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Portfolio Tools Still Needed in Asian EM to Mitigate Risk

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  • Post last modified:December 21, 2018

While the Shanghai-Hong Kong Stock Connect program is still in its infancy, brokers and portfolio managers (PMs) have come to realize that the lack of tools at their disposal still lack sophistication vs. other markets. High correlation between Asian equity markets and global equity markets present hedgeable risk, if said tools are available.

The Shanghai-Hong Kong Stock Connect program (the channel), launched in 2014, allows Hong Kong residents and investors worldwide the ability to invest in Shanghai-listed companies through a local broker. The channel connects the two exchanges and clearing houses to allow investors to actively participate in their respective markets. This historic effort aims to make mainland China and Hong Kong more competitive in the global economy.

Market participants like Yang Delong of China Southern Asset Management Co. said that, “the new measure will make it easier for mainland and Hong Kong investors to trade on the other’s market.”

This was an important step in the history of Asian capital markets, but a few months after the start of the program has seen incredible volatility creep into portfolios, a new experience to many new brokers, investors, and managers.

According to 20 years of data from MSCI, a globally recognized provider of index solutions, Singapore and Hong Kong correlate strongly with global equity markets. These two countries have a .70 correlation coefficient to global returns. Other markets like China and Thailand have correlation coefficients of .60, indicating less statistically significant, but still strong relationship to global equity market returns. Considering recent volatility levels experienced in Europe, various Asia-Pac countries, and North America, new investors should be prepared to experience statistically similar effects as per the MSCI data.

South China Morning Post sources indicated that the new channel will not see large institutional flows until more hedging options are rolled out. Moreover, given the low account minimum required to trade these markets (500,000 RMB) large institutions are keen on launching deeper and broader stock index futures products to provide more hedging and liquidity solutions for institutional portfolios. News sources have also indicated that managers are worried about domestic retail traders “flood[ing] out of the mainland stock market in the event of a sharp downturn.”

Fundamental sources for hedges like index ETF short sales in developed markets are still being mulled over by authorities. But with the recent volatility in the Asia-Pac marketplace, this could be delayed.

In the meantime, brokers, PMs, and investors might need to cover short term liabilities, fund redemptions, or need capital to cover operating costs. Attempting to time the market with position liquidation had proven to be detrimental to investors as previously explored here. In these short term cases, loans backed by stocks has proven to be a better solution for long term capital gains and fund returns.

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