On October 26, the revised compilation plans for the Shanghai Composite Index, the STAR Market Composite Index, and other Shanghai index series began implementation, bringing new management requirements for the investment operations of related index funds.
According to prior announcements from the Shanghai Stock Exchange and China Securities Index Co., Ltd., the revisions cover the Shanghai Composite Index, the Shanghai A-Share Index, the Shanghai Free Float Index, the STAR Market Composite Index, and related derivative indices. The main changes include adding a cap that limits the weight of any single constituent to no more than 15%, and adjusting the timing for removing risk-warning securities.
Industry insiders believe the revisions help improve the index risk management mechanism and optimize the indexed investment ecosystem. For related index funds, the implementation of the new plan does not mean forced concentrated rebalancing, but it does require greater attention to changes in constituent weights and index adjustment arrangements.
"The newly added rule capping any single constituent's weight at 15% aims to prevent excessive concentration in individual constituents and further improve the index's risk diversification mechanism," said Yang Delong, chief economist and fund manager at Qianhai Open Source Fund, in an interview.
Under the revised compilation plan, the relevant indices control the weight of any single constituent through weighting factors so that it does not exceed 15%. The weighting factors are adjusted on the trading day following the second Friday of each month, or when the weight of a newly included constituent exceeds 15%.
For funds tracking the relevant indices, whether holdings need to be adjusted mainly depends on the actual weight changes of the underlying index constituents. In Yang Delong's view, for broadly diversified composite indices, if existing constituent weights do not hit the cap, there may be no obvious need for rebalancing in the short term. Fund companies need to monitor index weight changes and prepare monitoring and response measures in advance.
Hou Wenjie, secretary-general of Yuce Think Tank, said in an interview that if the weights of relevant constituents are adjusted due to the cap rule, fund companies need to formulate trading plans based on index adjustments. By trading in batches and optimizing execution timing, they can reduce the risks that may arise from concentrated rebalancing.
The adjustment to the calculation rules for the timing of removing risk-warning securities also imposes new requirements on fund companies' investment management. Under the revised compilation plan, the removal timing for risk-warning securities is changed from starting on the date the risk warning is implemented to starting on the date the risk warning is announced. The actual removal date is still executed on the trading day following the second Friday of the following month.
This change means that related index funds need to pay more timely attention to listed companies' risk-warning announcements and prepare trading arrangements in advance based on index constituent adjustment schedules. Yang Delong believes that with the change in the calculation basis for removing risk-warning securities, fund companies need to track relevant announcements and index adjustment arrangements more promptly and optimize trading plans accordingly. Because some risk-warning securities may face reduced liquidity, fund managers need to reasonably arrange the pace of rebalancing based on actual trading conditions to avoid short-term concentrated trading increasing market impact costs.
"From a tracking management perspective, index constituent adjustments may cause a temporary deviation between a fund's actual holdings and the underlying index, resulting in certain tracking error. Especially when the liquidity of relevant stocks is insufficient and transaction prices fluctuate significantly, fund managers need to balance trading costs and tracking accuracy," Yang Delong further stated.
Hou Wenjie said fund companies can control the impact of index adjustments on fund operations by simulating rebalancing paths in advance, optimizing trade execution, and dynamically monitoring tracking error. At the same time, they should improve monitoring mechanisms for risk-warning securities and enhance portfolio adjustment efficiency.
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