H shares merit right of abode in HSI
Some unlucky Hang Seng Index (HSI) constituents could find themselves demoted from Hong Kong's flagship index soon - not due to some Lunar New Year monkey business but because of the quarterly review by index kingmaker HSI Services.
The perks of elevation for those chosen to be among the select 33 members of the blue-chip index include a higher profile and often a higher share price as index tracker funds have to own them. But one group of companies can forget this beauty parade. H shares, the darlings of the market last year, are deemed too foreign for inclusion.
Although everyone seemed happy with the fat fees and first-day profits generated by recent H-share offerings, that will not get them an invitation to the top table.
Instead, H shares (state-owned companies incorporated in China) have their own index, the Hang Seng China Enterprises Index. Promotion to the HSI is deemed a non-starter due to the classes of A shares in China and the non-tradeable block of shares held by the state.
Rules may be rules but it still seems counter-intuitive that China's largest state-owned mobile phone company, China Mobile, can make it into the HSI, while its largest fixed-line carrier, China Telecom, cannot.
Here, right of abode depends on where you are incorporated, not where your business and profits are earned. As such, China Mobile and China Unicom are naturalised red chips, not H shares. But despite what their prospectuses say, they are cut from the same cloth.
Is the 75 per cent held by the mainland government in China Mobile really any more tradeable than the 75 per cent it holds in China Telecom?
H share China Telecom's market capitalisation, based only on listed stock, adds up to a mere $25 billion, slightly smaller than Hong Kong's PCCW and dwarfed by China Mobile's more than $500 billion. But PetroChina's $66 billion capitalisation figure would grow tenfold if unlisted shares were counted, bigger than that of even China Mobile.
These inconsistencies also undermine the ability of the HSI to represent the broader market. While the 33 constituents are required to account for more than 70 per cent of the market's total capitalisation, H shares are omitted from this calculation. Their weighting - 7 per cent to 8 per cent - is inevitably understated.
HSI Services concedes the dilemma over H shares' representation would be less troubling under a free-float weighted index. This is the route Morgan Stanley Capital International indices have gone down and even Japan's Topix Index is considering. The compilers, however, remain unconvinced, only testing the water with some secondary free-float-based indices, not the benchmark HSI.
Given China's plans to list its Big Four state-owned banks, the puzzle of the missing H shares will only become more prominent.
But the HSI is nowadays used more by futures traders than as a benchmark for serious investors and HSBC, which ultimately owns the compiler, is no doubt quite happy with the status quo. After all, it comprises a third of the index's value - 37 per cent if you tag on subsidiary Hang Seng Bank.
Looking forward, it is the bigger inconsistencies in the HSI methodologies that will push H shares to get the recognition, or at least the representation, they deserve.
