier Wen Jiao Bao remarked on 3 Nov (Sat) the “Through-train” Scheme will be postponed
AHPI160.44
+ 4.75 p.p.
< Impact >HSI tumbled 5% while HSCEI tumbled 6.4%; SHCOMP tumbled 2.5%
HSI 5.0%
HSCEI 6.4%
AH (H) 5.9%
SSE 50 2.9%
SHCOMP 2.5%
AH (A) 3.3%
8
Risk: Higher Vol & Jumps in Premium Index
0
10
20
30
40
50
60
Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07
HSCEI SHCOMP
80
100
120
140
160
180
200
Jul-07 Aug-07 Sep-07 Oct-07 Nov-07
Risk 1: Increasing Volatility30-day Rolling Hist Annualized Volatility
Risk 2: Jumps in AHPI9 Jul 07 – 21 Nov 07
?
Highest: 183.76(17 Aug 07)
168.58(21 Nov 07)
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Higher Volatility and Jumps in A/H Price DifferentialHigher Volatility and Jumps in A/H Price DifferentialHigher Volatility and Jumps in A/H Price Differential
Who Cares?Who Cares?Who Cares?
100
1,000
2,000
3,000
4,000
5,000
6,000
Jan-07 Apr-07 Jul-07 Oct-07
AH(A) Index (HKD)AH(H) Index
Impact on "Fungible"
80
100
120
140
160
180
200
Jan-07 Apr-07 Jul-07 Oct-07
HSAHPI
“Fungible” Scheme Operational in ST
Questions:
Would contraction in AHPI lead to a broad-based drop in A shares? Would a significant drop in A-share market drag down HK and H-share market?After the sharp fall, what will be the future direction?
Who will be Harmed if A shares Fall?
Domestic Mainland InvestorsQFII Holders
Who will Suffer if H Shares Surge?
Foreign investors Under-weighted/Sold H sharesForeign investors Shorting H shares
Premium Index
AH (A) Index vs AH (H) Index
IndicativeProjection
IndicativeProjection
110
1,000
2,000
3,000
4,000
5,000
6,000
7,000
Jan-07 Apr-07 Jul-07 Oct-07
AH(A) Index (HKD)AH(H) Index
Nothing on the "Fungible"
80
100
120
140
160
180
200
Jan-07 Apr-07 Jul-07 Oct-07
HSAHPI
What if this is NOT happening in ST?
Nobody could predict themovement in AHPI becauseof:
DifferentSentimentGovernment Policy
Premium Index
AH (A) Index vs AH (H) Index
IndicativeProjection
IndicativeProjection
12
-10.0%
-8.0%
-6.0%
-4.0%
-2.0%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
-10.0% -5.0% 0.0% 5.0% 10.0%
Daily Return Rate of AH(A)
Dai
ly R
etur
n R
ate
of A
H(H
)
From launch day to current
-10.0%
-8.0%
-6.0%
-4.0%
-2.0%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
-10.0% -5.0% 0.0% 5.0% 10.0%
Daily Return Rate of AH(A)
Dai
ly R
etur
n R
ate
of A
H(H
)
From base day to launch day
AH (A) Index and AH (H) Index
Back-testing Data(4 Jan 06 – 6 Jul 07)
Real-time Data(9 Jul 07 – 21 Nov 07)
Period 3Jan06 to 6Jul07 9Jul07-21Nov07Correlation 0.3654 0.5886
Trading day*Move in the different direction 135 (38.68%) 26 (28.57%)Move in the same direction 214 (61.32%) 65 (71.43%)Total 349 91*Days when either A-shares or H-shares are traded.
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R(AHA)-R(AHH)
-10.00-8.00-6.00-4.00-2.00
-2.004.006.008.00
10.00
Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07
AH (A) and AH (H) Indexes – Relative Movement
ReturnAH(A) – ReturnAH(H)Back-testing Period
(3 Jan 2006 – 6 Jul 2007)Live Period
(9 Jul – 21 Nov 2007)
Average: 1.68 p.p.# of Trading Days: 181
Average: - 1.60 p.p.# of Trading Days: 168
Outperformance
Underperformance
Average: 1.85 p.p.# of Trading Days: 53
Average: - 1.90 p.p.# of Trading Days: 38
14-15.00
-10.00
-5.00
-
5.00
10.00
15.00
Jan-06 A pr-06 Ju l-06 O ct-06 Jan-07 Apr-07 Ju l-07 O ct-07
Dai
ly P
oint
Cha
nge
9 /7 /20
80
100
120
140
160
180
200
Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07
HSAHPI
Hang Seng China AH Premium Index (“AHPI”)
Premium Index
AHPI Daily Point Change
Period I (Back-testing)(3 Jan 2006 – 6 Jul 2007)
Period II (Live)(9 Jul – 21 Nov 2007)
Period I Period II
Maximum 10.46 8.89 Minimum -9.55 -8.83 Average of absolute changes 1.93 3.04
No. of days premium increase 188 56No. of days premium decrease 195 41No. of days unchanged 1 0
Average of premium increase 2.08 2.95 Average of premium decrease -1.80 -3.17
15
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07
AH(H) IndexHSCEI (rebased)
AH (H) vs HSCEI
×= 246# Annualised Volatility Standard Deviation of [ln (Price t)-ln (Price t-1)]
From 3 Jan 2006 to 21 Nov 2007
Correlation: 89.07%
% Change
1 month 3 months 6 months 1 yearSince 3 Jan 06
AH(H) Index 2624.06 -18.61 25.72 41.89 89.17 162.41 29.55HSCEI 15993.50 -18.91 29.94 46.92 92.11 195.47 29.48
Index Index Level # Annualised Volatility (%)
16
500
1,500
2,500
3,500
4,500
5,500
6,500
Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07
AH(A) IndexSSE50 (rebased)
AH (A) vs SSE 50
×= 246# Annualised Volatility Standard Deviation of [ln (Price t)-ln (Price t-1)]
From 3 Jan 2006 to 21 Nov 2007
Correlation: 90.11%
% Change
1 month 3 months 6 months 1 yearSince 3 Jan 06
AH(A) Index 4242.28 -7.32 19.35 57.45 174.90 321.17 32.21SSE50 4064.78 -9.56 4.13 41.92 195.27 400.22 29.75
Index Index Level # Annualised Volatility (%)
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Hedging the RiskHedging the RiskHedging the Risk
or Arbitraging the Differenceor Arbitraging the Differenceor Arbitraging the Difference
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Hang Seng China AH Index Series
Hang Seng China AHPremium Index
恒生AH股溢價指數
Hang Seng China AH(A) Index
恒生AH股A指數
Hang Seng China AH(H) Index
恒生AH股H指數
Hang Seng China AH(A+H) Index
恒生AH股A+H指數
Hang Seng China AH Index Series恒生AH指數系列
USD
CNY HKD
Same constituents for these 4 indexes
19
Hang Seng China AH Premium Index (“AHPI”)
Objectives
To provide market with a simple and easy-to-use barometer to gauge such a premium (or discount)
Measurement
To measure the “average” price premium or discount of A shares over H shares, weighted by freefloat market cap
20
AHPI - Calculation Methodology
Formula
Index = x 100Valuation of constituents based on A-share priceValuation of constituents based on H-share price
= x 100Freefloat number of shares (A+H) x H-share priceFreefloat number of shares (A+H) x A-share price
100
Premium Index
A shares at a discount A shares at a premium
21
Hang Seng China AH Price Indexes
Hang Seng China AH(A) Index
恒生AH股A指数
Hang Seng China AH(H) Index
恒生AH股H指数
Hang Seng China AH(A+H) Index
恒生AH股A+H指数
Same constituents, same weightingsShow purely price effect
USD
CNY HKD
22
Freefloat market cap weighted index
15% capping on individual company’s weighting in the A+H Index
AH Price Indexes - Calculation Methodology
Synchronised weightings from A+H Index to A Index and H Indexevery month
23
AH (A) Index / AH (H) Index – Illustration
100.0Total
39.3Others
8.9Company E
9.6Company D
12.5Company C
14.7Company B
15.0Company A
AH (A+H) Index
% Weighting in
Monthly Rebalance
Index weightings will be synchronise every month:
To reflect purely price effect
Similar to measuring prices of the same basket of products in different countries
100.0
39.3
8.9
9.6
12.5
14.7
15.0
AH (A) Index
% Weighting in
100.0
39.3
8.9
9.6
12.5
14.7
15.0
AH (H) Index
% Weighting in
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The Dynamics of the AH market
A shares Price
H shares Price
H Share Company Return
Red-chip Return
Index Futures?
Global Market
Sentiment, Liquidity
QDII
Individual Investors
Insurance Company
Invest Companies
25
Profit Opportunity
100
120
140
160
180
2007 2008 2009 2010 2011 2012
A / HPrice Ratio (%)
100
120
140
160
180
A / HPrice Ratio (%)
1 Year3 Year5 Year
Annualised Rtn:9.86%
Annualised Rtn:16.96%
Annualised Rtn:60.00%
Current A-share Premium at about 60%
If the A/H price differential is to diminish and return to the par level, an investor might be able to make profit at a return rate:
26
Hedging Strategy (I)
168.58200100
Directional Bet
(21 Nov 2007)
A shares Underperformance
AHPI will fall
A shares Outperformance
AHPI will rise
27
Hedging Strategy (II)
Non-Directional Play
(21 Nov 2007)168.58AHPI
263.74 Air China
265.12 Tianjin Capital
276.15 Beijing N Star
278.01 Jiangxi Copper
305.26 China South Air
A/H Price Ratio (%)AH Index Constituents
116.53 Anhui Conch
126.37 CM Bank
136.28 Bankcomm
141.00 Tsingtao Brew
141.86 Jiangsu Express
A shares Underperform
for High A/H Price Ratio
A shares Outperform for Low A/H Price
Ratio
28
The AH Products
Can any products be structured using the indexes to meet market demand?
Can market demand be created?Identifying investors who want to long AHPI as well as those who want to short
29
The Challenges
Any strategy needs to be played across two markets
A-share market is not a totally free market for foreign investors
A-share market cannot be shorted, for nowWill A-share Index Futures be launched soon?
30
The Opportunity
Can a strategy be formed to play just in the H-share market?
e.g. just H shares of the AH Index constituents according to the AH Price Ratio
Can a Mainland partner be found who can play freely (at least on the long side) in the A-share market?
31
HSI Services Limited
http://www.hsi.com.hk
(852) 2877-0704Contact No:
22/F, Hang Seng Bank Headquarters,83 Des Voeux Road Central, CentralHong Kong
Address: