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MEGA Summary: MSCI China ADR Inclusion 2nd Stage

Core Content

The document discusses the potential market impact of the MSCI China ADR Inclusion 2nd Stage, which is expected to take effect on May 31, 2016, following the MSCI announcement on May 12, 2016. It outlines the expected passive and active inflows into the MSCI China ADR index and provides insights into investment strategies, hedge options, and market positioning for the included stocks.

Main Points

1. Performance of the 1st Stage Inclusion

• Outperformance: The MSCI China ADR inclusion in the 1st stage led to a +37% outperformance compared to the MSCI China index over a 2-month period leading up to the Nov 30, 2015 rebalance.
• Timing: The outperformance began 2 months prior to the rebalance date.
• Impact Stocks: The stocks expected to see the biggest notional inflows and market impact include BAB, BIDU, CTRP, NTES, JD, with QUNR, EDU, BAB, BIDU, NTES likely to have the most significant impact in the days to trade.

2. Expected Flows for 2nd Stage Inclusion

• Passive Inflows: Anticipated to be USD4.5bn due to the full inclusion of MSCI China ADRs.
• Active Inflows: Expected to reach up to USD16.5bn, though timing and magnitude remain uncertain.
• Total Inflows: The combined passive and active inflows are estimated to be up to USD22bn.

3. Stocks Included in the 2nd Stage

The following stocks are expected to be included in the MSCI China ADR 2nd stage:

• BABA US (Alibaba Group Holding Ltd)
• BIDU US (Baidu Inc)
• CTRP US (Ctrip.com International Ltd)
• NTES US (NetEase Inc)
• JD US (JD.com Inc)
• VIPS US (Vipshop Holdings Ltd)
• WUBA US (58.com Inc)
• SFUN US (SouFun Holdings Ltd)
• EDU US (New Oriental Education & Tech)
• XRS US (TAL Education Group)
• QUNR US (Qunar Cayman Islands Ltd)
• YY US (YY Inc)

4. MSCI EM Weight Changes

• China's Weight: Increased from 23.9% to 26.0%.
• Other EM Countries: Slight reductions in weight, such as -0.6% for Other EM, -0.4% for Taiwan, and -0.3% for South Korea, India.
• China IT Sector: Gaining significant weight, potentially surpassing Taiwan in the MSCI China index.

5. Institutional and Hedge Fund Activity

• Institutional Buyers: Net sellers of USD1.2bn since July 2015.
• Hedge Funds: Have been buying Chinese ADR linked names for seven consecutive weeks, in contrast to being net sellers in the broader Info Tech sector.
• Short Interest: Increased in several stocks, with BABA US showing the highest short interest at USD7,017m (up from USD6,630m in October 2015).

6. Investment Strategies

• Buy Basket: Recommend purchasing a liquidity- or equal-weighted basket of the 10 inclusion stocks, with BABA and BIDU capped at 20% weight.
• Call Spread Collars: Suggest using costless call spread collars for BAB, BIDU, and CTRP due to lower implied volatility.
• Worst of Call: An ATM 17Jun 2016 call on BABU, BIDU, and CTRP is available at 3.75%, offering over 50% savings compared to vanilla calls.

7. Hedge Options

• MLDIADR3 Index vs FXI US: A long MLDIADR3 Index / short FXI US hedge is recommended.
• MLDIADR3 Index vs NASDAQ Internet & Tencent: A long MLDIADR3 Index / short NASDAQ Internet names and Tencent hedge is suggested.
• MLDIADR3 Index vs MSCI China (ex ADRs): A long MLDIADR3 Index / short MEGACXIT hedge is proposed.

8. Reporting Dates

• ADR Basket Names: Expected to report on April 19 to May 31, 2016.
• Comparable Stocks: Include GOOGL, FB, and AMZN, with reporting dates ranging from April 28 to July 21, 2016.

9. Earnings Beats

• The following companies are expected to report earnings beats:
  • Facebook
  • Amazon
  • Baidu
  • New Oriental Education
  • TAL Education
  • Alibaba
  • NetEase

Key Information

• MSCI China ADR 2nd Stage Inclusion is expected to have a significant impact on the market, with USD22bn in total inflows.
• Top stocks to watch include BABA, BIDU, CTRP, NTES, JD, and VIPS, which are expected to see the largest inflows.
• Hedge Funds have shown a positive stance towards the Chinese ADRs, while being net sellers in the broader Info Tech sector.
• Short Interest has increased in several ADR stocks, indicating greater market uncertainty.
• Hedge strategies are proposed using MLDIADR3 Index against FXI US, NASDAQ Internet names, and Tencent.
• Investment products are not FDIC insured and may lose value, with potential risks to capital.

Conclusion

The MSCI China ADR 2nd Stage Inclusion is anticipated to bring substantial passive and active inflows, with Alibaba, Baidu, and Ctrip leading the way. The report provides strategic recommendations for investors, including basket purchases, call spread collars, and hedge strategies, while highlighting market dynamics, short interest, and sector positioning. Investors should be cautious due to the uncertainty in active inflows and the potential risks associated with the investment products.