China IPO Index: Hottest Of The Hot

July 24, 2007

IPOX Schuster LLC is doing something new. Again. The Chicago-based index provider, the only index provider to focus on initial public offerings (IPOs), has launched yet another IPO index-the IPOX China 30 A-Shares Index.

IPOX Schuster LLC is doing something new. Again. The Chicago-based index provider, the only index provider to focus on initial public offerings (IPOs), has launched yet another IPO index-the IPOX China 30 A-Shares Index. It is the first of its kind, as IPOX Schuster's products have been in most of the markets they have entered.

China has a complex stock market. There are several classes of shares, and some of them are available to certain investors and not to others. Among those share classes, "A" shares are only available to domestic investors, while "H" shares are shares of domestic Chinese stocks that list on the Hong Kong Stock Exchange and are available to foreign investors.

IPOX Schuster already had an IPO index for China that was based on H shares, but the A share index means that domestic investors now have a gauge for the market they follow. And that market has been undergoing a boom, with the Shanghai stock exchange's composite index up 130% and the FTSE/Xinhua A50 Index (the largest 50 A shares) up 137% in 2006. As of July 20, the FTSE/Xinhua A50 Index was up 67.12% from the start of the year.  At the same time the FTSE/Xinhua All Share Index, which represents 95% of the A Share market, was up 98%, indicating that much of the growth is coming from smaller stocks.

Returns like that are what have driven millions of domestic individual investors to open accounts and begin trading. There have been some concerns about so many inexperienced investors flooding the market and driving up stock prices, and a popular word bandied about to describe the market is "overheated." Indeed, that would seem to be the case with the large differentials that can be seen between the prices of A and H shares of the same companies. One recent HSBC figure discussed in a Dow Jones Newswire article put the mainland premium on dual-listed shares at more than 60% versus Hong Kong prices. Not surprisingly, comparisons have been drawn between the current state of China's stock markets and that of the Nasdaq during the tech bubble in the late 1990s. Unsurprisingly, China's markets have already experienced one stock "tsunami" in the winter this year when there was a brief, though dramatic, plunge, but the dip was simply shaken off as China's markets powered on. However, some say the event marked a turning point in global markets and indicated the start of a new era of higher volatility.

It is into this melee that IPOX Schuster has launched its latest index. "The A-Share market is one of the most vibrant IPO markets in the world," IPOX Schuster founder, owner and manager Josef Schuster says, adding that it represents a huge opportunity. With China's stock markets currently characterized by strong performance and ample liquidity, the government is unlikely to move to restrict the launches of IPOs. "We believe there is a need for a strong benchmark."

The IPOX China 30 A-Shares Index includes the 30 largest and most liquid IPOs and spin-offs traded on China's domestic exchanges and is a subset of the broader IPOX China A-Shares Composite Index. Components enter the indexes at the close of their sixth day of trading after the IPO and remain for the next 1000 trading days, or approximately four years, the same entry and exit plans used in other IPOX indexes.

Stocks with less than 15% float are excluded from all IPOX indexes, and because of the numerous share classes and their varying levels of accessibility, IPOX adjusts the weights of the components for float, something it does not generally do for other regions or countries. The IPOX China A-Shares 30 Index, unlike its composite, is cap-weighted, with each component's weighting capped at 10% at each quarterly reconstitution. In addition, stocks representing more than 5% of the index cannot add up to more than 50% of the index, a standard rule borrowed from U.S. markets.

For all IPOX indexes, IPOs that see a price increase of more than 51% on their first day of trading are excluded from the index. Schuster says that in general, indexes that exclude these "underpriced" stocks outperform indexes that include them. While the difference amounts to a few hundred basis points over the long term for Europe, the United States and the rest of Asia, for China's stock market this difference over the long term can be up to 35%, Schuster adds.

"IPOs [in China's A-Share market] are hugely oversubscribed," Schuster says. "The rationale behind eliminating the hottest IPOs is that it provides a safety net against the exuberances of the IPO market."

The index was up 95% year to date as of July 20, and was up 104% last year. Over the past five years, it has outperformed the FTSE/Xinhua All-Share Index by 7.41 percentage points. According to Schuster, on average, its components have a daily equity turnover of $15 million, with the top 10 components each at $80 million to $100 million. Financials represent nearly 30% of the index, while there are no telecommunications companies and the next-smallest sector is Health Care at 3.33%. Its largest component is Industrial and Commercial Bank of China (ICBC), one of China's largest companies, which just went public in October 2006. 

 Schuster says the index will provide domestic investors in China with interesting diversification opportunities. He expects that there will be products based on the index eventually but says that there is nothing he can currently discuss. In total, Schuster says nearly $1.1 billion is already poured into products tied to IPOX indexes in the Asia Pacific region in the second quarter.


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