TraHK Suitable?
3 November 1999
Even after reading our previous articles (links at the top of this page) you may still be considering applying for the Tracker Fund of Hong Kong before tomorrow's deadline (if you are applying in the institutional offer, then you have a bit longer to finalise your orders). If you want to apply for the TraHK, you need to get your application in by 12 noon tomorrow. Your broker may set an earlier deadline to handle the paperwork.
If you believe that the stock market is at an attractive level, but have no time to pick stocks, and want to be invested for 2 years in the largest stocks of the market, then the TraHK is for you. The management fees are lower than any other mutual fund in Hong Kong that we know of, and there will be an increasingly liquid market place in which you can sell your units without a major penalty. You will also get loyalty units after 1 and 2 years, increasing your original units by 12%. Bear in mind that these will not include the dividends that the Government will earn on them in the meantime, and as previously explained, you may suffer a discount on the eventual sale of units, particularly in the case of odd lots arising from the bonus units.
At Webb-site.com, we regard equity markets in general (led by the US) to be seriously over-valued at present. The Nasdaq market set a record high this week. Price/earnings ratios, price/cashflow ratios and price/book ratios have almost never been higher in the US. The consumer savings rate is negative - they are living on borrowed money and borrowed time.
We have also explained in our previous article how the Hang Seng Index has out-performed the Hang Seng Mid-Cap Index (where no intervention took place) by 34% since the Government bought it up, which out-performance we attribute largely on the effect of the Government's purchases. The same mechanism should then work in reverse to drive it downwards.
You may have noticed that the value of your apartment has fallen 50% since 1997, but the HSI is only down a net 20% since it's all-time 7-Aug-97 high. And we've had deflation - in fact almost everything in Hong Kong is cheaper except the stock market. Bear in mind that the HSI's peak was a brief high. In fact, the HSI did not break through 14,000 for the first time until 14-May-97 and was back below it five months later on 14-Oct-97. So with the HSI closing today at 13,257, we don't see much upside.
The Government has $150bn of equities to sell, and only $10bn is going through the TraHK. The "Tap" mechanism will satisfy up to $3bn of further demand for equities in the last 6 weeks of the year, and perhaps $6bn per quarter after that. So any upside is limited by that supply of liquidity. You can't have a drought when it keeps on raining.
Obviously If you choose not to buy the TraHK on this occasion then you won't get the loyalty bonuses of this first offer. But if the Government comes back and offers a second batch, then they will probably have to offer the same or similar incentives that you have come to expect from the first issue. By then, markets may be lower and units cheaper.
What about the discount - isn't that worth it?
If you are feeling brave but agree that the market is over-valued, then you might still want to apply for TraHK just to get the discount, hoping to sell in the market as soon as possible (and give up the loyalty units). That's a viable strategy, but to maximise your advantage you should make sure your broker offers you a commission rebate. The going rate is up to 2.25% rebate (out of the 2.50% that most brokers receive) so make sure you get it. That plus the discount of at least 5% gives you an effective discount of at least 7.25%.
Bear in mind that the first day you can sell is 12-Nov-99 (if you have your units) so you are tied into the market until then. The value of stocks can plummet as well as rise. You may not get the full net asset value when you sell the units, so better allow for a 2% discount, plus stamp duty and commission, say 2.4% over-all, on your sale. That still leaves a potential gain of at least 5.8%, but you have some market risks until the 12-Nov. Your broker might insist on seeing the certificate before you sell, and since they won't be posted until 11-Nov, you may have to wait until Monday 15-Nov to sell. So that's a lock-in of up to 11 days. In the last year, the weekly fall in the HSI has exceeded 4% on 7 occasions. In the 11 days to 15-Oct-99, it fell 7.5% from 13,112 to 12,134 and has since gone back up past where it started.
If you have a futures account, you can lock in your gains by selling HSI futures contracts after you know what your allocation is. Allocations are due to be announced in the newspapers on 9-Nov. However, the value of your allocation almost certainly won't be equal to a whole number of contracts, so you'll still have some residual market risk. You could consider pooling your futures account with a relative or friend to make the numbers work out more evenly. Then when you get your units, you can sell the units and buy back the futures contracts.
Hedging the long-run
We wrote earlier in this series about collecting the discount and loyalty units without market risk. At that time, we were expecting a number of covered warrant issuers to start offering 1 or 2-year cash-settled puts on the Hang Seng Index. These would pay the amount (if any) by which the Hang Seng Index at the time of expiry is less than a preset level .
That would protect your downside and give you any upside on the TraHK while at the same time collecting at least the first year's bonus units. So far, no such warrants have been issued, but we may see such instruments in the market in the coming weeks. If you are working for a warrant issuer planning to launch such a product, let us know.
So for now the only way to hedge your position is to run a short futures position and roll it over every month (buying it back and selling the next month's contract). That's not something we can recommend to the retail investor because it ties up too much capital for the returns involved and involves "rollover risk" - the risk that you may make a loss rolling the position each month, particularly if the Government intervenes again during the next 2 years to support the market. We also thought that there might be "reverse tracker funds" set up to manage the short-positions for you, but so far none has come forward.
The next 3 trading days could be very interesting, because that is when the prices of the members of the Hang Seng Index will be used to determine the "reference market price" against which the discount will be set.
© Webb-site.com, 1999
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