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How Smart Beta Strategies Work in the Hong Kong Market

Accessing China's Growth via Dividends

How Smart Beta Strategies Work in the Hong Kong Market

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Priscilla Luk

Managing Director, Global Research & Design, APAC

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Liyu Zeng

Director, Global Research & Design

EXECUTIVE SUMMARY

Since the launch of the Hong Kong-Mainland Stock Connect programs, there has been increasing interest in smart beta strategies within the Hong Kong equity market. Our analysis examined the effectiveness of six wellknown risk factors including size, value, low volatility, momentum, quality, and dividends in the Hong Kong equity market from June 30, 2006, to June 30, 2017.

  • Apart from small caps, the rest of the examined factors delivered higher absolute and risk-adjusted returns in their equal-weighted top quintile portfolio versus their respective bottom quintile portfolios.
  • The 50-stock high value and dividend portfolios delivered the highest excess returns, while those for the low volatility and quality showed reduced volatility compared to the underlying benchmark.
  • Our macro regime analysis showed that factor portfolios in Hong Kong are sensitive to both the local market cycles and investor sentiment regimes.
  • The distinct cyclicality in Hong Kong factor performance indicated its potential for implementation of active views on the local equity market.

FACTOR-BASED INVESTING IN THE HONG KONG EQUITY MARKET

Smart beta strategies have gained significant attention in the asset management industry, and the exchange-traded products tracking factor indices have experienced significant asset growth since the end of 2008. Factor-based investing shares some common characteristics with passive investing such as rules-based construction, transparency, and costefficiency, and it also shares features of active investing by aiming to enhance return and reduce risk compared to market-cap-weighted indices.

Single-factor indices are constructed explicitly to capture a specific risk factor and exhibit distinct cyclicality in response to a changing market environment, which also makes them ideal tools for implementation of active views. Index-linked products in low volatility (minimum variance) and multi-factor categories witnessed the strongest asset inflows among smart beta products in recent years.

In Hong Kong, the adoption of factor-based investing by local market participants is far behind the U.S. and other Asian markets like Japan. However, since the launch of the Hong Kong-Mainland Stock Connect programs, there has been increasing demand for factor-based index-linked products within the Hong Kong equity market. Due to the sluggish Chinese economy, potential renminbi depreciation, and the tight control on QDII quota, the stock connect programs have become favorable channels to facilitate offshore diversification for many mainland Chinese asset managers.

In this paper, we examined the effectiveness of six well-known risk factors (size, value, low volatility, momentum, quality, and dividend) in the Hong Kong equity market and their investability in practice, as well as the behavior of these factors under different market regimes.

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Accessing China's Growth via Dividends

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Tianyin Cheng

Senior Director, Strategy Indices

The Chinese government appears to be committed to continuing structural reforms and supporting economic growth. Initiatives with these goals in mind are generally viewed as positive and may put China on a more sustainable growth trajectory in the long run. However, current reforms may be accompanied by volatility in the country’s economy and capital markets. In such an environment, a focus on growing and sustainable dividends can offer a relevant approach to investing in China’s equity markets. This could provide the opportunity to get a slice of the region's structural growth and its potential outperformance throughout the cycle.

This paper gives an overview of the current status of dividend payouts by Chinese companies, the unique features of dividend policies by stateowned enterprises (SOEs) and family-run businesses, and the dividendrelated policies and regulations issued by the Chinese authorities. It then reviews the S&P China A Share Dividend Opportunities Index, which is designed to offer a transparent, rules-based, and investable strategy for market participants looking for exposure to China’s growth via dividends.


DIVIDEND PAYOUTS BY CHINESE COMPANIES

How China Has Evolved

In recent years, with the release and implementation of a series of dividendencouraging policies issued by Chinese authorities, the amount of dividends issued by companies listed in China’s equity markets has gradually increased. Furthermore, the total amount of dividends and the proportion of companies that issue dividends are increasing as well.

Exhibit 1 illustrates these improvements from 2011 to 2016. According to the 2016 financial reports and interim reports, there were 1,570 companies in the S&P China A BMI that declared dividends, representing 68% of the S&P China A BMI universe, much higher than the 54% reported in 2009. The size of the total dividend pool for companies in the S&P China A BMI was USD 94 billion in 2016, nearly four times the size of the dividend pool in 2009. The dividend payout ratio was 33.7% in 2016, 7.4% higher than in 2009.

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