To The Moon

In the previous lesson, we provided a brief overview of the classification of Hong Kong ETFs.

This time, we will walk you through the lesson from an investment perspective, focusing on three key categories of Hong Kong ETFs: "Broad Market Index ETFs, Sector/Thematic ETFs, and Leveraged/Inverse ETFs." This will help unlock more investment potentials.

1.Broad-Based Index ETFs

Broad-Based Index ETFs are the type of ETFs that most investors will come to know first.

In the Hong Kong market, there are numerous index ETFs, with the most prevalent being the Broad-Based Index ETFs.

Currently, the largest Broad-Based Index ETF in size is TRACKER FUND (2800.HK), which tracks the Hang Seng Index. Additionally, there are ETFs that track the Hang Seng China Enterprises Index, such as HSCEI ETF (2828.HK), as well as ETFs following the Hang Seng Tech Index, like CSOP HS TECH(3033.HK) and IHSARESHSTECH (3067.HK).

Apart from Hong Kong stock indices, there are also many ETFs tracking China A-shares. For instance, CSOP A50 ETF (2822.HK) and the CAM CSI 300(3188.HK) are actively traded, which tracks the SSE 50 Index and CSI 300 Index respectively. There's also the X CSOPCHINEXT (3147.HK) that tracks the ChiNext Index. These broad based index ETFs boast active trading, substantial size, highly liquid, and have comparatively lower trading costs and management fees.

The benefit of investing in Broad Based Index ETFs is that you only need a relatively small amount of capital to own blue-chip and state-owned enterprises' shares, a low road for investing.

Another type of index ETF that investors favor is high-dividend index ETFs.

If you're looking for stable returns with regular dividends, you could consider high-dividend index ETFs.

In general, Broad-Based Index, index ETFs and high-dividend index ETFs tend to have lower volatility. Investors with a lower risk appetite could consider buying these as their "core holding".

2.Sector/Thematic ETFs

The second most sought-after category is sector/thematic ETFs, which invest in stocks of a specific industry or with a particular theme. They are known for their potential to generate significant returns.

For instance, if you are optimistic about the future development of electric vehicles and wish to invest in stocks of that sector, but are unsure of how to pick and choose, investing in a sector ETF focused on electric vehicles could be an option. During the growth stock rally of 2020-2021, the performance of many electric vehicle ETFs doubled.

Apart from the substantial profit potential, sector/thematic ETFs could potentially mitigating the volatility of a certain stock.

For example, starting from August 2022, Warren Buffett have been reducing Berkshire's holdings of BYD H-shares, from 19.92% to less than 10%.

BYD used to be one of Buffett's favourite stock. As far back as 2008, Berkshire Hathaway had acquired 225 million shares of BYD stock for US$232 million. In 2021, they held around 21% of BYD's shares, with a peak market value of over US$7 billion. Over more of than a decade of holding BYD, Buffett openly expressed his keen interest of the company a multiple times.

However, after August 2022, Berkshire began selling its BYD holdings. As of June 19, 2023, Berkshire Hathaway has reduced its holdings for BYD H-shares 12 times, down to only about 98.61 million shares of BYD H-shares.

Since Berkshire's sell-off began, BYD's maximum decline reached 32%, causing significant losses for investors who held onto BYD during this period. With hindsight, if you had held GX CN EV ETF (02845.HK) instead during this time, your drawdown might have been reduced by 12%.

（Source：Tiger Trade; 2022/08/09-2022/10/19）

（Source：Tiger Trade; 2022/08/09-2022/10/19）

Therefore, while sector/thematic ETFs are the "dark horses" of investment, allowing you to achieve high returns at certain stages, investing in industry and theme ETFs requires a better grasp of market timing for sector rotation and demands more attention to short-term volatility risks.

In addition to the GX CN EV ETF (02845.HK) we've discussed earlier, you can also find more sector/thematic ETFs by visiting the Hong Kong Stock Exchange's official website.

3.Leveraged/Inverse ETFs - "Magnifiers"

The third most talked-about category is Leveraged and Inverse (L&I) ETFs - products that invest in indices, also referred to as "magnifiers", as they can amplify the rise and fall of indices.

Leveraged products, also known as Bull ETFs, achieve positive multiples of the target index's daily returns by investing in leverage tools such as stock index futures and swap contracts.

For instance, a 2x leveraged product for the Hang Seng Index is constructed in a way that when the Hang Seng Index rises 1% on a certain day, theoretically, its net asset value should increase by 2% on the same day, thereby magnifying investment returns. On the other hand, it will lose 2% if the index declines by 1%.

Inverse products, also known as Bear ETFs, similarly invest in stock index futures or swap contracts, but achieve the opposite multiple of the target index's daily returns. For example, a -1x inverse product for the Hang Seng Index should see its net asset value rise by 1% when the Hang Seng Index drops 1%, thus availing investors the opportunity to profit from falling markets.

Why should you learn more about leveraged and inverse ETFs?? Let's delve into some key points:

(1) Amplifying Investment Returns in Trending Markets

Firstly, because Leveraged ETFs can use derivative products such as options, futures, or swap contracts to amplify the index's returns, these ETFs can potentially offer higher returns compared to traditional ETFs. This effect is known as the multiplier effect of leveraged products.

Usually, Leveraged ETFs provide twice the index returns, meaning when the underlying index rises 1%, the 2x Leveraged ETF should rise by 2%.

Let's say you're optimistic about the performance of the Hang Seng Tech Index and you buy an XL2 CSOP HSTECH ETF (7226.HK), since this ETF offers 2x leverage, when the Hang Seng Tech Index rises 5%, this ETF should rise by 10%.

(Source: Csopasset)

An Inverse ETF, also leveraged like a Leveraged ETF, has its role in moving in the opposite direction of the benchmark index. For instance, a 1x Inverse ETF (-1x) should rise by 5% in theory when its corresponding index drops 5%. Similarly, a 2x Inverse ETF (-2x) should theoretically rise 10% when its corresponding index drops 5%.

Let's say you're bearish on the Hang Seng Tech Index's trend, so you buy an XI2CSOPHSTECH ETF (7552.HK). As this ETF offers 2x inverse leverage, when the Hang Seng Tech Index falls 5%, this ETF should theoretically rise by 10%.

(Source: Csopasset)

Therefore, with Leveraged and Inverse ETFs, investors can trade with leverage and take either positions based on their view of the trend, and readily available for them to complement their existing investment strategies.

(2) Hedging Stock Holding Risks for Enhanced Portfolio Returns

Leveraged ETFs and Inverse Leveraged ETFs not only allow you to magnify returns by predicting market trends but can also be integrated into your investment portfolio to enhance overall returns.

In recent years, there have been frequent occurrences of market black swan events, such as the pandemic, liquidity crises, and geopolitical tensions, which often lead to increased market volatility. Even popular stocks like Tencent and Alibaba are not immune to such market fluctuations.

In the midst of a downturn, instead of parting with your favoured stocks, you can consider purchasing Inverse (-2x) Leveraged ETFs as a hedging tool.

But how do you implement this strategy?

For example:

From January 2020 to December 2020, the Hang Seng Tech Index experienced 5 significant fluctuations due to various risk factors.

(Source: Csopasset)

If you bought Alibaba (BABA.US) stocks at the start of this period and held them till the end of this period, your final cumulative return would be around 26.16%.

How could you have achieved more during this period of time? One answer is by purchasing inverse (-2x) leveraged ETFs at the right time, as follows: Buy inverse (-2x) leveraged ETFs when the 10-day annualized volatility of the Hang Seng Tech Index exceeds 40%, and sell the inverse (-2x) leveraged ETFs when the 10-day annualized volatility falls below 50% (if it doesn't reach 50%, then sell when it drops below 40%).

Backtesting shows that this strategy's return would reach 54.92%, which is 28.8% more than merely holding on to the same stocks. Furthermore, this annualized volatility would be 6% lower than holding alone, meaning you would experience a more pleasant investment journey than just holding on to these stocks. The Sharpe ratio is 1.08 higher than merely holding too - higher return for the same amount of risk.

(Source: Csopasset)

After you've understood the examples above, you should now be aware of the advantages of leveraged and inverse ETFs. However, we also need to acknowledge their risks, including but not limited to:

(1) Requires accurate judgment, higher risk of loss

As returns could be amplified, losses could similarly be magnified. For instance, when the underlying index drops by 1%, a 2x leveraged ETF should drop around 2%. In certain market fluctuations, leveraged ETFs might even lose all or a significant portion of their value.

Daily Target Returns and Compounding Risk – Most L&I ETFs "reset" daily, meaning that they are designed to achieve their stated objectives on a daily basis. Due to the effect of compounding, the return for investors who invest for a period different than one trading day may vary significantly from the L&I ETF's stated goal as well as the target benchmark's performance.

This is especially true in very volatile markets or if a leveraged ETF is tracking a very volatile underlying index. Investments in L&I ETFs must be actively monitored throughout the day and are typically not appropriate for a buy-and-hold strategy.

(2) The price of inverse ETFs could potentially become "0"

Inverse ETFs are primarily constructed by other derivative instruments. As the represented index rises continuously, the price of inverse ETFs keeps decreasing. In theory, when the index rises by 1x, the value of the inverse ETF would become zero. The issuer might announce dissolution to prevent the asset value of this inverse ETF from becoming negative.

Lastly, we have compiled a table below with commonly seen leveraged and inverse ETFs in the market for your reference:

(Data Source: Compiled internally, this data is provided solely for illustrative purposes in the course and does not constitute any financial advice.)

Alright, that's the end of this lesson. We believe you've gained a good understanding of these three key types of ETFs. In the next lesson, we'll guide you through practical knowledge of trading Hong Kong ETFs. See you then!