CESC: there is no Holy Grail when it comes to index investing
In the second part of an interview, Mao Zhirong (pictured), chief executive of China Exchanges Services Company Limited (CESC) and co-head of HKEx’s Mainland division, spoke to SRP about the opportunities around index-linked investments and CESC’s plans to become a provider and innovator of market access products featuring HKEx, the Shanghai Stock Exchange and the Shenzhen Stock Exchange.
What opportunities that can be pursued by index, ETF and structured product providers in the Asia Pacific region?
I am glad we are speaking on this now. It is an ideal time in view of the stellar performance of both the A-share and Hong Kong stockmarkets in the past month or so. Our conversation would have been very different at an earlier time in terms of the available opportunities.
Every client we have approached loved the idea – in light of the much widened investment universe created by the unprecedented connectivity.
Because of the capital netting arrangement the trading activity is in a sense not limited by the daily quota of the northbound and southbound route. In theory the actual transfer of capital can be very minimal compared with the notional size of total spot transactions through the scheme, thereby allowing more products to develop based on the very sizable pool that can be deployed.
The strong infrastructure of HKEx and the Shanghai Stock Exchange has supported transparency, price discovery, and efficiency of order flow into and out of China.
There are several opportunities to highlight. First, market players started looking at index futures products on both sides for hedging purposes amid a stronger need to insure against potential market corrections.
Second, as more underlying stocks become available, it makes it easier to develop a whole range of products including derivatives, ETFs and other synthetic instruments referenced to the eligible shares, with more transactions now being settled by physical delivery through the clearing houses in both Hong Kong and Shanghai.
Fund managers also began to explore actively managed non-ETF fund products that seek to generate alpha rather than tracking broad market performance as seen in the pre-SHSC time. Onshore asset managers can now access overseas underlyings through SHSC in addition to their QDII quota.
In sum the benefits to market participants would be the expansion of the whole investable universe and investor base, and along with it a new breed of index products.
Given the wide range of instruments out there offering exposure to the connectivity theme, what do you reckon as the best index strategy in the current atmosphere?
There is no such thing as the Holy Grail when it comes to index investing. The question is how each instrument can be best utilized by investors under different market scenarios.
At the fundamental core of investment there is the underlying asset, whether it is a stock, a bond or any other conventional asset. Then an index can be compiled to represent and mimic the performance of a group of such underlying assets using a variety of methodologies. Finally, there is a whole new array of products which are derived from the usage of that index and offer various payoff structures.
Having said that, we are operating at the second level here and are therefore closer to the underlyings, which should be of more relevance to product performance. Anyone from third level onwards, be it asset managers or structurers, is more distinct by default so they create even more customized payoff profiles deriving from the indices. Complexity and hence uncertainty will go up as we move away from the core underlyings.
However, I do believe all index products are designed to make reasonable return relative to their risks despite vast differences in their focus, strategy and methodology. The same goes for alternative index strategies such as risk premia and smart beta, which apparently have their own merits and supporters.
A definite conclusion we can draw is that we will be having more diversity of products in the pipeline with greater connectivity and that product innovation will come at a much faster pace that most people would anticipate.
Do you think the connectivity program also mirrors the call for greater technology integration currently taking place in structured products arena with the recent setup of a number of multi-issuer platforms? In what way will it affect the future buyer-seller relationship?
Definitely this is happening as we speak. Without referencing to the specifics of the trading platforms you mentioned, my understanding is that all platforms more or less share the same attributes such as openness and connectivity. In this regard SHSC can be seen as an integrated platform from its roles in connecting the investors, investment ideas and investment products across the border.
What we are experiencing in the context of securities trading is that more and more end customers, namely the buy side, are actively seeking choices in the form of new investment opportunities, accessible at the right time and at the right prices; so the emergence of a platform is a natural answer to such a need.
I believe with greater usage frequency of the SHSC platform itself, as demonstrated by the robust market turnover in both Hong Kong and Shanghai, will lead to even better market quality and eventually wider user acceptance - that in turn will generate more demand for products that are traded on the platform.
Any kind of platforms fundamentally require the connection of people - whether they are from the service providing or service receiving side - to be economically viable and in the end market forces will determine what is to be offered and in what format.
What would be the future plan(s) for CESC in terms of product and service development?
Being in a strategic position as an index provider representing the three exchanges, we are lucky enough to be the center of all the actions and market developments.
Our future plan would be to consolidate our current product line-up, particularly the two SHSC-themed indices, and market them to our institutional clients while looking into new product ideas and building on the success of our flagship products.
We will continue to enhance our relationship with the investment community, including ETF and structured product providers. Going forward CESC will position itself as a provider and innovator of market access products featuring the three exchanges in much the same way as Hong Kong is serving as a financial gateway into and out of China.
Shanghai-HK Stock Connect prompts growth in index strategies