Economy, Talking Point

Soon to reach 100

New entrants to the HSI reinforce the view it’s become a China index

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Drugs made by Hansoh Pharmaceutical, one of the four new entrants added to the Hang Seng Index

The Hang Seng Index (HSI) stands out as “the ultimate capitalist measure of Hong Kong,” wrote Robert Nield, president of the Royal Asiatic Society’s Hong Kong branch, in his foreword to The Dragon and the Crown, the memoir of the benchmark’s creator Stanley Kwan.

Kwan served as a wartime interpreter for American troops in China before joining Hang Seng Bank as a researcher. In the late 1960s the Hong Kong lender’s chairman Ho Sin Hang decided the bank needed to create a measure of the performance of the local stock market for investor reference. He instructed Kwan to devise “the Dow Jones Industrial Average of Hong Kong”.

One of the major challenges, Kwan recalled, was that any stock selected for the HSI would immediately be considered as ‘blue-chip’ quality – meaning that all the executives of Hong Kong’s larger listed firms lobbied hard to be included. This put Ho in a bind as the veteran banker did not want to upset any of his relationships with local business bosses. It also meant that the debate on the selection process went on for some time, with some city newspapers dismissing the HSI as “the Old Pal Index”.

With less than 100 firms listed on the local bourse, Kwan chose 33 companies as the constituent stocks. The HSI made its debut on November 24, 1969. For decades the number of blue chips would stay the same until 2007, when H-shares, or companies incorporated in mainland China and traded in Hong Kong, were made eligible for inclusion.

The number of ‘blue chips’ in the HSI has now reached 73 and membership is expected to increase to more than 100 choices in a few years time. It’s often suggested that changes in the HSI reflect the social and economic transformation of Hong Kong over the last 50 years. But is the HSI still the best expression of Hong Kong’s commercial vigour? Or, as its creator’s personal journey also once seemed to suggest, is the index now much better defined by the much larger ‘dragon’ of mainland China?

Step forward the HSI newcomers

Following the latest quarterly review from compiler Hang Seng Indexes Company (HSIC), four new firms will join the benchmark next week, bringing the total number of constituents to 73.

Each of the newcomers are Chinese firms or have a heavy business focus on the mainland market. State-owned energy conglomerate China Shenhua will regain blue-chip status, after being ousted from the index two years ago, for instance. The share price of China’s biggest coal producer has climbed nearly 50% over the past 12 months, helped by the wider energy crisis created by the war in Ukraine. Its market value is now more than HK$660 billion ($85 billion) or twice the combined value of CLP (formerly known as China Light & Power) and HK & China Gas, two local utility firms that have stood the test of time as Hong Kong-based blue chips since the HSI’s inception in 1969.

Baidu also becomes the final member of China’s much-heralded BAT internet trio to be embraced by the Hong Kong bourse. Having completed a secondary listing in the city in March last year, it joins its rivals Alibaba and Tencent in Hong Kong’s HSI blue-chip family. At HK$343 billion, it is some way back on the market value of Alibaba (HK$2 trillion) and Tencent (HK$3.2 trillion), although local newspapers reckon that heavy investment in areas such as AI and quantum computing might help Baidu to narrow the gap.

Healthcare and biotech is another fast-growing sector for stocks listed in Hong Kong, although the volatile performance of Hansoh Pharmaceutical might diminish its appeal among more conservative fund managers. The company’s market capitalisation tripled to nearly HK$300 billion in the six months after its Hong Kong debut in June 2019 but then dipped to about HK$90 billion more recently.

Hansoh is China’s largest psychotropic drug seller (see WiC457). It was founded in 1995 by Zhong Huijuan, its 61 year-old chairperson, and her Cambridge-trained daughter Sun Yuan, who now serves as company CEO. Zhong’s husband Sun Piaoyang is known as ‘China’s pharmaceutical king’, and he controls Hengrui, the most valuable pharma firm in the A-share market (see WiC554 for one of our more recent reports on the group).

The last of the new quartet joining the HSI is Chow Tai Fook, a gold and jewellery retailer, and also a sister company of fellow Hong Kong-based blue chip New World Development.

The group is controlled by the Cheng clan, one of the handful of wealthy families that have dominated Hong Kong’s local economy, including its property market, since the 1970s. Chow Tai Fook’s inclusion adds a sense of ‘local flavour’ to the benchmark index, although the impression can be misleading. As of the end of December, 98% of the retailer’s 5,765 outlets were located in mainland China.

How has the HSI changed over the decades?

New World – the company controlled by the same family as Chow Tai Fook – was first added to the HSI in March 1973. A few years later it was joined by other fast-growing real estate developers, including Cheung Kong, SHK Properties and Henderson Land.

At the time, the real estate counters were largely displacing long-established transport firms in the pecking order, such as Star Ferry, Hong Kong Tramways and Kowloon Motor Bus. The theme was that the British colony was transforming into one of the world’s most property-obsessed cities. It also underlined the start of a shift in the local political scene. As China began talks in the 1970s with the British government over Hong Kong’s post-1997 sovereignty, local property tycoons – sometimes perceived as ‘patriots’ by Beijing’s leaders – would gradually replace the taipan bosses of the British trading houses, or hongs, as the most influential businesspeople in the territory.

Hutchison, most notably, was acquired by Cheung Kong in 1979. The deal paved the way for Cheung Kong’s founder Li Ka-shing, previously a plastic flower maker, to become Hong Kong’s richest man. Jardine Matheson and Hongkong Land, two of the most valuable blue chips at the time, would soon relocate to Singapore. Swire Pacific, which had emerged from the businesses founded over many decades by the Swire family, chose to hang around, however. Indeed, the British hong and original HSI blue chip only departed the index after a quarterly review late last year.

The eventual inclusion of Chinese firms in the HSI now looks something of an inevitability, of course, given the rapid growth of the Chinese economy since the launch of economic reforms nearly half a century ago. An early pacesetter was Citic Pacific, a unit of the state-owned conglomerate set up to spearhead changes in China’s economy, which was included in the HSI in 1992 after investing in sizeable stakes in other British-controlled blue chips such as Cathay Pacific and Hongkong Telecom.

Two years later it was joined by Guangdong Investment, a ‘window SOE’ (state-owned enterprise) controlled by the provincial government of Guangdong, and then by China Resources, another SOE that reported directly to the State Council.

After the handover of Hong Kong’s sovereignty in 1997, red chips (including China Mobile and CNOOC) started to feature more in the HSI at the expense of lesser property counters (such as Hopewell, Great Eagle and Shangri-La). Red chips like these were defined as Chinese firms that had registered as businesses offshore to facilitate sales of their shares to investors outside China. Then in 2007 it was time for H-shares, or SOEs incorporated in the mainland and listed in Hong Kong, to be made eligible for HSI inclusion. That really changed the game for the benchmark, with an influx of new heavyweights such as banking giant ICBC. The index manager HSIC also decided to lift the unofficial cap on the number of blue chips, and expanded the HSI’s membership to 43 within 12 months.

Another major change was introduced in 2018 when Hong Kong regulators began to accept listing applications from companies with multiple classes of shares, or weighted voting rights. These dual-class shareholding structures are common among Chinese tech firms and prior to the amendment the Hong Kong Stock Exchange was missing out on lucrative IPOs, including that of Alibaba in 2014, to the exchanges in New York.

What’s going to change now?

Trading programmes such as Stock Connect, which allows mainland investors to buy Hong Kong stocks, and Hong Kong investors to do the same for designated companies in China, have pulled the two markets closer together than ever before. And in another attempt to keep the HSI as “the most representative and important benchmark” of the Hong Kong stock market, its compiler announced another review in March last year. The target was to have at least 80 constituents by mid-2022 and, ultimately, to fix the number at 100 (see WiC530).

The problem with the changes, say some local investors, is that Hong Kong firms are going to make up an ever-smaller share of the benchmark, even though the HSIC is promising to protect the biggest Hong Kong’s companies with provisions that 20 to 25 of them must stay in the index. HSIC will review the number of local blue chips every two years but the commercial realities mean that there aren’t likely to be many new homeborn candidates for inclusion. As long-time WiC readers will know, Hong Kong’s property prices – and small population – has meant the city is hardly fertile ground for start-ups to grow to blue-chip scale. Outside of the property sector, the territory hasn’t produced a new corporate heavyweight for decades.

Even after the four new entrants join the HSI next week it will still be seven short on the plan to boost its membership to 80 by June – not to mention the ultimate goal of 100 companies in the group. The HSIC says it has no rigid timetable for the revamp proposed last year. Some analysts believe the compiler might have helped investors dodge a bullet by taking a slower-burn approach. In all likelihood, many of the shortlist of new entrants would have been from the Chinese internet and tech sectors, much of which has been the subject of an antitrust and cybersecurity crackdown that has savaged their valuations.

Is the HSI still representative of the city?

The index has often been criticised over the years. For instance, in 1998 at the height of the Asian financial crisis, local lawmakers queried whether it was a suitable benchmark for the local stock market given the heavy weighting of global bank HSBC (another mainstay of the HSI since 1969). More recently HSBC, Tencent and the insurance giant AIA have accounted for more than 30% of the index weighting between them as well. To address the issue, the HSIC has proposed to cap the weighting of each individual constituent at 8%. The inclusion of more companies from China, as well as the expansion of the HSI family to 100, will also make it harder for speculators to move the benchmark by buying or selling one particular index heavyweight, Hong Kong Economic Times notes.

In this way, the HSI is moving away from the more traditional school of blue-chip indices like the DJIA. In all fairness, many naysayers have suggested that the 30-member Dow Jones Industrial Average is outdated and unrepresentative of the American economy (tech stocks such as Amazon and Alphabet aren’t included, for instance). The performance of other indices such as the S&P500 is more in sync with the wider market but the chances are that the DJIA will continue to be used by news channels and market commentators as the indicator of blue-chip mood.

Back in Hong Kong, the HSI will become more of a proxy for events in China – with all of the 27 pending additions almost certain to be from across the border. In truth, its value in signposting what is going on in Hong Kong’s economy came to an end some time ago. But as the HSI reaches 100 stocks, including some potentially volatile choices from the mainland market, investors may also start to question whether it is a ‘blue chip’ index any longer. It will also find it much harder, WiC suspects, to distinguish itself from a host of other China indices.


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