| The MSCI Turmoil |
Every six months or so we have the clouds of the MSCI index re vamp
looming over us. A weight gain or loss in the index is awaited with a bated breath. The
impact of the same on the foreign institutional inflows into the country, especially an
emerging market like India, are tremendous. But what is this MSCI index and why is it so
important to emerging markets such as India?
MSCI is a leading provider of global indices and benchmark-related products and services
to investors worldwide. Morgan Stanley Dean Witter & Co., a global financial services
firm and a market leader in securities, asset management and credit services, is the
majority shareholder of MSCI, and The Capital Group Companies Inc., a global investment
management group, is the minority shareholder. The index is used as a bench mark for
foreign financial institutions as to how to allocate funds amongst various markets all
over the world.
The Emerging Markets (EM) MSCI covers 28 emerging market country indices. Designation as
an emerging market is determined by a number of factors. MSCI evaluates factors such as
gross domestic product per capita; local government regulations that limit or ban foreign
ownership; the regulatory environment; perceived investment risk; or a general perception
by the investment community that the country should be classified as "emerging."
To construct an MSCI Country Index, every listed security in the market is identified, and
data on its price, outstanding shares, significant owners, free float, and monthly trading
volume are collected. The securities are then organized by industry group, and stocks are
selected, targeting 60% coverage of market capitalization. Selection criteria include:
size, long- and short-term volume, cross-ownership and float. By targeting 60% of each
industry group, the MSCI index captures 60% of the total country market capitalization
while maintaining the overall risk structure of the market — because industry, more
than any other single factor, is a key characteristic of a portfolio or a market. Once
stocks are selected for the index, companies with greater than 40% float are included at
their full market capitalization weight. Companies that are added to an index with less
than 40% float are included at a fraction of their market capitalization in accordance
with the MSCI partial inclusion schedule. This partial inclusion policy facilitates the
inclusion of companies with a modest float, while taking into consideration potential
limited supply.
The indices use Price/Book Value (P/BV) ratios to divide the standard MSCI country indices
into two sub-indices: Value and Growth. All securities are classified as either
"value" securities (low P/BV securities) or "growth" securities (high
P/BV securities), relative to each MSCI country index. In this manner, the definition of
value and growth is relative to each individual market as represented by the MSCI index.
In the month of may India’s weightage fell by 3.01 percentage points in the emerging
markets recast MSCI Emerging markets Free Index series, which represents 26% of the
world’s emerging equity markets. A part of the reason attributed to this change in
weightage has been a change in the methodology of the index. Under the new method, the
MSCI has increased its coverage in its globally tracked indices to 85% of the free float
adjusted market capitalization within each industry group in each country from the present
60% of the total market value.
The free float is described by the index compiler as the total shares outstanding
excluding shares held by strategic investors such as governments, corporations,
controlling shareholders and management and shares subject to foreign ownership
restrictions. India’s weighting has fallen mainly due to restrictive foreign
ownership laws. The recent budget had upped the share ownership limit of foreign
institutional investors to 49% from 40% in February has been offset by the limited free
float of the Indian shares.
Before the re-act the MSCI covered 18 industry groups and 71 companies in India. As per
the new methodology India will now be represented by 59 companies. New entrants like
Reliance Petroleum , VSNL, Dabur India and HDFC Bank have been added and Apollo Tyres and
Videocon have been removed from the index.
These changes will impact the flow of institutional funds into India. Also with the new
rules of the game in terms of a ban in badla and the introduction of futures and options
one will see more volatility in the scrips which are the index. Investors will do well to
watch the scrips, especially the ones newly added to the index, and see the enhanced
volumes and peaks and troughs of the same.
Aru Srivastava
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