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IHS Markit Fair Value Case Study: China Golden Week 2020
21 October 2020
Fair Value Event: China Golden Week Exchange Holiday,
October 2020
IHS Markit Fair Value in review
When market quotations are not readily available, such as when a
foreign security's primary market is closed, many funds switch to
fair value pricing. Using fair value pricing ensures that investors
in the fund benefit from the most accurate share price possible.
IHS Markit provides an independent fair value service that
calculates the best estimate of stock and bond prices outside of
active trading hours.
The following case study provides an analysis of fair value
results for the China Golden Week stock exchange closure that
spanned five days from October 1-8, 2020 and included several
consecutive national holidays. In the absence of readily available
quotes for Chinese securities during this holiday, IHS Markit
provided fair value prices for Chinese securities to enable
investors, primarily mutual funds with Chinese exposure, to more
accurately calculate their net asset values (NAVs).
IHS Markit Fair Value results - 2020 Chinese Golden
Week
Throughout the Chinese stock exchange holiday, IHS Markit
continued to provide fair value prices, calculated using
patent-pending multi-factor methodology, for 3600+ Chinese
securities. The most common input factors in the IHS Markit Chinese
fair valuation models included:
Hang Seng Index Futures, S&P Futures
iShares China Large-Cap ETF, Sector ETFs
Chinese ADRs
Despite the Coronavirus refusing to ease its grip on most of the
world, over 630 million Chinese traveled during the national
holiday, spending tens of billions on goods and services. While the
numbers were down from 2019, the magnitude of consumer spending was
a positive sign for a Chinese economy ravaged by a global pandemic
and continuing trade war with the United States.
In addition to the economic activity within China, major market
indexes such as the S&P Index had steady upward trends
throughout the holiday. And, unusually, Golden Week ended on a
Thursday. Chinese markets reopened on Friday, October 9th. Fair
Valuation is most difficult in Friday to Monday open situations, as
there is far more time for significant market events to occur
between valuation points.
Consistent market movements and a business week reopening set
the stage for highly accurate fair value performance. 3621 out of
3696 IHS Markit priced Chinese securities opened on October 9th. We
were directionally across 3596 individual securities and closer to
open across 3383. Potential arbitrage was reduced by 50% or more
for 2286 securities. The two tables below showcase overall
performance. Table 1 displays unweighted averages while table 2
aggregates IHS Markit's priced universe by market cap into a single
fund.
Fair Value Modeling: Market Events and Human
Bias
The classic approach to fair valuation is to use a proxy such as
the S&P Futures and apply its return over a duration as the
fair valuation adjustment for a group of securities. From that
starting point, methods such as single variable regression modeling
can increase the complexity of this process. Within single variable
regression, look back periods determine the training data set, and
different proxies can be used for different regions.
IHS Markit's multifactor stepwise regression model uses a
yearlong look back period, specific global factor combinations for
each country, approximately fifty sector factors assigned to one
hundred and forty plus individual classifications, and thousands of
ADRs to build custom models for tens of thousands of securities.
Using detailed models in a completely automated process allows for
consistent accuracy over long time horizons.
Often during holidays such as the Chinese Golden Week or times
of market volatility, investors pay extremely close attention to
major market indicators such as the four in the chart below. Fair
valuations for relevant securities not in line with the observed
movements of these indicators raises alarms.
As shown below, these four major Chinese proxies were trading
significantly up from the September 30th Chinese market close
through the October 8th US Market close. Any rational actor could
assume that since the Hang Seng Futures and MSCI China Large Cap
ETF were both trading up roughly 3.5% over the weeklong period,
Chinese markets would open on the 9th somewhere in that range.
However, despite the market optimism outside of China, the
average return over the holiday for Chinese securities was only
1.5%. A +3.5% fair valuation adjustment would significantly
overvalue an investor's holdings, opening large arbitrage
opportunities. The use of rigorously tested, detailed fair
valuation methods prevents seemingly rational human observations
from exposing portfolios to arbitrage.
Fair Value: Individual Large Cap Securities
As in the tables displaying overall performance, IHS Markit fair
value captured movement with precision at the security level. Table
three displays performance across various individual Chinese
securities with large market capitalizations.
IHS Markit's Fair Value service helps clients meet their
regulatory and compliance requirements by providing daily fair
value adjustment factors and prices for over 150,000 equity and
fixed income securities. We provide security-level as well as
aggregate-level fair value adjustment factors across global hourly
snaps with the ability to add custom snap times tailored to client
requests. To learn more, please visit: ihsmarkit.com/products/pricing-data-fair-value.html
or contact:
MK-FixedIncomePricingBusinessDevelopment@ihsmarkit.com
Appendix
Actual Overnight Return: The return of a security from its last
close to its next open, regardless of how long the time gap may
be.
Directional Correctness: occurs when a fair value price is in
the same direction (+, -) as the actual overnight return of the
underlying security. The values present in the document are the
proportion of securities within a group that were directionally
correct.
Closer to Open: whether a fair value price is closer to the next
day open than the previous close. The values present in the
document are the proportion of securities within a group that were
closer to open.
Arbitrage Reduction: the amount of the movement in the
underlying security that we captured using our Fair Value price.
These values can be positive or negative, with 100% being full
capture. For tables 1 and 2, the values are the average arbitrage
reduction across the group.
Market Cap Calculations: To represent components of an index we
use shares outstanding multiplied by either the close, fair value,
or open price of a security. The result of this is an individual
security's market cap at a given time. The sum of the securities'
market caps within each index gives the total market cap at a given
time. Domestic currencies are used for all calculations.