A sector-balanced approach to manage risk in China portfolios
Apr 4, 2022
Co-Head of Equities Product Development, Markets, HKEX

While China’s economic transformation is creating immense opportunities, it also presents challenges to investors who seek to capture China’s dynamically changing growth drivers. This necessitates investment benchmarks and risk management tools that can offer a balanced representation of China’s shifting economy. With this in view, HKEX launched the MSCI China A 50 Connect (USD) Index Futures in October 2021. The debut has drawn encouraging response and several ETFs listed on the same underlying index had attracted great investor interest. 


Unfulfilled demand in A-share risk management

China’s capital market opening and the launch of HKEX’s Stock Connect program have been facilitating strong foreign inflows into A-shares in recent years. Foreign ownership in the A-share market has seen consecutive years of growth and by end-2021, the amount of foreign-owned A-shares has surpassed RMB 3.94 trillion. Despite strong foreign inflows, the choices of offshore A-share hedging tools had been limited. Before the launch of HKEX’s A-share futures, there were only one offshore A-share futures contract available to foreign investors. Since the underlying index of that alternative contract is biased towards financials and consumer staples, it may not be an effective hedging instrument for diversified A-share portfolios. 

Another A-share hedging solution is onshore index futures. However, the accessibility of onshore futures is limited to qualified institutional investors. The lack of a broad-based offshore A-share risk management tool leaves a yawning gap between the surging investor interest in China equity and foreign investors’ ability to hedge. 

Consequently, HKEX launched Hong Kong’s first A-share futures contract – the MSCI China A 50 Connect (USD) Index Futures in October 2021, providing international investors with a new offshore A-share risk management tool with a balanced representation of China’s various industries. In February 2022, the average daily volume and open interest of the new product increased to 23,519 contracts (equivalent to a notional value of USD 1.5 billion) and 27,777 contracts (USD 1.8 billion) respectively, and its single-day trading volume reached a record high of 65,682 contracts on 16 February 2022. 

Growing liquidity in the contract is contributing to spread tightening. The average spread of the spot contract during T session narrowed from 3.5 bps in October to around 2.0 bps in December 2021, which can help investors lower transaction cost. 

A broadening investor base that includes hedge funds, asset managers and proprietary traders suggests a wide applicability of the new A-share futures. Investors can use the product for managing systematic risks in the A-share market or as a core part of their China allocation. Some financial institutions also use the new futures for proprietary and arbitrage trading.


The start of the MSCI China A 50 product suite

The MSCI China A 50 Connect Index marks the beginning of a new product ecosystem with a number of issuers in the Mainland, Hong Kong and the US launching ETFs based on it. Among the newly listed ETFs, the Mainland ones traded more than RMB 10 billion on the first trading day while the market cap of the three Hong Kong-listed surpassed HKD 3 billion just three weeks after launch. With the unique feature of sector neutrality, the MSCI China A 50 Connect Index is set to create a product ecosystem that has its own niche. 

In summary, demand has been growing for a sector-balanced A-share benchmark that can extensively cover China’s economic sectors. HKEX’s MSCI China A 50 Connect (USD) Index Futures contract is introduced to meet the risk management demand of China-bound investors; this tool will only become more important as international investors pursue more diversified asset allocation in their China portfolios.

Similar to all investments, futures products involve risks and A-share futures are closely associated with the risks of China’s stock market. Investors should understand the risks involved before entering into any futures contracts.


Credits: Content based on an article published in HKET on 21 February 2022