Passive Investors Get Sucked Into Hong Kong Market Failures

03-Dec-2016 Intellasia | WSJ | 6:00 AM Print This Post

Multibillion-dollar bubbles like Fullshare may end up fitting a pattern

A controversial report from brokerage house Sanford C. Bernstein in August accused passive investing of being “worse than Marxism.” In a capitalist outpost of the world’s biggest communist country, passive investing can indeed be ominous.

Hong Kong-listed Fullshare Holdings fell 11 percent, wiping out $1 billion from its market value Thursday, a day after MSCI added the wildly overvalued property developer into its China index. Around the same time it entered the index, Fullshare issued new shares for its acquisition of wind equipment maker China High Speed Transmission. China High Speed shareholders, who received Fullshare shares in the deal, are now dumping them on the market.

Other than the index funds who are forced to buy, there may not be anyone else in town. Four shareholders own around 80 percent of the company, including the 4.3 percent owned by Zall Group, another bubbly stock in which Fullshare has an 8.8 percent stake. Mainland investors, through the Shanghai-Hong Kong Stock Connect, own another 3.4 percent, or around 20 percent of its free float.

The scene should already be familiar to Hong Kong investors – multibillion-dollar bubbles with stocks that have small floats but get added to major benchmarks and then collapse. Goldin Properties, one of the stocks that plunged in same spectacular manner the day after Hanergy Thin Film crashed, was added to the MSCI indexes in May last year.

The Hong Kong regulator subsequently warned that 13 shareholders owned around 95 percent of Goldin. MSCI later decided that companies who got such warnings of concentrated ownership would no longer be included in its indexes and kicked Goldin out in February. Its short nine months in the indexes, however, was enough to inflict an 86 percent loss on whoever had to follow MSCI’s benchmarks.

Fullshare isn’t on the regulator’s list of stocks with concentration warnings, but some think it should be. Shareholder activist David Webb has petitioned the Securities and Futures Commission to investigate the company’s shareholders.

Making things worse is that shares of Fullshare can’t be shorted due to arcane and paternalistic Hong Kong regulations. Stocks are only eligible for short sales if its daily turnover exceeds 60 percent of the company’s market capitalisation. But as Fullshare’s sevenfold jump since 2015, that threshold looks even more difficult to reach – defeating the whole purpose of using short selling to correct fast-rising stock prices.

The point of passive managed index funds is to not be in the game of picking good stocks over bad. But they should exclude markets and stocks that don’t meet basic investible criteria in the first place. An investor may be wise enough to not buy directly into such bubbles. Passive managers may have no choice.


Category: Hong Kong

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