China rising STAR
In mid-July of last year China launched the Shanghai Stock Exchange Science and Technology Innovation Board in Shanghai. Better known as the Star Market, the new board is being talked up as a challenger to the US Nasdaq.
Twelve months later, the new board lists over 120 firms and is on its way to becoming one of Asia’s most valuable stock markets. Its ability to attract Chinese technology company listings and initial public offerings (IPOs) has been boosted by US threats to kick Chinese companies out of major American exchanges.
But how real is Star Market’s challenge to Nasdaq? And just how high can it rise?
Following in who’s footprints?
Since the Star Market is still very young, there is a shortage of mutual funds and ETFs indexed to it that can be tracked directly or serve as a proxy for the new board.
That will change. Kraneshares filed a registration statement with the SEC for the STAR Market 50 Index ETF on May 7th 2020, so we suspect there will be more STAR-tracking ETFs made available to institutional and retail investors globally. Throw in MSCI increasing inclusion factor for domestically listed Chinese shares, as well as active investors heavy underweight (see Chart 1 below) in those shares, and it is clear there is plenty of room for the Star Market to grow.
Chart 1 – China Domestic Share Class Allocation (Simple Weighted Average, Act vs Psv)
In the meantime, how best to assess the new market with the data EPFR does have? One approach is to utilize Hang Seng Internet & Information Technology Index (HSIII) and the funds which track it or many of the stocks in it.
Top-heavy and under-explored
HSIII’s constituents encompass the major China technology firms. As with the FANG stocks (Facebook, Amazon, Netflix, Google) in the Nasdaq, the top four stocks (Alibaba, Meituan, JD and Xiaomi) in the HSIII account for a disproportionate share of investment flows and market capitalization.
A breakdown of Chinese tech holdings among EPFR-tracked mutual funds and ETFs, utilizing the Stock Flows dataset, shows that these four names account for $41.6 billion of these funds collective investment in Chinese technology companies (see Chart 2 below).
Chart 2 – Total AuM invested from ETFs & Mutual Funds
Furthermore, EPFR’s flow data highlights a huge imbalance in terms of the trading activities of ETFs and mutual funds. Since there are not that many ETFs tracking this part of the sector, flows from these predominately passive funds are barely moving the needle for the kind of names being listed on the STAR board (See Chart 3 below). As for the active investors, they are focused on the top names with, at best, tiny positions in the smaller names.
Chart 3 – Daily Flows & Five-Day Cumulative Flows
Lastly, EPFR’s data shows this segment of the Chinese equity market is underexplored. Fund Count (FundCt) is a variable designed to measure the breath of a security’s ownership by investor groups (See Chart 4 below). The majority of the funds holding top Chinese tech stocks are still ETFs, which means that active managers are not generating optimal pricing signals because of their modest involvement in – and due diligence for – this asset class overall.
Chart 4 – Total number of long positions into security & Global Funds Allocation
Chasing pack still getting a fix on the prize
Overhauling the Nasdaq is a tall order. The companies listed on the Nasdaq-100 currently have a collective market capitalization of around $10 trillion, 20 times bigger than the value of the STAR market’s listings.
It took the Nasdaq-100 just over 14 years for its collective market capitalization to increase twentyfold. Can China’s Star make up the necessary ground by, say, 2040?
Based on our analysis of the Hang Send Internet & Information Technology Index, which is 4 years older than China STAR market, it could take a lot longer than that. Despite its age advantage, the HKSIII’s constituents remain under explored – and frequently under-owned -- by global investors. It is hard to catch up when a key source of capital is still operating in the dark.
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