TRANSTHERA 200 billion "vanished" — The ins and outs of the Hong Kong Stock Connect innovative drug portfolio adjustment event

In the movie "The Best Partner," Shen Teng is worried about spending one billion in a month.

However, in the capital market, a scale of 200 billion can vanish in just two and a half hours.

The institutional "hunting" of the Hong Kong Stock Connect innovative drug ETF has been brewing for some time. Xiao Ming's article yesterday was the first to bring this matter to the forefront, and it was very detailed. Initially, I didn't want to wade into this murky water, but since many people have been asking, today I want to attempt to restore the details of this matter from the perspective of institutions, and then look at how to avoid and resolve this issue from the standpoint of protecting the interests of the majority of shareholders (non-arbitrageurs).

Cause

Everyone is clear about the regular index rebalancing. Generally, the index company will communicate with fund companies three to four days in advance, and fund companies will typically make adjustments around the effective date. For example, if it takes effect after the close on the second Friday of September, fund companies usually buy most of their positions before the close on that Friday, with a small portion bought the following week.

However, this time, an unexpected guest arrived—TRANSTHERA-B. However, this stock is not as worry-free as its name suggests. The main issue comes from the liquidity of this stock. I took a screenshot of the trading situation from the time this stock was listed until it entered the Hong Kong Stock Connect:

The average daily trading volume is about 20 million. But how much does the ETF need to buy once it is added to the index?

First, let's look at the weight: I don't have the index document, but I can use the PCF from various products last Friday to do a reverse calculation. Theoretically, the PCF is based on index weight, so it should be very close.

It's clear that this stock has a weight of 2.62% in the Guozheng Hong Kong Innovative Drug Index. So how large is the scale of this index? A total of 36 billion. This means that within this short one to two days, they need to buy 943 million of this stock with an average daily trading volume of 20 million. As we all know, stock prices reflect matched trades; if you want to buy stocks at this price, someone has to sell them to you at that price. When it's a completely seller's market, and a company with a total circulation of less than 20 billion has someone wanting to buy 5% of its stock all at once, it’s no surprise that the price would soarSo, the first question is, why was this stock included in the index?

Personally, I tend to think that the index compilation did not consider everything thoroughly. Of course, there are many conspiracy theories circulating in the market. If there are indeed these issues, there will naturally be people to address them, and we don't need to worry about it.

But what I want to understand more is: if the index company's people are not familiar with the trading activity of the Hong Kong stock market, when the fund companies receive the new rebalancing list, everyone is a seasoned veteran; did they realize that there might be problems in this process?

There are at least two time periods when feedback could be given to the index company regarding potential issues:

First, from the time they received the weights until last Friday's rebalancing;

Second, last weekend. Because it was clear that there was a significant inability to buy in last Friday, the two days over the weekend provided ample time to think about contingency plans.

Wudang Tiyun Zong

What caused such a large-scale fluctuation in TRANSTHERA-B? One aspect is the underlying liquidity crisis, and another important reason is the positive feedback mechanism of ETFs.

Let me explain this logic: The net asset value was announced on Friday night, and some situations could already be seen—

The index rose by 2.83%, and among them, there was one with the smallest scale, whose net asset value fluctuation exceeded that of the index, which likely means they had already bought TRANSTHERA-B early, and most likely in the morning. Why do I speculate this? Because after 3 PM, TRANSTHERA-B dropped by more than ten points, so the excess return must have come from morning purchases. Moreover, buying in the morning also reflects that they were very aware of the stock's poor liquidity, so they needed to buy in advance.

Yesterday's net asset value further illustrates our hypothesis—only the smallest one kept up with the index, which means they had already bought in full by Friday (also benefiting from their small scale). The concerning part is that we found two products were close to underperforming the index by two points, while TRANSTHERA-B rose by 115% yesterday, but the CSI Hong Kong Innovative Drug ETF had little increase, which means that all the fluctuations in the Guozheng Hong Kong Stock Connect Innovative Drug Index yesterday were contributed by this one stock (the CSI index did not include TRANSTHERA-B).

Thus, we can deduce what the actual holdings of this stock are across various firms: estimated at—

70%, 16%, 34%, 100%

• Note that this is just an estimate, as the net value will be affected by the timing of your stock purchases. For example, buying early or late can lead to different profits, which may impact the estimated position. However, based on the trading volume, it shouldn't deviate too much.

The trouble with the positive feedback loop of ETFs has emerged: because the position is not fully bought, but the stock price has doubled. Yesterday, the weight was originally 2.62%, and now it has changed to 2.62 * (1 + 115%) = 5.63%. If you have fully bought, there is no problem, and the weight naturally increases; but if you haven't fully bought, you owe even more. However, due to the poor underlying liquidity, buying will inevitably raise the stock price, and as the stock price rises, your weight must increase, and as the weight increases, you have to buy more. Subsequently, it becomes like the Wudang martial arts technique "Ti Yun Zong," stepping on the left foot with the right foot to reach the sky.

But this sky definitely has a ceiling, as the upper limit of the index weight is 10%. Theoretically, if it rises by about 80% today, this arbitrage will become meaningless.

Suspicion Chain

So today is the most critical time for the game.

The game here involves not only the competition between fund companies and market funds but also the competition between fund companies themselves.

First, who is the target of the market? It is the few ETFs that WuXi AppTec has not fully purchased. Because they are the clear buyers today, estimating the amount based on yesterday's post-rise weight is around 600 million. But how much capital is participating? Today's trading volume for WuXi AppTec is 4.5 billion, and countless people want to get a piece of the pie.

What is the market consensus? This stock is not worth this price at all and is bound to fall; if it doesn't fall today, it will fall tomorrow, depending on when the fund companies complete their purchases.

Arbitrage funds' thoughts: Push it up; what if the fund companies can't help but buy? I will sell my shares to them! Or sell to later competitors.

Fund companies without shares: When should I buy this stock to avoid taking over? But if it doesn't fall today, I will underperform the market for a day, and the investors will definitely criticize me, and my scale will run to competitors.

Fund companies with shares: Although I have shares, this price is clearly inflated. If I don't sell, I will keep up with the index, but if I sell at a high point, I can achieve excess returns, and I can brag to my clients for a long time.

Fund companies with shares but not many: Although I also want to buy, if this price drops, I won't have to buy so much. Rather than let it drop on its own, why not give it a push and do a T?

In this environment of mutual suspicion, today's trading began.

Who Died?

Next, let's explain using today's WuXi AppTec's stock chart:

Looking at the intraday chart, the trading volume is clearly at both ends. The sharp decline began after 2:10 PM, and after 3 PM, there was a significant drop in volume, mostly sell orders; close to the market close, there were mostly buy orders. WuXi AppTec's market value peaked at nearly 260 billion in the morning, which is roughly at the level of Beijing-Shanghai High-Speed Railway in A-shares (Beijing-Shanghai High-Speed Railway has a revenue of 40 billion in 2024) The highest increase was 55%, and it closed down 53%. Even so, this company with an 8 million revenue still has a market value of HKD 76.2 billion.

Let's take a look at today's net value situation just released:

First, the worst performer was the one with the lowest position yesterday. It is highly likely that this manager placed a full-day TWAP buy order today, or they simply couldn't withstand the pressure due to a small position.

Second, the one that dropped the least today was actually the only one that kept up with the index yesterday! As a reference, the CSI Hong Kong Stock Connect innovative drug index dropped -0.62 today, while this one only dropped -0.98. I can almost conclude that this manager engaged in a high sell-low buy operation today.

Third, the largest manager is the most honest one. They probably just made a low-position supplement and still wanted to keep up with the index without making any flashy moves.

Conclusion

In the coming period, the index will likely continue to be dragged down by WuXi AppTec: because this stock still has a market value of HKD 76.2 billion, which it is not worth. If it returns to the scale before the entry, it would need to drop at least 70%. Individual holders may consider switching to the CSI or Hang Seng Hong Kong pharmaceutical ETFs.

For index fund managers, some personal insights: it’s best to first control the subscription and redemption limits, then contact the index company to adjust the weights. Moreover, since you have chosen a side, stick with it to the end. If what you do benefits the existing holders, there won't be regulatory issues, and other problems are minor.

Finally, buy coffee for customer service and legal, and prepare to welcome the storm of arbitrage private equity!

Author of this article: Shan Ji Shuo, Source: Shan Ji Shuo, Original title: "Kill That Rebalancer" — The Beginning and End of the Hong Kong Stock Connect Innovative Drug Rebalancing Incident

Risk Warning and Disclaimer

The market has risks, and investment requires caution. This article does not constitute personal investment advice and does not take into account the specific investment goals, financial conditions, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article align with their specific circumstances. Investing based on this is at your own risk