Xingye Securities released a research report stating that, in the long term, the domestic ETF market is expected to continue to focus on large-cap stocks, high concentration, and continuous expansion, promoting the revaluation of domestic leading companies. Looking at the experience of the US stock market, the expansion of passive funds is an important reason for the long-term outperformance of US leading stocks. The current domestic ETF market also presents the important characteristics of focusing on large-cap stocks, high concentration, and continuous expansion. In the future, broad-based ETFs are likely to continue to maintain a dominant position, and products invested in leading stocks such as the CSI 300, China Securities A50, SSE 50, and STAR 50 are expected to remain the main force in expansion, benefiting large-cap leading stocks. Various industry and style ETFs also adhere to the market value weighting characteristic, benefiting leading stocks in various industries. In the long term, the expansion of domestic ETFs is expected to promote the revaluation of leading companies in the domestic market.

I. Passive fund scale: Nearly a trillion yuan in net inflow since 2023, currently exceeding 2 trillion yuan

In the past two years, the expansion of passive funds has accelerated again. Passive index funds have accelerated their expansion in recent years, especially with more significant increases since last year. As of the end of Q2 2024, the market value of A-shares held by passive index funds has exceeded 2 trillion yuan, while it was only 446.6 billion yuan in 2018.

From the perspective of net inflow, since 2023, stock ETFs have already seen a net inflow of nearly a trillion yuan, becoming one of the leading increments in the market. The disclosure transparency of stock ETFs is relatively high, and the net inflow scale can be estimated through the daily disclosed share changes and transaction prices. According to calculations, as of July 26, 2024, the cumulative net inflow of stock ETFs since 2023 has reached nearly a trillion yuan, amounting to 999.8 billion yuan, of which broad-based ETFs have cumulatively inflow of 883.5 billion yuan.

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At the same time, the trading activity of stock ETFs has also been increasing. This year, the average daily transaction amount has accounted for 5%-7% of the total A-shares.

II. ETF product matrix/structure: Product diversification, still mainly broad-based

Under the encouragement and care of policies, the product matrix of passive index funds has become more and more perfect in recent years. In recent years, the regulatory authorities have always encouraged the innovation and development of ETF-related products. The "Nine National Articles" launched in April this year specifically mentioned "establishing a fast approval channel for exchange-traded funds (ETFs) and promoting the development of index investment."

Since 2022, passive index funds have still been able to maintain a hot momentum of 10-40 new products per month. Unlike previous products that were mostly concentrated on a few indexes such as the CSI 300, SSE 50, and STAR 50, new products in recent years have deepened the diversity of passive investment. New products not only cover small and medium-cap indexes such as the CSI 1000 and CSI 2000 but also focus on important directions that meet national strategic development, such as carbon neutrality, central enterprises, and technology.

From the perspective of product distribution, the characteristic of product matrix diversification has become increasingly significant. In the past, the market's perception of ETF products was mainly focused on weight indexes such as the CSI 300 and SSE 50, as well as popular industry directions such as liquor and securities. However, since 2022, it can be seen that the issuance of ETFs has shown two new characteristics: 1) The market value and sector coverage are broader, such as more issuance of tracking products covering small and medium-cap listed company indexes such as the CSI 1000, CSI 2000, and STAR 100; 2) Industry and thematic ETF products are more focused on directions that meet the economic transformation, such as TMT and manufacturing.

From the perspective of the proportion of existing stocks, ETFs are still mainly broad-based. At present, broad-based ETFs tracking large-cap indexes such as the CSI 300, STAR 50, and SSE 50 are still the mainstream of the market. As of the end of Q2 2024, the scale proportion of broad-based ETFs reached 69%, with TMT (7%), consumer pharmaceuticals (7%), and financial real estate (5%) ETFs having a relatively high proportion. Among broad-based ETFs, the scale proportion of products invested in the CSI 300 is close to half, and the scale proportion of products invested in leading indexes such as the China Securities A50, SSE 50, and STAR 50 also accounts for nearly 1/4. The expansion of passive funds focuses on large-cap leading stocks.III. ETF Holder Structure: High Individual Share, Significant Increase in Insurance Holdings in Recent Years

Both institutions and individuals have increased their holdings of equity ETFs in recent years, with individual investors currently holding a higher proportion of the market. In terms of holder structure, as of the end of 2023, institutional and individual investors held equity ETF products worth 648.6 billion yuan (45.1%) and 789.4 billion yuan (54.9%) respectively, with individual investors currently holding a higher proportion of the market.

From the perspective of holdings, private trusts, insurance, and securities proprietary are the main institutional investors in ETFs. According to the Shanghai Stock Exchange's 2023 data on institutional investors in the Shanghai market, the top institutional investors in terms of average daily ETF holdings are private trusts (184.4 billion yuan), insurance (155.2 billion yuan), and securities proprietary (143.2 billion yuan).

Among them, insurance funds saw the most significant increase in average daily holding value in 2023, increasing by more than 70 billion yuan compared to 2022, making it an important institutional investor in increasing ETF holdings in 2023. In addition, the average daily holding value of securities proprietary (+27.1 billion yuan), corporate annuities (+1.06 billion yuan), and private trusts (+0.41 billion yuan) also saw certain increases in 2023.

From the perspective of trading volume, institutional investors account for more than 60% of the transaction volume, with securities proprietary, private, and foreign investors being the most active. In 2023, the transaction volume of institutional investors in equity ETFs has exceeded 60%, with securities proprietary, private trusts, and foreign capital being the most active, with total transaction volumes of 6.7 trillion yuan, 4.3 trillion yuan, and 1.0 trillion yuan respectively in 2023, accounting for 90.57% of the total transaction volume of institutional investors. Other institutions such as general legal persons, insurance, fund proprietary accounts, public funds, and corporate annuities are also quite active in ETF trading, with ETF transaction volumes exceeding 100 billion yuan.

In terms of various types of ETFs, institutional investors hold a higher proportion in central and state-owned enterprises and broad-based products, while individual investors hold a significantly higher proportion of consumer healthcare, financial real estate, manufacturing, and TMT products than institutional investors.

IV. Industry Holding Structure: Passive Holdings in Non-Bank Finance, Banking, and Construction Exceed Active Holdings

At the industry level, as of the end of 2023, under the full holding disclosure of fund annual reports, the proportion of passive fund holdings in non-bank finance, banking, and building decoration industries has already exceeded that of active funds, with passive proportions of 77.9%, 66.0%, and 50.2% respectively. The passive fund proportions in public utilities, beauty care, coal, power equipment, petrochemicals, steel, electronics, and other industries are also relatively high, all exceeding or approaching 40%.

Looking at the secondary industries, in industries such as coke, securities, joint-stock banks, insurance, infrastructure, and aerospace equipment, the proportion of passive fund holdings is significantly higher than that of active funds.

In terms of absolute levels, as of the end of 2023, the industries with the highest proportion of passive fund holdings in terms of floating market value are electronics (3.9%), non-bank finance (3.4%), power equipment (3.3%), pharmaceuticals and biotechnology (3.2%), and food and beverages (3.1%). Benefiting from the overall trend of passive fund expansion, the proportion of passive fund holdings has steadily increased in most industries over the past five years.Five, Individual Stock Position Structure: Passive Holdings of the Top 50 Mutual Funds Exceed Active Holdings

The proportion of passive fund holdings has rapidly increased, and currently, the relative holding proportion of passive funds in the top 50 stocks held by mutual funds has exceeded 50%. As of the end of Q2 2024, among the top 50 stocks held by equity funds (passive index + active equity), the holding proportion of passive funds has already broken through the 50% mark, jumping to 51.6%, while at the end of 2021, the passive proportion was only 22.9%. Under the full holding口径 of equity funds, the holding proportion of passive funds has also risen to 43.4%, while at the end of 2021, the proportion was only 21.4%.

At the level of all individual stocks, the influence of passive funds has also been gradually increasing. As of the end of 2023, there are already 26 stocks where the proportion of passive fund holdings exceeds 10% of the circulating market value, and there are 144 stocks and 211 stocks in the 5%-10% and 3%-5% ranges, respectively.

Specifically, the listed companies where the proportion of passive fund holdings exceeds 10% of the circulating market value include SMIC,澜起 Technology, Jingchen Shares, and Sino Micro Company, etc., which are mainly concentrated in the Science and Technology Innovation Board and the Growth Enterprise Market.

Six, Impact of Passive Expansion: Reshaping the Style of Large-cap Leaders

Since the second half of last year, there has been an important change in the dominant funds, and ETFs have become one of the most important incremental funds. Looking at several main types of funds, during the period from 23H2 to 24H1, the market's incremental funds were relatively limited, and equity ETFs became one of the most important incremental funds in the market, which is profoundly changing the market's ecosystem.

When ETF inflows increase, the market often welcomes at least a period of stabilization and rebound. Especially from January 16th to February 19th this year, funds have poured into the market through ETFs by more than 300 billion yuan, supporting the market to rebound strongly after touching the bottom.

In terms of style, the inflow structure of ETFs profoundly affects the market style, and this year, passive funds have become an important driver for leaders to achieve excess returns. Since 2024, equity ETFs have a total inflow of more than 550 billion yuan, mainly flowing into broad-based ETFs. Looking at it in detail, only ETFs tracking the CSI 300 Index have a net inflow of more than 400 billion yuan, accounting for more than 70% of the total inflow scale, and the significant inflow of CSI 300 ETFs has driven the leaders' weight stocks to achieve significant excess returns.

At the industry level, taking banks as an example, their market performance this year has significantly benefited from the expansion of passive funds. The bank sector has performed strongly this year, and as of July 29th, the SW Bank Index has risen by 16.05%, ranking first among all 31 first-level industries. From a capital perspective, banks are one of the sectors with the highest relative holding proportion of passive funds, and thus have also become a direction that significantly benefits from the expansion of passive funds. Especially this year, passive funds have become the main source of incremental funds for equity funds, and their expansion is mainly concentrated in broad-based indexes represented by the CSI 300, and banks, as the largest weight industry in the CSI 300, have significantly benefited.

Seven, Looking Forward to the Future: Drawing on Overseas Experience, Passive Expansion Remains a Long-term TrendLooking ahead, drawing on the experience of the United States, the expansion of passive funds has accelerated over the past decade. Following the financial crisis of 2008, the growth of passive products in the U.S. has picked up pace. From 2014 to 2023, passive index funds invested in the U.S. domestic market collectively attracted approximately $2.5 trillion in net inflows. By the end of 2023, the market value of shares held by U.S. passive funds had accounted for nearly 60% of all mutual funds and ETFs.

The expansion of passive funds is a significant reason for the long-term outperformance of U.S. market leaders. By market capitalization style, ETFs focusing on large-cap styles in the U.S. equity ETF market accounted for 76%. By ETF, the top three largest ETFs all track the S&P 500 index, with their size accounting for more than 20%. Focusing on large-cap stocks and high concentration are the main characteristics of the U.S. passive fund market, and their expansion has played an important role in promoting the long-term outperformance of market leaders. We can see that the excess inflows of U.S. ETFs relative to active funds have a strong correlation with the excess returns of large-cap stocks over small-cap stocks.

Not only in the United States, but also in the past decade, many markets, including Europe and Taiwan, have seen an accelerated expansion of ETF sizes. As of the end of 2023, the market size of European ETFs reached $1.74 trillion, accounting for about 15% of the global total, and has developed into the world's second-largest ETF market. Starting in 2019, ETFs surpassed mutual funds to become the largest category of mutual funds in Taiwan.

Europe, with its different market structure and leading industries, also has a similar characteristic to the U.S. stock market, that is, the excess inflows of ETFs relative to active funds have a more obvious positive correlation with the excess returns of large-cap stocks over small-cap stocks.

For the A-share market, the promulgation of the "Nine National Articles" is expected to accelerate the expansion of the domestic ETF market and promote medium and long-term capital to enter the market more quickly. The newly released "Nine National Articles" pointed out the need to "establish a fast-track approval channel for exchange-traded funds (ETFs) and promote the development of index-based investment." The development of the ETF market is expected to promote the entry of medium and long-term capital into the market, and its own size is also expected to maintain high growth. In addition, regulatory measures to promote product innovation and improve supporting mechanisms are also expected to further enhance the attractiveness of ETF products to various investors, and the development of domestic ETFs has ushered in an opportunity period.

Compared with overseas developed markets, there is a broad expansion space for domestic ETFs. The proportion of equity ETFs in the total market value of stocks reflects the development level and growth space of the ETF market. As of the end of 2023, in the U.S., European, and Japanese markets, the proportion of equity ETFs in the total market value of stocks reached 13%, 8.5%, and 7.9%, respectively. In contrast, the current proportion of the A-share market has just broken through 2%, and there is a broad space for subsequent expansion.