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Index indifferent

May 7, 2007

Uh, oh! According to a press release, MSCI Barra, a leading provider of global benchmark indices and risk management products, has made 3 additions to the 70 stocks that comprise the orginal MSCI India Index and deleted 10 stocks. So, should investors react when someone changes the components of an Index? Indices represent a basket, a sort of sample to give you an idea of which direction a broader market is headed and what the rate of change (appreciation or depreciation) is over time. There are indices on various products like stocks (in India we have the BSE-30, the BSE-100, the BSE-200, the BSE-500, the Nifty, the Nifty Midcap each of which aims to "represent" a wider swathe of the market.

But indices can be dangerous. In the technology bubble days, Nokia in Finland represented some 65% of the Finnish stock market index. If a mutual fund or individual investor owned a lot of Nokia in 1999, they would certainly have outperformed all those other fools who did not own Nokia. By 2001, a mutual fund or individual investor owning Nokia, would have been pretty depressed about the huge erosion in the value of their portfolio and would have underpefromed the fools who stayed away from Nokia in the technology bubble era.

Closer to home, about a year ago, Zee was dropped from the BSE-30 Index - the stock and its spin-offs have gained over 100% while the Index may have gained 10% over the same time period. MSCI Barra's addition of Unitech (already up some 650x in 2 years - yes, 650x, this is not a typo) or ABNL (3x), or Videocon may be a rear-view mirror action. Their revised Index is probably catching up with the reality of how these sectors and stocks have performed. Sometimes companies that are in an Index, drop out for many years, and then re-emerge. Videocon and GE Shipping would be in that category. And if we were to make a prediction, we would say that Zee will get back into the BSE 30 Index by 2008.

Compiling indices for gold is pretty easy - gold is a commodity and defined by purity, irrespective of where it is mined or stored gold of the same purity will trade at the same price. But stocks are not identical. The only characteristic stocks have in common is one of perceived risk and uncertain return. Much as Securities and Exchange Board of India (SEBI) would like to see one uniform "rating" of stocks, we believe it is a near impossible task and probably doomed to failure. Just as Index-watching is, in our opinion, not a good indicator of deciding whether a stock is a good or not-so-good investment for investors.

So, while businesses are legitamately built around constructing an Index and maintaining an Index, or by launchng funds around Index, investors should understand their stocks better to decide if they wish to invest in them or not. Changes by any external agency in defining or re-defining any Index should never influence your investment decisions.

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