On January 10, a significant milestone was reached in the investment landscape of China with the approval of the first-ever free cash flow Exchange-Traded Funds (ETFs) by Huaxia Fund and Guotai FundThese ETFs, which are set to begin trading on December 16, 2024, track two distinct indices: the Guozhen Free Cash Flow Index and the FTSE China A-Share Free Cash Flow Focus IndexThis development is indicative of a broader evolution within the index ecosystem in the financial markets, providing investors with a wider array of tools for index-based investment strategies.
The concept of free cash flow is not entirely new, particularly in the western financial markets, where it has been recognized as an essential metric for assessing a company's financial health and viabilityIn fact, the Pacer US Cash Flows 100 ETF (COWZ), introduced in 2016, has grown to a substantial asset size of $26.8 billionThe COWZ ETF, by focusing on companies exhibiting strong free cash flow rates, has been an essential component of many portfolios owing to its consistency and reliability as a performance gauge.
Free cash flow is the cash that a company generates after accounting for capital expenditures such as buildings or equipmentIts importance lies in its role as a measure of a company’s ability to generate additional wealth for shareholders—be it through dividends, stock buybacks, or reinvestment in growth potentialHuaxia Fund emphasizes that free cash flow is vital for the survival and growth of businesses and crucial for sustaining stable cash dividendsIn China, firms with high free cash flow have consistently outperformed their peers in the stock market, especially during years of economic instability and volatility.
Market analysts note that the rising approval of free cash flow ETFs represents the increasing sophistication of the financial market ecosystem in China, illustrating that investors are seeking more specialized, diverse, and effective investment vehicles
Advertisements
As financial markets mature, there is a growing demand for more granular investment options that cater to various risk appetites and strategic preferences.
The Guozhen Free Cash Flow Index, launched at the end of 2012, underwent modifications for the second half of 2024, which included a wider selection of stock candidates from across various exchangesNotably, the index excludes companies from the financial and real estate sectors due to their distinct cash flow characteristics, aiming to provide a clearer and more reliable metric for free cash flow assessment among the remaining sectors.
The methodology for constructing the Guozhen Free Cash Flow Index elaborates on stringent selection criteria, beginning with the removal of the lowest 20% of securities based on their average daily trading volume over the past six monthsIt further disqualifies companies based in the financial or real estate industries and those with the least stable Return on Equity (ROE) over the past twelve quartersThe final index sample is derived from the top 100 companies ranked by their free cash flow rates, which are calculated as free cash flow divided by enterprise value.
In contrast, the FTSE China A-Share Free Cash Flow Focus Index provides an alternative perspective by encompassing a broader range of industry representation, including sectors like automobiles, energy, and metals without excluding financial and real estate industriesThis index seeks to reflect the performance of stocks that possess ample free cash flow and are perceived to be undervalued in the market.
The rising focus on free cash flow concepts parallels the recent introduction of additional free cash flow indices by CNI, catering to the growing institutional demand for structured investment solutionsThe CNI plans to unveil three new indices—HS300 Free Cash Flow Index, CSI500 Free Cash Flow Index, and CSI1000 Free Cash Flow Index—on November 12, 2024. These indices will reflect the overall performance of publicly listed companies that show higher free cash flow rates within their respective benchmark samples.
The focus on free cash flow is largely driven by its comprehensive nature as it illustrates a company's ability to generate cash that can be used for dividends, debt repayment, and reinvestment
Advertisements
Advertisements
Advertisements
Advertisements