MSCI INDEX – LETS WAIT AND WATCH ITS RECLASSIFICATION

By Ruma Dubey

Tomorrow, 20th June, the markets of developing economies across the world are expected to undergo a huge change. Morgan Stanley Capital International Index or MSCI Inc will be carrying out its annual review and this means that the markets are poised for reclassification. This is HUGE given the fact that we are talking about reclassification of assets worth almost $9 trillion. We are not talking about stocks to be added or deleted but it will state which market in which country will receive how much per cent of its funds.

In India, the stock inclusions were already done and from 31st May 2017, A semi-annual exercise (done in May and November), in India specifically, it added 76 companies in the MSCI India Index. This included the strong and expected ones - HDFC, Infosys, Reliance Industries Limited, TCS, ITC, Axis Bank, Maruti Suzuki, Tata Motors, Hindustan Unilever and L&T are the top ten constituents in MSCI India index.

The MSCI Index shows that the highest weightage is given to the financial sector at 22.65%, and then comes IT at 15.37%, Discretionary at 13.49% and Energy at 10.57%.

So then the question which logically comes to mind – should one track MSCI Index stocks and follow them? Well, the stocks that they select in a nutshell gives you the synopsis of almost all stocks tracked by majority of the FIIs. The index is just like the others which we have – Sensex or S&P or Dow Jones but amongst all, MSCI is the most widely used and followed. Most of the FIIs buy into stocks based on the composition of the MSCI Index. These FIIs even assign weightage to its sectoral buying/selling based on that followed by MSCI. In a way, one can say that the FIIs follow the MSCI blindly – it’s like all the research is done by MSCI and the FIIs just follow. Thus the moment the MSCI announces a rejig, there is a major spike up or fall. The moment MSCI announces an addition, the FIIs also make adjustments to their portfolios accordingly; ditto for deletion from MSCI.

Now, the MSCI Index has innumerable numbers of indices, tracking stocks and markets right across the globe. Specific to India there are many but most widely tracked are MSCI India Index and now MSCI India Small Cap Index.

The MSCI India Index is designed to measure the performance of the large and mid cap segments of the Indian market. With 69 constituents, the index covers approximately 85% of the Indian equity universe, where maximum stocks are from the financials and least from telecom.

The MSCI India Small Cap Index likewise is designed to measure the performance of the small cap segment of the Indian market. With 146 consituents, the index represents approximately 14% of the free float-adjusted market capitalization of the India equity universe. Here too, maximum investment is in financials though least is in energy.

And it’s not like stocks are selected at random. The index is based on the MSCI Global Investable Indexes (GIMI) Methodology—a comprehensive and consistent approach to index construction that allows for meaningful global views and cross regional comparisons across all market capitalization size, sector and style segments and combinations. The main aim while choosing the stocks is index liquidity, investability and replicability. The index is reviewed quarterly—in February, May, August and November—with the objective of reflecting change in the underlying equity markets in a timely manner, while limiting undue index turnover. During the May and November semi-annual index reviews, the index is rebalanced and the large and mid capitalization cutoff points are recalculated.

It does not mean that from 1st June onwards, the stocks added will zoom and those deleted will always remain in the red. But what it does indicate is that a rebalancing will come in - other funds will also follow suit and say, in two-three weeks, the new index will get balanced. So in coming days, for short term these stocks could see some added volumes and volatile prices.

Based on all this that we read, one would feel that following the MSCI could probably be the best way to invest. It is to some extent but only if you know beforehand the name of a stock which is going to be added or deleted. And getting that insider information is impossible. So the same age old formula remains the best – track the fundamentals of a stock, you will never go wrong and you most certainly do not need a MSCI for tracking.

Just as exclusion of a stock from the MSCI does not mean that the company’s fundamentals have gone phut; addition also sometimes might be purely from a technical perspective. So do not go purely by what MSCI adds or deletes as your cues to buy and sell respectively. Use it only as information but act only on fundamentals and future prospects of the company. Use the MSCI Index to see which industries the FIIs are backing actively and which have the least weightage – now that is good information to make your choice of stocks based on fundamentals.

As Warren Buffet rightly says, “Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now. Over time, you will find only a few companies that meet these standards – so when you see one that qualifies, you should buy a meaningful amount of stock.”