It's one move that can make or break a stock. Inclusion in or exclusion from an index, or a change in its weight in an index, is a strong hint about where a stock is headed, especially in the short term.
In addition to Sensex, S&P CNX Nifty, S&P CNX Nifty Junior and S&P CNX Nifty Midcap, indices by Morgan Stanley Capital International, or MSCI, are keenly watched. The reason is that MSCI indices are widely tracked by foreign funds.
"A lot of funds are benchmarked against these indices," says Suresh Mahadevan, managing director and head of equities, India, UBS. This means these funds, known as passive funds, invest on the basis of the composition of MSCI indices and the weight assigned to each stock in these indices. Any change in the index leads to a corresponding change in their portfolios. So, if a stock is included in the index, these funds will automatically adjust their portfolios and buy it, that too according to the weight it has been given in the index.
Suppose a stock, with a 3 per cent weight, is dropped from an MSCI index. Now, if funds worth $10 billion are benchmarked to it, 3 per cent of the amount will go out of the stock and its price will fall.
"The addition of a stock in an index results in higher volumes & liquidity and ensures inclusion in index fund/exchange-traded fund portfolios," says Siva Subramanian KN, chief investment officer, India, Franklin Templeton Investments.
Entry or exit from local indices has a similar impact, but in India the ratio of index funds to total assets is minuscule.
"Stocks normally take a few weeks to adjust after inclusion in or exclusion from indices," says Mahadevan of UBS.
In mid-November 2011, MSCI announced changes in MSCI India index. It decided to include Bharti Airtel, Idea Cellular and Power Finance Corp and dropped Steel Authority of India (SAIL), Indiabulls Real Estate and Housing Development & Infrastructure (HDIL) from close of November 30.