The Hang Seng Index (HSIINDICES: ^HSI) is the main equity benchmark in Hong Kong, tracking the largest, most liquid companies. Its transformation over the decades reflects how this financial hub has evolved.

In 1998, shortly after the British handover of Hong Kong, only one mainland company was on the index. However, as China gained more clout worldwide, its companies began to dominate the market, squeezing out some local and British companies.

As I recently wrote, the Hang Seng has become a proxy for the state of the Chinese economy (thus, recent U.S.-China trade tensions have sent the index into bear market territory). Here's a look at the massive shift over just two decades:

 

Top 10 Largest Stocks by Market Capitalization

 

31 December 1998

31 December 2008

24 September 2018

1

5 HSBC

857 PetroChina

700 Tencent

2

941 China Mobile

941 China Mobile

1398 ICBC

3

16 Sun Hung Kai

1398 ICBC

857 PetroChina

4

11 Hang Seng Bank

939 CCB

939 CCB

5

13 Hutchison Whampoa

5 HSBC

941 China Mobile

6

2 CLP

3988 BOC

1288 ABC

7

12 Henderson Land

386 Sinopec

2318 Ping An

8

19 Swire

2628 China Life

5 HSBC

9

6 HK Electric

1088 Shenhua

3988 BOC

10

3 HK China Gas

883 CNOOC

386 Sinopec

Source: Data provided by S&P Global Market Intelligence.

In 1998, China Mobile was the only China-based company in the top 10 constituents. The Hang Seng Index at that time was highly influenced by Hong Kong's real estate sector.

In 2008, U.K.-based HSBC remained a significant player but no longer dominated. In just a decade, the Hang Seng became dominated by Chinese companies -- nine of its top 10 holdings. All of them were state-owned enterprises (SOEs).

Reflecting another change in China's economy, by 2018, Tencent, a non-SOE, had become the top dog in town.

How the Hang Seng Index works

Today, since the Hang Seng is weighted by "freefloat adjustment" for investability and is capped at 10% to avoid a single stock dominating the index's daily movements, the non-SOE companies with higher freefloat have higher influence on the Hang Seng Index's up and down movements. According to the Index Methodology for managing the Hang Seng Index, "shares held by any entities (excluding custodians, trustees, mutual funds and investment companies) which control more than 5% of the shareholdings would be considered as non-freefloat and are excluded from index calculation." That is to say, shares held by government, founders & management, corporate cross holdings and lock-up shares all fall into the non-freefloat investor class.

According to Hang Seng Indexes, as of Aug. 31, 2018, the 10 largest constituents and their weighting in the Hang Seng Index are:

Symbol/Company

Weight

5 HSBC

9.92%

700 Tencent

9.25%

1299 AIA

9.23%

939 CCB

7.54%

941 China Mobile

5.12%

1398 ICBC

4.81%

2318 Ping An

4.45%

3988 BOC

3.16%

388 HKEX

2.97%

883 CNOOC

2.8%

You can see HSBC (No. 8 market cap) becomes the No. 1 weighting because no entity can make up more than 5% of the total weighting. In other words, it is 100% freefloat. Actually, both HSBC and Tencent are dual champion of HSI weight capping at 10% at the beginning of Q2 2018. The largest by market cap, Tencent, dropped more than HSBC in Q2 and surprisingly becomes No. 2 by weighting as of Aug. 31, 2018 -- until Hang Seng Indexes Limited rebalances again at the beginning of Q4.

Interestingly, ICBC (No. 2 by market cap), of which the Chinese government holds 70% of shares, accounts for just 4.81% weighting on the HSI, while much smaller insurance group AIA has an astonishing 9.23% weighting. As with HSBC, no major entity holds more than 5% since AIG has disposed of its stake.

Final thoughts

Like many other world indexes, the Hang Seng has changed drastically over the years. One thing that has remained consistent is its incredible long-run performance. Real estate often gets the headlines in Hong Kong, but it might surprise you to know that the Hang Seng has not only outperformed HK real estate over the long run, but the margin is meaningful. I detail all that and much more in a new special report I've put together, "The 4 Rules for Winning in the Stock Market: A Foolish Guide for Hong Kong Investors."

Click here to download a free copy right now!

This article first appeared on our sister site, Fool.hk.

Disclosure: Hayes Chan, CFA, is The Motley Fool Hong Kong's investment analyst. Hayes does not own shares of any companies mentioned.