HSI Services tells industry of favoured method arising from consultations as benchmark looks to admit China heavyweights HSI Services, which manages the Hang Seng Index, is likely to adopt a method that measures the free-float level of stocks when it revises the index to include mainland companies, market watchers say. HSI Services told fund managers, analysts, and brokerage representatives in two consultation sessions last week that the free-float, market-weighted method with a weighting cap on each stock was the most popular of the three proposed options, sources said. In such an index, each stock is weighted by the portion of shares readily available for trading in the market. This excludes shares held by the company, its directors, strategic investors and other companies in which it also owns shares. 'Unless the Hong Kong Tracker Fund opposes this approach, I think the index compiler is very likely to adopt it,' said China Everbright analyst Wong Chi-man. 'This approach can tackle the issue of investibility, which is particularly important for H shares that have a majority of shares held by its major shareholders.' Mr Wong said that as a large chunk of shares in the mainland firms were held by state-owned majority shareholders and could not be traded, their share prices could be subject to substantial swings arising from index-related trading if their weightings were measured by market value only. HSI Services also suggested two other systems - the currently used market-weighted and the modified market-weighted method with cap - to calculate the eligibility for the Hang Seng Index inclusion. However, market watchers said the newly developed approach was too complex. According to HSI Services' consultation document, 17 stocks were eligible for inclusion in the blue-chip index as of May 19. These include China Construction Bank, Huaneng Power International, Yanzhou Coal, Jiangxi Copper, China Shipping Development, Angang New Steel and Anhui Conch Cement. Ernie Hon, an analyst at ICEA Securities, said the free-float method with a weighting cap, probably at 15 per cent, was more feasible as it was easy to apply and could address the issue of state-owned shares. Moreover, this method is used by other index compilers such as Morgan Stanley Capital International and FTSE. Mr Hon said that the index would become more volatile with the change as fund managers would need to adjust their portfolios. However, gradual implementation would ensure that the impact was not 'disastrous', he said. Analysts said weightings of the biggest stocks in the Hang Seng Index, including HSBC Holdings and China Mobile, would probably be reduced substantially under the free-float approach. According to BNP Paribas, HSBC's weighting would decrease to the cap that HSI Services sets for the index, varying from 10, 15 and 20 per cent, while China Mobile's would decrease to below 10 per cent. The two stocks now account for about half of the index's total weightings. 'Switching to free float has been a trend for all global indices, as it only takes into consideration the proportion of shares that can be invested by the market,' BNP Paribas analyst Winner Lee said in a report. 'We favour a 20 per cent cap, as it would prevent an overly dramatic cut in HSBC's weighting as well as its dominance of the financial sector when more China banks become possible candidates after their [initial public offerings].' Analysts said China Construction Bank, if included in the index, might account for about 10 per cent while Lenovo Group and Johnson Electric Holdings would suffer most. Cheung Kong Infrastructure is likely to be removed from the index under the free-float approach. People attending the consultation sessions were told that the representative of State Street Global Advisors, the management company of the Tracker Fund, did not make any comments. State Street Global Advisors could not be reached for comment. 'The index compiler told us the chance of making no change is slim. Therefore, I think the chance we are going to see the index changing towards the free-float weighted approach is high,' said a source who was at Monday's meeting. The consultation will last until Thursday and the final decision will be announced by the end of the month. HSI Services' general manager Vincent Kwan said he did not expect a market consensus and declined to comment on the responses so far.'
