Sentiments are a very integral part of the way Indian stock market
perform in the short term. Time and again, the prevailing sentiments in the stock markets affect the stock price of a company, albeit, in the short run. In the long term, fundamentals of the company guide the stock prices. But this time, stock prices of some Indian companies are likely to move for an altogether different reason. And the reason is new MSCI norms.
What is MSCI? MSCI is a leading provider of investment decision support tools to over 5,000 clients worldwide, ranging from large pension plans to boutique hedge funds. It offers a range of services such as indices and portfolio analytics. The MSCI Global Equity Indices are one of the most widely adopted benchmarks for cross border equity funds and serve as the basis for several exchange traded funds (ETFs) throughout the world. The indices comprise of stocks from over 70 countries in the developed, emerging and frontier markets.
Many Indian stocks such as Reliance Industries (RIL), Infosys, Hindustan Unilever Ltd (HUL), ICICI Bank, and Tata Consultancy Services (TCS) are the part of the MSCI global indices. From time to time, as per the set criteria, stocks keep getting included and excluded from the indices. Recently, MSCI has announced that it is going to change its methodology for the treatment of securities with limited investability due to foreign ownership restrictions. It is going to refine its treatment of securities subject to foreign ownership restrictions where the proportion of shares still available to foreign investors (Foreign Room) is less than 25% of the maximum allowed. MSCI will use an adjustment factor reflecting the actual level of Foreign Room to adjust the security's final foreign inclusion factor.
As per the new norms, for the new companies in the index, if the Foreign Room is equal to or higher than 25%, the adjustment factor would be 1. In case, the Foreign Room is less than 25% and equal to or higher than 15%, the adjustment factor would be 0.5. If the Foreign Room is less than 15%, new securities will not be eligible for index inclusion. For existing companies in the index, norms are slightly relaxed. Therefore, existing constituents with little or no Foreign Room may continue to remain in the index, but their weight may get reduced on account of lower Foreign Room left.
All this is bound to spell mixed results for Indian stocks. For example, stocks like Bharti Airtel, State Bank of India (SBI) where headroom for foreign ownership is high, would witness a rise in their adjustment factor leading to a rise in their weightage in the index. On the other hand, ICICI bank which is left with just 10% as Foreign Room would witness a decline in its weightage. Fund managers mirroring the MSCI index would accordingly offload or buy more. Hence, the stock prices of those companies would witness a change.
No doubt, the stock prices of a few Indian stocks would witness a change in the short term on account of change in the norms. Will that effect last for a longer time period? We do not believe so. In the long term, only fundamentals of the companies would prevail.