Introduction

In recent times, numerous established Chinese technology giants such as Alibaba (HKEx: 9988), JD.com (HKEx: 9618) and Netease (HKEx: 9999) have filed for secondary IPO in Hong Kong Exchange (HKEx) to raise capital. The move also helps to provide a safety net against the potential delisting of Chinese stocks from U.S. exchanges.

In addition, it is expected that more foreign-listed Chinese companies or “unicorns”, privately-held start-up firms valued at more than USD1 billion, will return or begin to file for IPO in Hong Kong, Shanghai and Shenzhen exchanges.

The secondary and new listings of Chinese technology companies have bolstered the financial market in Hong Kong, which was shaken by months of anti-government protests in 2019.

The listings of technology companies on HKEx have led to the launch of the Hang Seng TECH Index on 27 July 2020. The new index will have a technology-focused exposure as compared to the “old economy” stocks represented in the Hang Seng Index.

As such, many believe that the Hang Seng TECH Index will be the flagship index for the technology sector in Asia.

Methodology of the Hang Seng TECH Index

Technology and growth stocks tend to have higher volatility than traditional large cap stocks. The Hang Seng TECH Index helps to reduce the volatility through diversification, and provides access to the growth potential of technology stocks.

Below are the three beneficial features and reasons to invest in the Hang Seng TECH Index:

1. Diversification

The Hang Seng TECH Index comprises 30 of the largest Hong Kong-listed companies with high business exposure to technology themes. It contains companies from five different sectors; industrials, consumer discretionary, healthcare, financial, and information technology.

A 8% cap is applied on individual securities to avoid overweighting any single stock in the index. This problem is especially prominent in the top-heavy S&P 500 index, which is dominated by Facebook (FB), Amazon (AMZN), Apple (AAPL), Microsoft (MSFT), and Alphabet (GOOG) (formerly known as Google), collectively known as the FAANG stocks. The top five stocks in the index encompass more than 20% weightage in a portfolio of 500 U.S.companies. Hence, the cap on individual security weighting in the Hang Seng TECH Index helps to prevent over exposure to any particular company.

2. Growth Potential

Unlike traditional technology indexes, the Hang Seng TECH Index is a thematic index with diversified coverage in technological themes such as Internet (including Mobile), FinTech, Cloud Computing, E-commerce and Digital Activities.

These themes currently occupy the early stages in the Technology S-Curve and can provide higher growth potential than an ageing sector.

Figure 1:
An Illustration of the S-Curve (Orange Line) and Rogers Adoption Curve (Bell Curve)

Besides having business exposure to the themes mentioned earlier, technology companies must also meet at least one of the below criteria for inclusion into the Hang Seng TECH Index.

1. Technology-enabled business model delivered via the Internet or Mobile platform
2. R&D Expense to Revenue Ratio of more than or equal 5%
3. Year-on-Year Revenue Growth of more than or equal 10%

The stringent screening measures ensure that the companies included in the index boast strong fundamentals and tremendous growth potential.

3. IPO Fast Entry

The Hang Seng TECH Index has a unique IPO fast entry mechanism to prepare for the homecoming of foreign-listed Chinese companies and the new listing of Chinese “unicorns” in HKEx. The rule enables sizable newly listed technology companies to be included in the index in a timely manner without the need to wait until the quarterly review.

The newly listed security will be added to the index if its full market capitalisation ranks within the top 10 holdings of the existing constituents on its first trading day.

With this mechanism in place, the index will be able to capture potential investment appreciation opportunities brought about by the listing of Chinese concept stocks in HKEx. To illustrate, JD.com and Netease have joined the index via the fast entry mechanism.

China has the world’s largest number of “unicorns” with Ant Financial topping the list at a valuation of USD 150 billion.¹ The possibility of these start-ups listing in HKEx has the potential to further boost the Hang Seng TECH Index.

It is believed that under the prevailing listing trend of Chinese” unicorns”, the index will enjoy even greater room for growth.

Exchange Traded Funds

Investors can gain exposure to the Hang Seng TECH Index by buying its selected component stocks. However, there is a minimum lot size for each stock ticker listed in HKEx and the investment amount can be substantial for investors using this tactic.

For example, it will cost investors more than HKD 100,000 / USD 13,000 just to invest in one lot for each of the top five constituents in the index.

A more cost-effective solution is to utilise Exchange Traded Funds (ETFs) as investment vehicle. There are several ETFs listed in HKEx that tracks the Hang Seng TECH Index and the minimum investment amount can be as low as a few thousand HKD.

The ETFs will also be rebalanced on a quarterly basis and/or whenever a new stock listing qualifies for inclusion under the IPO Fast Entry mechanism. The management fees and transaction costs are already factored into the Total Expense Ratio of the ETFs, which save time and costs for investors.

ETF information is accurate as of 8 September 2020.

Conclusion

China has emerged on the world stage with a number of tech companies. However, there are over 200 Chinese “unicorns” that are yet to be publicly-listed in exchanges. The rising U.S.-China tension will inevitably cause these privately-held companies to seek listing in HKEx and China exchanges.

The increasing number of potential IPO in HKEx featuring tech “unicorns” can uplift HKEx’s offerings and enhance the Hang Seng TECH Index.

Investors can capture the diversification benefit and growth potential of Hang Seng TECH Index via the ETFs that track the index.

Reference:

• ^[1] https://www.bbc.com/news/business-50134460

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