I. Why implement expansion and reconstruction to SZSE Component Index?
SZSE Component Index (Code: 399001, hereinafter referred to as “SZSE Component”) was launched by Shenzhen Stock Exchange in 1995 as a benchmark index to reflect the status of the Shenzhen market. For the past two decades, the Shenzhen market has witnessed rapid development, with the number of listed companies increasing from 120 to 1640, as well as the market size and structure. However, the Index still only has 40 constituent stocks without any expansion, which has already become unable to reflect the characteristics of the Shenzhen market in the following aspects:
- first, inadequate representativeness for the Shenzhen market. With 40 constituent stocks, the SZSE Component only accounts for 2.4% of the total number of listed companies in the Shenzhen market or 18% of the total market capitalization, whereas other benchmark indices generally have more than 60% market capitalization coverage.
- second, failure to reflect the development achievements of the multi-tiered capital market. Currently, with only 11 companies listed on the SME board and 3 on the ChiNext board included, the SZSE Component’s industrial structure is deflected to traditional pillar industries (for example, finance and real estate, weighing 31% in the Index, only account for 12% in the Shenzhen market.), which is difficult to reflect the achievements of capital markets in fostering small and medium enterprises and strategic emerging industries.
- third, falling market recognition and influence. For the recent years, the market behaviors of SZSE Component have become more and more close to SSE Composite Index and CSI 300 Index, but more and more differentiated from SZSE Composite Index, SZSE SME Index and SZSE ChiNext Index, which shows its weakening role as scaleplate in the Shenzhen market.
At present, with SSE Composite Index and CSI 300 Index measuring blue chip stocks, the market lacks a benchmark index to reflect the growth of small and medium-sized listed companies. In order to fully reflect the achievements of multi-tiered capital market in our country, facilitate market players fully understand the overall performance and give play to the important role of benchmark indices, SZSE has decided to implement expansion and reconstruction for SZSE Component Index.
II. How will SZSE Component Index be expanded and reconstructed?
Related research work was started in 2011. Based on long-term and in-depth arguments, opinions and suggestions widely solicited from fund brokers, institutional investors, international index companies, fund holders and medium and small investors, and many discussions carried out among SZSE committee of index experts and Innovation and Development Committee under the board, the scheme for expansion and reconstruction of SZSE Component Index has been decided as follows:
1) The number of constituent stocks will be increased from 40 to 500;
2) Code, name and sampling methodology of the Index will remain unchanged.
In order to achieve a smooth transition and fully protect rights and interests of investors, SZSE will arrange the listing of the new Index after two months upon the announcement.
Fully considering the development trends and operational characteristics of the Shenzhen market, and learning from successful reconstruction experiences of S&P 500, Hang Seng Index and SSE 180 Index, the scheme conforms to the evolution rules of benchmark indices, and has comprehensive advantages of extensive representativeness, low technical risks, good historical continuity and conformity to investor habits.
III. Why expand the constituent stocks to 500?
The Shenzhen market has been expanded rapidly for the past ten years. The reconstruction this time aims to concentratedly solve the accumulated problems. Based on the following four reasons, SZSE will expand the constituent stocks to 500:
- first, to reach an appropriate market coverage level. In order to reflect overall characteristics and market behaviors, benchmark indices must reach certain coverage of market capitalization, usually above 60% in the international markets. Due to the large number of SMEs, the Shenzhen market is featured with low concentration of market capitalization and prominent fat-tail phenomenon. For example, the top 400 companies in size only cover 50% of the total market capitalization in the Shenzhen market, whereas the top 50 companies in size already cover 53% of the total market capitalization in the Shanghai market. Therefore, to reach a coverage level of a benchmark index in Shenzhen market, constituent stocks must be plenty.
- second, to reflect the structural characteristics of the market. According to the evolution analysis on market capitalization structure, industrial structure and sector structure in the Shenzhen market, taking 500 constituents can better reflect the structure and evolution of the Shenzhen market and fully mirror the market structural characteristics on the basis of overall reasonable coverage.
- third, to meet the needs of further development of the market. The transformation of economic development patterns and industrial transition and upgrade in China call for development of small and medium-sized enterprises, innovative enterprises and emerging industries. On a mission to build up a multi-tiered capital market, SZSE fully supports the development of SMEs. In the future, the number of listed companies will further increase. The number of constituent stocks should have the foresight to adapt to the development needs of the market in the future.
- fourth, to combine the functions of benchmark and investment. Benchmark indices are not only scaleplates reflecting the overall market, but also important investment targets for indexed products like ETF. The needs for market reflection and investment should both be taken into consideration in the design. According to characteristics of the Shenzhen market, taking 500 constituents can better combine the two functions of benchmark and investment. The fixed sample size of 500 constituents has been successfully used in several markets, such as S&P 500 Index, CSI 500 Index, etc. So it will be easy for investors to understand and accept, and is conducive to index promotion and product development.
From the above, the expansion of SZSE Component has taken market representativeness, perspectiveness and investment needs into account, and adapts to the mid-and-long term development trends of the capital market, complies with the prudence principle of benchmark index reconstruction, and is beneficial to maintain the stability of preparation scheme over a longer period.
From the point of expansion range, the number of Shenzhen listed companies has increased by 12.5 times since the launching of SZSE Component in 1995, while the number of constituents of the Index will be expanded by 11.5 times, keeping a consistent growth rate with the total number of listed companies.
IV. What characteristics will SZSE Component have after the expansion?
The new SZSE Component has been proven to be more representative and at reasonable valuation level by statistics.
First, outstanding performance with less fluctuation. During the period from the beginning of 2009 to the end of February 2015, the new SZSE Component has created an accumulated income of 157% in its simulation run, whereas the figure for the original SZSE Component is 81% during the same period, 82% for SSE Composite Index and 97% for CSI 300 Index. Along with the improved performance, the fluctuation rate for the new SZSE Component is falling, reporting an annualized fluctuation rate of 20.77% for the last two years, lower than the original SZSE Component. It reflects the growth and return advantage of emerging industries and SMEs.
Second, fully reflecting the characteristics of the Shenzhen market. After the reconstruction, the correlation coefficient between the new SZSE Component and SZSE Composite Index is 0.99, fully reflecting the characteristics of the Shenzhen market. Meanwhile, the difference between the new SZSE Component and SSE Composite Index becomes more notable. In the past five years (2009-20140), the income correlation between the original SZSE Component and SSE Composite Index and CSI 300 Index is 0.95 and 0.97 respectively, showing coincident movements. After the reconstruction, its correlation with SSE Composite Index is sharply reduced. As of the end of February 2015, their correlation for the last three years and the last one year is 0.86 and 0.80 respectively. For the same period, the correlation between NASDAQ 100 Stock Index and Dow Jones Index is 0.84 and 0.85 respectively, and the correlation between NASDAQ 100 Stock Index and S&P 500 Index is 0.86 and 0.75 respectively. After the reconstruction, the new SZSE Component will work in coordination with SSE Composite Index and CSI 300 Index, which is conducive to objectively reflecting the whole picture of China's securities market.
Third, reasonable valuation level. According to the latest statistics of sample stocks, the new Index reported a dynamic P/E ratio of 29.8 in 2014, lower than that of SZSE Composite Index, SZSE SME Index and SZSE ChiNext Index. In the sight of international situation, NASDAQ Composite Index reported a dynamic P/E ratio of 30 at the end of 2014 with an annual average ratio of 34. The 100 China concept stocks listed on NASDAQ, deducting loss-making companies, reported an average P/E ratio of 25. The valuation level of the new Index keeps in line with NASDAQ and China concept stocks with sound profitability.
V. What characteristics will the new Index have in terms of company structure?
First, market capitalization coverage will be greatly increased. The coverage will be increased from 18% to 61% and maintains at a high level for a medium and long term.
Second, more equilibrium distribution will be seen among different boards of the market. As of the end of February, the new Index has 52% constituents listed on the main board, 33% on the SME board and 15% on the ChiNext board, quite close to their capitalization proportion in the Shenzhen market. The 211 SME-listed companies and 90 ChiNext-listed companies (totally accounting for 60% in the constituents) have shown adequate representativeness for medium and small companies with high growth.
Third, industrial structure is in high consistency with the Shenzhen market. After the reconstruction, the weight of finance and real estate industries will reduce from 31% to 16% and the weight of consumer discretionary industry, including wine, will reduce from 28% to 17%; whereas the weight of information technology industry will rise from 12% to 18%, becoming the heaviest-weighted industry, the weight of raw material industry including new materials will rise from 2% to 12%, and the weight of medicine and healthcare industry will rise from 5% to 9%.
VI. How will the new Index position itself in the indices family?
The new Index will reflect the development of SMEs, innovative enterprises and emerging industries in the market. Working together with SSE Composite Index and CSI 300 Index, the new Index can mirror the market’s overall performance from a different side, similar to the relation among Dow Jones Index, S&P 500 Index and NASDAQ Index in the U.S.
In the Shenzhen market, the new Index will act as the benchmark for the entire market, while SME Index and ChiNext Index will act as the benchmarks for respective boards in the market.
The new Index also has the function of investing. SZSE 100 Index is the benchmark for large-caps in Shenzhen, and SZSE 300 Index is the benchmark for medium-caps and large caps. The function and position of the new Index, SZSE 100 Index and SZSE 300 Index corresponds to that of SSE Composite Index, SSE 50 Index and SSE 180 Index.
VII. Will the index reconstruction curse market volatility or influence on the running of other indices?
Currently, there are four fund companies, namely, China Southern Fund, SWS MU Fund, Rongtong Fund and Tianhong Fund, which have developed five index fund products tracing SZSE Component Index. As of the end of 2014, the total asset of such funds was RMB 7.8 billion. During the process of reconstruction research, SZSE has carried out plenty of communications with the four fund companies and adopted the opinions and suggestions raised by the fund managers.
In the reconstruction this time, a group of new constituent stocks will be added to the Index, which is quite similar to regular sample adjustment in nature. So no extra risk would occur to investment management. We believe careful preparation in advance and allowing more time for portfolio reallocation could achieve smooth operation for index funds.
VIII. What measures will be taken to protect the rights and interests of holders of index funds?
The official listing of the new Index will be arranged in two months after the disclosure of this announcement. SZSE and fund managers will make timely and sufficient information disclosure during such period.
Currently, there are five funds tracing SZSE Component Index, namely, China Southern SZSE Component ETF, China Southern SZSE Component ETF Feeder Fund, SWS MU SZSE Component Classified Fund, Rongtong SZSE Component Enhanced Fund and Tianhong SZSE Component Fund (LOF). Relevant measures and arrangements will be disclosed later. Investors can visit the websites of the fund companies for more information.
IX. Are there any similar index reconstruction cases at home or abroad?
Yes. Take S&P 500 Index for example. In 1941, its number of constituents was expanded from 233 to 416, and to 500 later; in 1976, finance stocks were added as constituents; in 1988, the restriction on number of constituents from single industry was removed. The constituents of Dow Jones Industrial Average Index were only 12 when launching in 1896, and expanded to 20 in 1916 and to 30 in 1928. The constituents of Hang Seng Index were only 33 when launching in 1964, and expanded to 38 in 2006 and to 50 in 2007.
In domestic markets, Shanghai Stock Exchange issued SSE 180 Index based on the expansion and reconstruction of SSE 30 Index in 2002. The sampling methodology of CSI 300 Index was changed after learning from international standard methods.