Creating a physical ETF for Russian equities For professional clients only

Transcription

1 Whitepaper Creating a physical ETF for Russian equities For professional clients only

2 Contents European-domiciled ETFs for Russian equity selection Physical versus swap-based ETFs The challenge with launching a physical ETF for Russian equities Summary While the debate on physical versus swap-based ETFs rages, one argument put forward in support of swap-based ETFs is that they are useful in cases where a physical version is not possible. In this paper we explain how HSBC addressed the challenges in launching the first European-based physical ETF tracking the Russian equity market.

3 European-domiciled ETFs for Russian equity Table 1: List of European-domiciled ETFs tracking Russian equity indices Until July 2011, investors looking for an ETF tracking the Russian equity market could only choose from a selection of swap-based products. In July 2011, the HSBC MSCI Russia Capped ETF was launched, offering investors the first physically replicated Russian ETF in Europe. It also breaks new ground in terms of TERs for physical ETF, matching swap-based TERs at just 0.60 per cent per annum. Issuer TER (bps) Replication method Launch date HSBC MSCI Russia Capped 60 Physical Jul-11 Lyxor DJ Russia GDR 65 Swap Jun-06 RBS Daxglobal Russia 70 Swap Jul-07 db x-trackers MSCI Russia Capped 25% 65 Swap Feb-08 ComStage MSCI Russia Capped 30% 60 Swap Dec-08 EasyETF DJ Rus Titans Swap Sep-09 Source Russian Depository 65 Swap Jan-10 Credit Suisse* MSCI Russia ADR/GDR 65 Physical Aug-10 ishares MSCI Russia Capped 74 Swap Sep-10 Average 64 Source: Bloomberg, all data as at 31/12/2012 * Credit Suisse converted the ETF from synthetic to physical replication on 10 May

4 selection Table 2: constituents of European-domiciled ETFs on Russia equity Issuer TER (bps) Replication method constituents Number of components capping HSBC MSCI Russia Capped 60 Physical Local +DRs 27 30% db x-trackers MSCI Russia Capped 25% 65 Swap Local +DRs 27 25% ComStage MSCI Russia Capped 30% 60 Swap Local +DRs 27 30% ishares MSCI Russia Capped 74 Swap Local +DRs 27 30% Credit Suisse* MSCI Russia ADR/GDR 65 Physical DRs 20 No RBS Daxglobal Russia 70 Swap DRs 30 10% Lyxor DJ Russia GDR 65 Swap DRs 17 20% EasyETF DJ Rus Titans Swap DRs 10 15% Source Russian Depository 65 Swap DRs 15 20% Source: Providers annual reports and websites, all data as at 31/12/2012 * Credit Suisse converted the ETF from synthetic to physical replication on 10 May 2012 The table above shows that the ETFs available use a few different indices, some of which are not particularly representative of the market. Challenges with indices on Russia: Contain too few stocks to be representative (eg DJ Rus Titans 10) Contain ADR/GDRs 1 only (eg Daxglobal Russia, DJ Rus Titans 10, Russian Depositary and MSCI Russia ADR/GDR), making them less representative of the investable market in Russia In order to overcome these challenges, HSBC selected the MSCI Russia Capped index, composed mainly of local Russian stocks and some liquid ADRs/GDRs 1 when the liquidity of the local stocks does not meet the criteria. The MSCI Russia Capped caps each index constituent (as measured at the parent entity level) at 30 per cent, making the index, highly correlated with the Russian market and sufficiently diversified to be compliant with the UCITS directive. To find out more about the MSCI Russia Capped index methodology, please refer to the factsheet at the end of this document. Table 3: Composition of the MSCI Russia Capped used by HSBC ADRs/ GDRs 17% Local Stocks 83% Weights (%) Number of components ETF ETF Local Stocks 83% 83% ADRs/GDRs 1 17% 17% 9 9 Source: Bloomberg, data as at 31/12/ DR (Depository Receipts): DRs are created when a broker purchases a foreign company s shares on its home stock market, delivers the shares to the depository s local custodian bank and then instructs the depository bank to issue Depository Receipts. ADR (American Depositary Receipt): Negotiable certificate issued by a US bank representing a specific number of shares of a foreign stock traded on a US stock exchange and denominated in US dollars. GDR (Global Depositary Receipt): Very similar to ADRs. A bank certificate issued in more than one country for shares in a foreign company ADRs/GDRs make it easier for foreign investors to invest in Emerging Market securities.

5 Physical versus swap-based ETFs The direct holding of the underlying basket requires constant adjustment of the fund (corporate actions, rebalancing cost...) in order to replicate the index. This makes it more challenging for fund managers of physical ETFs to keep the tracking error as low as swap-based ETFs. However the HSBC MSCI Russia Capped ETF has, so far, delivered better tracking difference than most swap-based ETFs since launch. The good performance of the HSBC MSCI Russia Capped ETF to date is due to: The HSBC MSCI Russia Capped ETF being fully replicated. The ETF invests into the exact same local stocks and DRs 1 as the index Direct investment in local stocks: by investing in local stocks, the HSBC ETF eliminates the tracking error due to mismatch of the performance between local stocks and DRs 1 Foreign exchange and execution price: the HSBC ETF trades the same Ruble FX rate (WMR) and local stocks prices used by MSCI in the Russia Capped index, while Ruble is a restricted currency 2. Table 4: Performance of European-domiciled Russian equity ETFs Issuer HSBC db x-trackers ComStage Credit Suisse * ishares Source MSCI Russia Capped MSCI Russia Capped 25% MSCI Russia Capped 30% MSCI Russia ADR/GDR MSCI Russia Capped Russian Depository TER (bps) 60 Replication method Physical Launch date Tracking difference (Net) ** Start 05/07/2011 End 31/12/2012 Tracking difference (Gross) *** Tracking error **** Jul % -0.19% 0.34% 65 Swaps Dec % -0.51% 0.08% 60 Swaps Dec % 0.01% 0.07% 65 Physical Aug % -2.16% 0.11% 74 Swaps Sep % -0.69% 0.07% 65 Swaps Jan % -0.66% 0.05% Past performance should not be seen as an indication of future returns. Dividend distributions are reinvested. Source: Bloomberg and Providers websites, all data as at 31/12/2012 *Credit Suisse MSCI Russia ADR/GDR was previously swap-based until it converted to physical replication on 10 May **The tracking difference Net is the difference between the return of the fund (NAV) and that of the underlying index, after management fees (TER). ***The tracking difference Gross is the difference between the return of the fund (NAV) and that of the underlying index, before management fees (TER). ****The tracking error also known active risk, is the standard deviation of the tracking difference i.e. how variable is the tracking difference over time. 1 Refer to page 3 for definitions 2 Currency that can not be traded outside of its country due to local government regulation 3

6 The challenge with launching a physical ETF for Russian equities Challenges T+0 settlement cycle: The Russian exchange locks in the buyer s cash and seller s shares in real time. Which implies that the cash has to be held locally prior to trade on behalf of the ETF. Free of Payment (FOP) settlement: Foreign investors mostly trade over the counter (OTC 1 ) which is executed FOP, i.e. the seller delivers securities before receiving the cash, leaving the seller with counterparty exposure. Physical re-registration: Physical shares re-registration could take up to 30 days with the registrars, because there is no centralised depository. The buyer is not entitled to sell the shares until the shares are re-registered with the buyer s name. FX issues: The Russian Ruble is a restricted currency 2 and not all funds are able to execute creation and redemption prices against the WM Reuters closing spot rates (WMR). HSBC solutions Our local broker borrows and lends stocks on T+0 to enable the transaction in real time and ensure the ownership continuity of the fund. HSBC leverages the strong local presence and local custodian relationship in Russia to bring the settlement cycle in line with European market standards and in compliance with UCITS guidelines. The ETF settles on T+3 with the broker. The settlement is executed delivery versus payment (DVP). The buyer receives the shares and the seller receives the cash after the settlement is matched, largely reducing the counterparty exposure. The local sub-custody uses the bridge set up with Russia s largest depositories and a number of local registrars. No physical re-registration is required. As a result, the fund is not subject to the completion of long re-registration process to sell its holdings. The fund trades WM Reuters closing spot rates (WMR) with the local brokers, eliminating the tracking difference risk resulting from trading at different FX rate from the one used in the index. Conclusion By harnessing all of HSBC s capabilities, we have been able to manage a Russia equity and emerging market ETFs on a physical and competitive basis. It is also about focus. We have chosen to offer a physical product range that is high quality, as simple as possible and good value. We were determined to bring to market products such as the HSBC MSCI Russia Capped ETF, which was the first physical ETF in Europe tracking this market. 1 Over-the-counter(OTC) trading is to trade financial instruments such as stocks directly between two parties. The two parties agree on how a particular trade or agreement is to be settled in the future. It is usually from an investment bank to its clients directly. 2 Currency that can not be traded outside of its country due to local government regulation 4

7 Annex: facts and methodology The MSCI Russia Capped ( the ) is based on the MSCI Russia ( Parent ), which offers a representation of the Russian market by targeting all companies with a market capitalization within the top 85% of the Russian investable equity universe. At construction and at each rebalancing (quarterly review), if the weight of the largest Group Entity in the MSCI Russia is greater than 30 per cent, its weight will be capped at 30 per cent. The weight of the remaining Group Entities will be increased in proportion to their weight prior to such capping. If the resulting weight of any of the remaining Group Entities is greater than 20 per cent of the index, its weight will be capped at 20 per cent, while simultaneously maintaining the weight of the largest Group Entity at 30 per cent. The remaining Group Entities are weighted according to their free float adjusted market capitalizations applicable to foreign investors as a percentage of the remaining non-capped weight. On a daily basis, if the weight of the largest Group Entity in the MSCI Russia Capped increases above 35 per cent, its weight will be capped at 30 per cent. The weight of the remaining Group Entities will be increased in proportion to their weight in the MSCI Russia Capped prior to such capping. Any changes in the constituent companies of the Parent will also be reflected in the. and ETF codes MSCI Russia Capped Review period Rebalancing frequency Type of index Maximum weight currency Quarterly Quarterly* Total return (net) See capping details above USD * Rebalancings generally take place on the last business day of February, May, August and November. The top three sectors in the index as of 31 December 2012 were: Oil & Gas (56.28 per cent), Financials (17.10 per cent) and Basic Materials (10.45 per cent). Oil & Gas 56.28% Financials 17.10% Basic Materials 10.45% Telecommunications 8.00% Consumer Services 4.37% Utilities 3.43% Industrials 0.36% Top ten constituents Gazprom OAO 21.79% Lukoil OAO 14.48% Sberbank 14.14% Rosneft OAO 4.82% Novatek OAO-Spons Gdr Reg S 4.65% TR Bloomberg ticker TR Reuters RIC HSBC MSCI Russia Capped ETF MSEURC$N.dMIRU000P6NUS HRUB Uralkali 4.41% Magnit Ojsc-Spon Gdr Regs 4.37% Tatneft-Cls 4.34% Mobile Telesystems-sp Adr 4.08% MMC Norilsk Nickel Ojsc 3.78% Source: HSBC Global Asset Management (UK) Ltd, all data as at 31/12/2012 5

8 Important information This document is intended for professional clients only and should not be distributed to or relied upon by retail clients. The material contained herein is for information purposes only and does not constitute investment advice or a recommendation to any reader of this material to buy or sell investments. Care has been taken to ensure the accuracy of this document, but HSBC Global Asset Management (UK) Limited accepts no responsibility for any errors or omissions contained therein. Fund information HSBC ETFs are sub-funds of HSBC ETFs plc, an investment company with variable capital and segregated liability between sub-funds, incorporated in Ireland as a public limited company, and authorised by the Central Bank of Ireland. The company is constituted as an umbrella fund, with segregated liability between sub-funds. For investors in the UK All applications are made on the basis of the current HSBC ETFs plc prospectus, the relevant Key Investor Information Document ( KIID ), Supplementary Information Document (SID) and fund supplement, and the most recent annual and semi-annual reports, which can be obtained upon request free of charge from HSBC Global Asset Management (UK) Limited, 8 Canada Square, Canary Wharf, London, E14 5HQ, UK, or from a stockbroker or financial adviser. Investors and potential investors should read and note the risk warnings in the prospectus, relevant KIID and Fund supplement (where available) and additionally, in the case of retail clients, the information contained in the supporting SID. UK-based investors in HSBC ETFs plc are advised that they may not be afforded some of the protections conveyed by the Financial Services and Markets Act (2000), ( the Act ). The company is recognised in the United Kingdom by the Financial Services Authority under section 264 of the Act. For investors in France All applications are made on the basis of the current HSBC ETFs plc prospectus, relevant Key Investor Information Document ( KIID ) and supplement, and most recent annual and semi-annual reports, which can be obtained on our website: \fr or upon request free of charge from CACEIS France, the centralising correspondent in France, 1/3 Place Valhubert, Paris. Investors and potential investors should read and note the risk warnings in the prospectus, relevant Key Investor Information Document ( KIID ) and fund supplement. For investors in Switzerland The HSBC MSCI RUSSIA CAPPED ETF is registered in Switzerland in the meaning of Art.120 of the Federal Collective Investment Scheme and can therefore be distributed publicly in or from Switzerland. The prospectus and Key Investor Information Document (KIID) of the afore mentioned sub-fund and (semi-) annual reports of the Company can be obtained free of charge at the Swiss office of the Swiss representative of the fund: ACOLIN Fund Services AG, Stadelhoferstrasse 18, CH-8001 Zurich. Paying agent in Switzerland: HSBC Private Bank (Suisse) S.A., Quai Général Guisan 2, P.O. Box 3580, 1211 Geneva 3. There are risks involved with this type of investment. Please refer to the prospectus for general risk factors, and to the KIID for specific risk factors. All other funds within this document not specifically mentioned in this paragraph are not admitted for public distribution in Switzerland. This presentation is therefore intended exclusively towards qualified investors in the meaning of Art. 10 para 3 of the Federal Collective Investment Schemes Act (CISA). For investors in Spain All applications are made on the basis of the current HSBC ETFs plc prospectus, the relevant Key Investor Information Document ( KIID ) and fund supplement, and the most recent annual and semi-annual reports, which can be obtained upon request free of charge from HSBC Global Asset Management (France) Sucursal en España, Plaza Pablo Ruiz Picasso, 1, Torre Picasso floor 21, Madrid 28020, Spain. Investors and potential investors should read and note the risk warnings in the prospectus, relevant Key Investor Information Document ( KIID ) and fund supplement. The company is recognised in Spain by the Comisión Nacional del Mercado de Valores. For Investors in Italy The commercialisation in Italy of the HSBC ETFs sub-funds is subject to Consob s authorisation. All applications are made on the basis of the current HSBC ETFs Plc Prospectus, the relevant Key Investor Information Document ( KIID ), supplement and the most recent annual and semi-annual reports, which can be obtained upon request free of charge from HSBC Global Asset Management (France) Italian Branch (the Company ) - Piazzetta Bossi, Milano, Italy. Investors and potential investors should read and note the risk warnings in the Prospectus, relevant KIID and fund supplement. The Company is recognized in Italy by Banca d Italia. For investors in Sweden The commercialisation in Sweden of the HSBC ETFs sub-funds is subject to FSA s authorisation. All applications are made on the basis of the current HSBC ETFs Plc Prospectus, the relevant Key Investor Information Document ( KIID ), supplement and the most recent annual and semi-annual reports, which can be obtained upon request free of charge from HSBC Global Asset Management (France) S.A. Stockholm Branch ( the Company )- Birger Jarlsgatan 2 SE Stockholm, Sweden. Investors and potential investors should read and note the risk warnings in the Prospectus, relevant KIID and fund supplement. The Company is recognized in Sweden by Finansinspektionen. Restrictions The shares in HSBC ETFs plc have not been and will not be offered for sale or sold in the United States of America, its territories or possessions and all areas subject to its jurisdiction, or to United States persons. Affiliated companies of HSBC Global Asset Management (UK) Limited may make markets in HSBC ETFs plc. Risks The value of investments and any income from them can go down as well as up, and investors may not get back the amount originally invested. Where overseas investments are held, the rate of currency exchange may cause the value of such investments to go down as well as up. Investments in emerging markets are by their nature higher risk and potentially more volatile than those inherent in established markets. Stock market investments should be viewed as a medium to long-term investment and should be held for at least five years. Any performance information shown refers to the past and should not be seen as an indication of future returns. There are significant risks inherent in investing in Russia, which could affect the value of the investment. These include a lack of clarity in laws and regulations in the following areas: investor protection; banks and other financial services; the Russian economic system; taxation; transaction settlement and fiduciary duty; and responsibilities of company management. Please see the supplement for full information. To help improve our services and in the interests of security, we may record and/or monitor your communications with us. HSBC Global Asset Management (UK) Limited provides information to institutions, professional advisers and their clients on the investment products and services of the HSBC Group. disclaimer: The funds or securities referred to herein are not sponsored, endorsed, or promoted by MSCI, and MSCI bears no liability with respect to any such funds or securities or any index on which such funds or securities are based. The Supplement to the Prospectus contains a more detailed description of the limited relationship MSCI has with HSBC ETFs plc and any related funds. This document is approved for issue in the UK by HSBC Global Asset Management (UK) Limited, who is authorised and regulated by the Financial Services Authority; in France by HSBC Global Asset Management (France), a Portfolio Management Company authorised by the French regulatory authority AMF (no. GP99026), in Switzerland by HSBC Global Asset Management (Switzerland) Ltd and in Spain by HSBC Global Asset Management (France) Sucursal en España authorised and regulated in Spain by the Comisión Nacional del Mercado de Valores (CNMV). Copyright HSBC Global Asset Management (UK) Limited All rights reserved. FP Further information on HSBC ETFs For investors in the UK Tel: +44 (0) broker.sales@hsbc.com For investors in Switzerland Tel: swiss.investorservices@hsbc.com For investors in Italy Tel: hsbc-am.italy@hsbc.com For investors in France Tel: hsbc.client.services-am@hsbc.fr For investors in Spain Tel: asset.management.spain@hsbc.com For investors in Sweden Tel: +46 (0) Designed and produced by HSBC Global Publishing Services_130314_52349