Hong Kong’s status as an international financial hub faces a new challenge as the United States’ federal pension fund has decided to exclude Hong Kong-listed shares from the benchmark indexes for its international funds.
The decision was announced by the US Federal Retirement Thrift Investment Board (FRTIB) on Tuesday before Chinese President Xi Jinping and US President Joe Biden met in San Francisco on Wednesday. In a dinner on Wednesday evening, Xi called on the US business community to boost investment in China.
The FRTIB said it had conducted a routine review of the four benchmark indexes followed by its Thrift Savings Plan (TSP) and decided to adjust its International Stock Index Investment Fund, or I Fund, which has an asset size of US$68 billion as of the end of last month. It said it had reviewed the recommendations of its staff and Aon, its investment consultant.
“Overall, operational complexity has increased when investing in emerging markets in recent years given a range of events such as investment restrictions on sensitive Chinese technology sectors, delisting of Chinese companies and sanctions on Russian securities due to the Russia-Ukraine conflict,” Aon said.
“These types of unforeseen events can incur transaction costs and may cause performance and volatility swings,” it said.
It said any announcement of investment restrictions can cause the value of a stock to decline at a time where the investor is forced to sell. It said, given the asset size of the I Fund, the forced selling or restricted investments could incur higher than average market impact costs due to liquidity challenges.
It said it will work with its fund managers to implement the transition from the current index (MSCI Europe, Australasia and Far East (EAFE) Index) to the next index (MSCI All Country World (ACWI) ex USA ex China ex Hong Kong Investable Market Index (IMI)) in 2024. It said the next index is expected to outperform the current one on a risk-adjusted basis over the long term.
Assets in Hong Kong
The MSCI ACWI IMI ex USA ex China ex Hong Kong, launched in June this year, provides exposure to 5,621 large-, mid-, and small-cap stocks in 21 developed markets and 23 emerging markets.
The MSCI EAFE Index currently provides exposure to 798 large- and mid-cap stocks in 21 developed markets. Hong Kong stocks represent about 3.3% of the index’s assets, according to the geographical breakdown of a similar MSCI index.
If the I fund is closely tracking the MSCI EAFE Index, it should have allocated US$2.2 billion of its assets into Hong Kong markets.
Simon Lee, a US-based Hong Kong commentator, noted that the asset size of the I Fund’s assets in Hong Kong is not enormous, comparatively speaking. But he predicted the fund’s departure will still hurt the city’s stock markets.
“In general, the US now sees China as a risk, not an opportunity, and it does not treat Hong Kong as an independent economy from mainland China,” Lee said. “As the TSP is representative, its departure from Hong Kong may make some state-level pension funds follow suit.”
He said the TSP’s departure will fuel capital outflows in Hong Kong and hurt the city’s status as an international financial hub.
A Shanghai-based columnist says in an article that shares of 29 Hong Kong-listed firms, including AIA Group Ltd, Hong Kong Exchanges and Clearing Ltd, CK Hutchison Holdings and Sun Hung Kai Properties Ltd, will face downward pressure when the TSP’s fund managers dispose of them next year.
The Hang Seng Index, a benchmark of the Hong Kong stock markets, has fallen 13.4% so far this year. The Shanghai Composite Index, which tracks the A-share markets, has dropped by only 2%.
Trump’s decision
In November 2017, the FRTIB decided to let its I Fund follow the MSCI ACWI IMI ex USA, instead of MSCI EAFE Index, as a way to enter the A-share markets.
As of July 31, 2019, China received the third-most investment on a per-nation basis within the MSCI ACWI IMI ex USA at 7.56% of the index’s assets.
In August 2019, US Senators Marco Rubio and Jeanne Shaheen told FRTIB Chairman Michael Kennedy in a letter that some of the US federal government employees’ money mightd have been invested in Chinese firms that pose national security, human rights and financial disclosure risks.
The FRTIB was ordered to stop investing in A-shares by the Trump administration in May 2020.
As of the end of March in 2020, the TSP had US$557 billion of assets while its I Fund had US$41 billion.
The Economic Daily, a state-owned newspaper, said in a commentary in 2020 that the negative impact on the A-share markets of the TSP’s exit was negligible.
Citing an estimation of the Bocom Schroders Asset Management Co Ltd, it said all US pension funds totaled US$30 trillion but the US federal government only controlled US$1.9 trillion of that while the remaining was owned by state governments and the private sector.
It added that no more than US$15 billion of US pension funds had been allocated to the Greater China region and most of it was in Hong Kong.
The Chinese Foreign Ministry in May 2020 criticized the US government for blocking American investors from entering China’s markets and politicizing the matter in the name of national security. It said such a move would hurt US investors’ interest.
‘Butterfly effect’
In the first 10 months of this year, the average daily turnover of Hong Kong’s stock market was HK$106.6 billion (US$13.7 billion). Market capitalization amounted to HK$30.8 trillion (US$3.95 trillion) at the end of last month.
Some analysts said the I Fund’s US$2.2 billion investments in Hong Kong is negligible as it is only about 16% of the market’s daily turnover and 0.06% of its market capitalization.
However, they are worried that if more institutional investors are leaving Hong Kong, it will create a “butterfly effect” that may lead to a market crash.
In October 2022, the Teacher Retirement System of Texas, managing a US$184 billion public pension fund, cut its China target allocation to 1.5% from 3% of its assets.
In April this year, Ontario Teachers’ Pension Plan (OTPP), Canada’s third largest pension fund, reportedly closed down its China equity investment team based in Hong Kong.
On Wednesday, lawmakers passed a bill to lower the stamp duty for stock trading to 0.1% from 0.13%, hoping to make the bourse more competitive.
Read: BlackRock, MSCI probed for investments in China
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