• Hang Seng Indexes, the compiler of the index, announced this week it will be making major changes to the main Hong Kong stock benchmark, and eventually include 100 constituents in the index.
• Other changes include the selection of constituents from seven industry groups as well as adopting an 8% weighting cap of all firms in included in the Hang Seng index.
• The shakeup in the Hang Seng index will be "very effective" for passive investors, according to Somerset Capital Management's Min Chen.

This week's announcement about a shakeup in Hong Kong's stock index is a "positive move" that could help diversify risks, according to Somerset Capital Management's Min Chen.

"We believe that (the Hang Seng Index's) new methodology will be a good way to prevent overconcentration in the risks and it's very effective to help the passive investors," Chen, portfolio manager of China strategy at the firm, told CNBC's "Street Signs Asia" on Tuesday.

Passive investing is a long term investment strategy aimed at minimal trading, and often involves buying into funds that track market barometers.

His comments came after Hang Seng Indexes Company, the compiler of the index, announced Monday it would tweak the main Hong Kong stock benchmark. The decision came after a month-long consultation exercise with its stakeholders, the company said.

In a press release, Hang Seng Indexes outlined five main changes to the Hang Seng Index. The changes will be implemented starting from the index review in May:

1. Increase constituents to 100: Targeting an increase in the number of HSI constituents to 80 by mid-2022, with the ultimate goal of having 100 firms in the index. The index currently has about 55 constituents.
2. Select constituents from seven industry groups: These range from financials, information technology to health care. The target is to achieve at least 50% coverage, by market capitalization, of each industry group.
3. Shorten listing history requirement: This will be reduced to three months, making it potentially faster for new listings to be added to the index.
4. Maintain representation of Hong Kong firms: About 20 to 25 constituents classified as Hong Kong companies will be maintained in the HSI, and the number constituent stocks will be reevaluated at least every two years.
5. Lower the weighting cap to 8%: All HSI constituents — which include those with weighted voting rights or secondary-listings — will be subject to a weighting cap of 8%. Constituents with weighted voting rights or secondary listings are currently capped at 5%, while others are capped at 10%.

"The new enhancements to the HSI will further increase its representation and make the Index more balanced and diversified," Anita Mo, CEO of Hang Seng Indexes, said in the release.

Hong Kong's benchmark index has had a strong start so far this year, rising more than 9% since January, as of its Wednesday close.

Chen the portfolio manager said the new changes will increase exposure of the Hang Seng to new economy sectors, as well as maintain a reasonable amount of diversification.

Pointing to the weighting cap decline to 8%, he said this was much lower than other indexes. He cited the MSCI China Index as an example, where tech juggernauts Alibaba and Tencent cumulatively account for more than 30% in weighting.

How investors might react

Goldman Sachs pointed out that investors will likely reallocate their portfolios in light of the Hang Seng overhaul.

"As the HSI raises the number of constituents to 80 and applies an 8% weighting cap on all the constituents, the top current index constituents could see outflows led by the reallocation as their index weights would be re-capped at 8%," Goldman analysts said in a Tuesday note.

Meanwhile, weighted voting rights or secondary listing firms — in addition to potential new additions in the index — could see "large inflows" as their index cap is lifted to 8% from 5%.

Firms that currently have a weighting of more than 8% on the Hang Seng include gaming giant Tencent as well as life insurer AIA, according to data from Hang Seng Indexes.

"In addition to the portfolio reallocation flows, we expect the enhanced HSI index, with its expanded index coverage and higher exposure to New China, could attract more capital to track it as the benchmark," the Goldman Sachs analysts said.

"As the index cap could increase by 25% when the number of index constituents reaches 80, we forecast the (assets under management) tracking HSI could grow proportionally from around US$20bn now to US$25bn," they said.

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