Many investors may know that there is a significant difference between the Chinese stock market and the U.S. stock market. That is, the U.S. stock market is dominated by institutional investors, while individual investors, or retail investors, in the Chinese stock market account for a considerable share of the market. Proportion.

Statistics show that in 2018, U.S. institutional investors held 93.2% of the market value, while individual investors held less than 6% of the market value. According to the 2017 Statistical Yearbook released by the Shanghai Stock Exchange, as of the end of 2017, the market value of A-share institutional investors was 4.53 trillion, and that of individual investors was 5.94 trillion. There are significant differences between individual investors and institutional investors in their investment philosophies and methods, and there are also significant differences in profits. Taking 2017 as an example, retail investors in the Shanghai Stock Exchange contributed 82.01% of the trading volume, while institutions only accounted for 14.76%. Retail investors have a trading volume that is five times higher than that of institutions, but the profits they receive are less than 30% of those of institutions.

Generally speaking, institutional investors pay more attention to medium- and long-term value investments, while retail investors statistically have more irrational and short-sighted behaviors. Theoretically, the ultimate source of profits for stock market investors is the profits and growth of listed companies. Therefore, investors in a mature market must adhere more to fundamental value investment logic.

Since the second half of 2016, the proportion of institutional investors in A-shares has gradually increased to close to 50%. At the same time, MSCI inclusion, new asset management regulations, tax deferral and other policies will benefit the entry of institutional investors in the long term. A-shares are developing in a mature and stable direction, and fundamental value investment will gradually highlight its value and significance.

Figure 1 Proportion of A-share institutional investors

In many cases, the Shanghai Stock Exchange 50 and CSI 300 Index are considered the reference standards for fundamental investment. Both the SSE 50 and the CSI 300 use company size as the selection criteria for index constituents (the CSI 300 also considers liquidity). There is a strong correlation between company size and fundamentals, but there is no necessary connection. The Harvest Fundamental 50 Index starts from fundamental value and selects the 50 stocks with the largest fundamental value in the Shanghai and Shenzhen stock exchanges, which can better achieve the purpose of fundamental value investment.

The fundamentals of listed companies include financial status, profitability, market share, operation and management system, talent composition and other aspects. The frequently used basic indicators mainly involve two aspects: financial status and profitability. The Fundamental 50 Index selects four indicators: dividends, operating income, net assets, and cash flow. These fundamental indicators are not directly related to the stock price and can reflect the company's economic scale and represent the company's value

Fundamental 50 The preparation can be divided into three steps:

1. Calculate fundamental value

Select four fundamental indicators: dividends, operating income, net assets, and cash flow, and calculate the average of the four indicators in the past five years for each listed company. Under each fundamental indicator, calculate the proportion of each company, and calculate the sum of the proportions of each indicator of listed companies, that is, the fundamental value.

2. Calculate the investable fundamental value

Use the fundamental value multiplied by the proportion of outstanding shares to calculate the investable fundamental value.

3. Fundamental stock selection and fundamental value weighting

Select the top 50 stocks based on investable fundamental value. The weight of each stock is determined based on the proportion of its investable fundamental value among the 50 selected stocks.

The way the Fundamentals 50 Index is compiled determines that it has the following advantages. First, the non-market capitalization weighting method can avoid pricing errors. Compared with the U.S. stock market, A-shares are still a relatively inefficient market. In an inefficient market, stocks have pricing errors and mean reversion characteristics, that is, overvalued stocks have worse expected performance, while undervalued stocks have better expected performance. Under the market capitalization weighting method, overvalued stocks are given high weights, and undervalued stocks are given low weights, which is not conducive to index performance, while fundamental value weighting can better reflect the relationship between the company's quality and stock price. Secondly, compared with the SSE 50 and CSI 300, the Fundamentals 50 Index has the characteristics of low valuation and high dividends. Higher dividend yields are also more in line with investor preferences.

Figure 2 Valuation advantages of the Fundamentals 50 (March 20, 2019)

Compared with the Shanghai Composite 50, the Fundamentals 50 Index has experienced significant excess returns in the long term. The cumulative return in the past five years (2014-2018) was 138%, and the annualized excess return on the SSE 50 was 8%. At the same time, in the past five years, the Fundamental 50 has steadily outperformed the Shanghai Composite 50 every year, highlighting the value of fundamental investment through empirical evidence. Harvest Fundamentals 50, the fund corresponding to the Fundamentals 50 Index, received Morningstar’s three-year and five-year five-star ratings.

Figure 3 Comparison of fundamentals 50 and SSE 50 performance

Figure 4 Fundamentals 50 excess returns in the past five years

In summary, fundamentals 50 is equivalent to Blue chip stocks selected based on fundamental value among blue chip stocks have the advantages of indexed passive investment and fundamental value driving, as well as the advantages of lower valuation and higher dividend rate. As the Chinese market gradually de-retailes and becomes more stable and mature, the fundamentals of 50 are expected to further reflect its investment value.