Hong Kong’s Hang Seng Index Had a Makeover—Then the Market Got Ugly

Hong Kong’s 50-year-old stock market benchmark has fallen victim to poor market timing.

The index’s poor performance is partly due to a review of its constituent stocks that began last year.

Prior to 2021, the benchmark consisted primarily of financial, information technology, real estate, and consumer stocks. When a major internet and tech stock rally in 2020 led to big gains in markets in Japan, South Korea and the US, the Hang Seng Index significantly underperformed most of its regional peers.

The aim of the revision – which is ongoing – was to make the index more representative of the broader Hong Kong market, which is now dominated by mainland China companies.

Hang Seng Indexes Co., the index’s compiler, has made sweeping changes, including increasing the number of components from the current 55 to 73; the end goal is 100 shares. It has also reduced the importance of individual stocks, reduced the time a company must list before it can be included in the index, and put additional strain on industry selection.

That gave a greater exposure to Chinese tech companies, including internet giant Alibaba Group Holding GmbH.

and Meituan.

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But while the Hang Seng index added Chinese new economy stocks, regulators in Beijing began a sweeping crackdown on the country’s domestic high-growth tech giants, prompting a massive sell-off. Alibaba and Meituan, which now make up 7.3% and 7.4% of the benchmark, respectively, have both lost more than half their value since increasing their weighting in the index from 5%.

Tech stocks are among the worst performers this year; a separate 30-stock benchmark called the Hang Seng Tech Index is down 44%. Financials, whose weights were reduced during the index’s overhaul, have also fallen, but by far less.

“Unfortunately, the Hang Seng index suffered a penalty…when it included more new economy stocks and technology constituents,” said Bruce Pang, chief China economist at Jones Lang LaSalle.

China has also been trying to eradicate Covid-19 since the beginning of the pandemic. It has adhered to a strict zero-Covid policy. The country closed its borders and enforced strict restrictions on movement to stop the spread of the coronavirus, locking down major cities for months.

As a result, China’s economic growth has slowed significantly this year as consumer and business confidence plummeted. The country’s housing market is also in a deep slump, dragging Hong Kong-listed shares of many Chinese real estate developers lower.

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“Investor confidence in China is currently very low. People have lost faith in Chinese companies,” said Pruksa Iamthongthong, an Abrdn portfolio manager at the company’s Asia Dragon Trust, a fund that holds some Chinese stocks. She said she expects the market to recover when there are clearer signs of economic improvement in China, as well as policies that benefit mainland companies.

The aggregate value of all publicly traded shares in Hong Kong has more than doubled over the past 11 years, despite the city’s benchmark index returning to where it was in October 2011. That’s largely due to a large increase in listed companies, according to stock exchange operator Hong Kong Exchanges & Clearing, from 1,326 at the end of 2011 to 2,581 last month GmbH.

“In terms of the value of constituents, there was a total mismatch between the Hang Seng index and Hong Kong’s market capitalization,” said Andy Maynard, head of equities at China Renaissance Holdings, a Chinese securities firm.

Chinese companies now account for almost 77% of Hong Kong’s total market value, up from 57% a decade ago, according to the bourse.

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“The growth in market capitalization in the Hong Kong market has been driven by its ability to raise capital for more companies rather than rising share prices,” said Redmond Wong, market strategist at Saxo Capital Markets.

Many market participants are hoping that the Chinese Communist Party’s 20th National Congress, which begins on Sunday, will provide a catalyst for a stock market recovery. Held twice in a decade, the conclave will outline China’s economic and other policies for the next five years.

Beijing is unlikely to further tighten its regulatory scrutiny of Chinese tech giants as it seeks to combat an economic slowdown and tensions with the US. That should make Chinese tech stocks more attractive to investors.

But Hong Kong-listed Chinese stocks are likely to remain at the mercy of US Federal Reserve speculation on rate hikes. That will be the main driver for all stock markets, not just the Hang Seng index, said Louisa Fok, China equity strategist at Bank of Singapore.

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