TraHK U-Turns on U.S. Executive Order Backwash: Impact Analysis

Tracker Fund of Hong Kong stopped adding new investments in sanctioned companies but resumed after 3 days.

Jackie Choy, CFA 04.02.2021
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The "Executive Order on Addressing the Threat from Securities Investments That Finance Communist Chinese Military Companies" became effective on Monday, Jan. 11, 2021, at 9:30 a.m. EST. The Executive Order brought some "backwash" as its ripples reached markets outside of the U.S. State Street Global Advisors (SSGA), the manager of the Tracker Fund of Hong Kong (02800, TraHK), announced on Jan. 11, 2021 that it would stop adding new investments in the sanctioned securities to TraHK. However, SSGA reversed its position three days later, stating it would resume buying the sanctioned securities for TraHK from Jan. 14.


With this U-turn and the relatively high market volatility, it is worthwhile to understand the impact on TraHK's portfolio over these 3 days. A closer examination revealed the following observations:

Portfolio movements

  • On Jan. 11, TraHK reduced the impacted securities in the same proportion as their weights in the Hang Seng Index.
  • On Jan. 12, the fund did not add impacted securities despite the addition of the overall portfolio, resulting in a slight underweight position (0.02 percentage points) when compared to the benchmark.
  • On Jan. 13, the fund did not reduce the impacted securities despite the reduction of the overall portfolio. Lack of action resulted in a slight overweight of the impacted securities (0.09 percentage points) as compared to the Hang Seng Index.
  • On Jan 14, the fund reduced the impacted securities at a higher proportion than the reduction of the overall portfolio, bringing their weights in-line with those in the index at the end of day.


Portfolio and Tracking Difference Analysis

Share price movements

  • The share prices (day-end) of China Mobile (00941) and China Unicom (00762) climbed on Jan. 11 by 5.8% and 5.7%, respectively, and continued the positive momentum on Jan. 12, gaining 6.6% and 6.0%, respectively. Their share prices slipped by 0.4 and 1.8%, respectively, on Jan. 13, putting their total gain over those 3 days at around 11%. The performance of the unimpacted securities rose by around 1% for the 3 days.
  • The absolute performance differential of the impacted and unimpacted securities over the 3 days was around 10 percentage points.


Inflows and outflows

  • We estimated outflows of HK$2,415 million (US$311 million) on Jan. 11, inflows of HK$313 million (US$40 million) on Jan. 12 and outflows of HK$3,097 million (US$400 million) on Jan. 13.
  • During the 3 days, we estimate a net outflow of HK$5.2 billion (US$670 million), representing 4.94% of TraHK's asset under management as of Jan. 8.


Tracking Performance

  • The daily tracking differences for TraHK from Jan. 11 through Jan. 13, 2021, including other effects from normal index-tracking operations (e.g. fees, cash drag, etc.), landed between  0.10 and 0.30 bps each day (meaning the fund’s performance lagged the index’s performance), for a combined effect of 0.51 bps (42 bps on an annualized basis).
  • While these figures were on the high side if extrapolated to an annualized figure (especially when compared to its ongoing charge of 10bps), a 0.30 bps daily tracking difference is well within one standard deviation of the tracking differences in the past two calendar years.
  • TraHK resumed transactions in the impacted securities on Jan. 14, 2021, limiting tracking difference/error concerns to the 3 days. While the impact was small and driven by relatively large variables (10% outperformance of the impacted securities along with a 5% change in asset size), it would have been ideal for an index fund to fully replicate an index in order to minimize tracking differences/errors.

 Daily Tracking Difference

Recall that Blackrock/iShares HK announced on Jan. 8 that two Hong Kong-domiciled ETFs would no longer make new investments of the impact securities in their funds from Jan. 11. And BlackRock/iShares did not make any subsequent announcement to revert the decision. That suggests U.S.-based asset managers have different interpretations about how their non-U.S. affiliates should conform to the Executive Order.

The U.S. swore-in a new president on Jan. 20. Investors should continue to take note and assess the impact on any changes relating to the Executive Order.

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About Author

Jackie Choy, CFA  is the Director of Passive Investment Ratings, Global Manager Research.

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