Hanergy's share plunge highlights flaws in index-tracking stock funds

The blistering sell-off in mainland solar firm Hanergy Thin Film Power this week burned several index-tracking stock funds, exposing the flaws in such investment structures, especially in volatile markets like China.

Late on Thursday, one prominent fund announced changes to the index it tracked following Hanergy's almost 50 per cent tumble, suggesting other funds could follow suit and raising more worries for investors who were trapped when trading in the shares was halted on Wednesday.

Guggenheim Investments, which manages about US$200 billion, said the MAC Global Solar Energy Index tracked by its solar exchange-traded fund (ETF) was dropping Hanergy as a constituent, meaning the fund will have to sell its holdings of the mainland firm when shares resume trading.

Critics of ETFs, which mostly track indices passively, say that while such products generally offer more liquidity than traditional funds, they are sometimes prone to illiquidity risks and redemption pressures, especially when a big component in their underlying basket of shares faces a trading halt.

That's especially applicable to the mainland markets, where ETFs have emerged as a popular investment tool. Mainland-focused equity ETF and index assets under management grew more than 75 per cent to US$132 billion in the five years to the end of March.

Over the same period, assets of actively managed mainland focused stock funds shrank 12 per cent to US$199 billion.