On February 12, MSCI announced its first quarter rebalance that is effective at the onset of trading on March 1, 2024. The removal of 66 Chinese companies from MSCI indexes has sparked widespread press coverage, highlighting the challenges facing China this year. However, the actual impact of these deletions may be less significant than portrayed in the media. We analyze how the rebalances for the MSCI World Index and MSCI Emerging Markets Index affected composition and performance of the targeted securities, and how rebalances impact investors and index portfolio managers.

Key Changes in the Indexes

MSCI Rebalances impact all constituents in the underlying index. The impact tends to be larger for companies being added or deleted from the standard indexes because they are typically smaller in size and less liquid. However, current constituents that have sizeable share and/or float changes can also experience significant abnormal volume going through on rebalance day.

In the MSCI World Index, there were 7 additions and 20 deletions. Among the additions was Williams Sonoma Inc, with an index weighting of 0.02%. Overall adds and deletes contributed 17 basis points (bps) of turnover, which, along with the rest of the rebalance led to moderate and not overly disruptive changes.  

In the MSCI Emerging Markets Index, there were 17 additions and 81 deletions, with 66 of the deletions coming from China. Three of the largest additions were Indian corporations, Punjab National Bank, NMDC Limited and Bharat Heavy Electricals. Overall adds and deletes led contributed 100 bps of turnover, indicating a more significant change in the index composition compared to the MSCI World index.

In light of these changes, it is important for portfolio managers to remain diligent to minimize the implementation costs associated with the rebalance. Additionally, investors may need to reassess their exposure to specific sectors or regions that have seen significant changes in the index composition.

EXHIBIT 1: KEY CHANGES IN MSCI WORLD AND EMERGING MARKET INDEXES

The MSCI Emerging Markets first-quarter rebalance saw adds and deletes contribute 100 bps of turnover, a more significant change in the index composition compared to the MSCI World index.

Region and Country Changes

In the MSCI World Index, the rebalance resulted in modest country changes. Notably, Switzerland’s weighting rose  1.7 bps and Australia increased 1.0 bps , while Spain’s weighting fell 1.6 bps and the U.S. fell 1.4 bps.

Country weight changes in MSCI Emerging Markets Index were more significant, reflecting evolving market dynamics and shifting investor preferences. In line with a recent trend, the benchmark's weight to India increased by 32 bps, marking a historic high for India’s weight at over 18%. China’s weight decreased by 32 bps. While media buzz surrounded the heavy number of deletions of Chinese companies, the removal of those securities only dropped China’s overall weight by 0.3% to 25%. In isolation, 0.3% is not a large decline, however it piles on to a decline of China’s weight in the index which peaked in late 2020 at over 40% and now is now significantly lower.

EXHIBIT 2: RECORD HIGH COUNTRY WEIGHTING FOR INDIA

The benchmark's weight to India increased by 32 bps, marking a record high for India’s weight at 18.2%.

Sector and Industry Impact

In the MSCI World Index, the rebalance resulted in modest weighting changes to industries. Notably, there was a 25 bps decrease in the technology hardware and equipment industry. Among other information technology industry groups, software and services rose 9 bps while semiconductors gained 6 bps. The most significant industry weighting change in the MSCI Emerging Market index included a 10 bps decrease in media and entertainment and an 11 bps increase in banks.

EXHIBIT 3: Most Signification Impacts to Information Technology

The MSCI World rebalance caused a 25 bps decrease in the technology hardware and equipment industry in the MSCI Word Index, causing a decrease in the information technology sector, while the weight of banks rose 11 bps, boosting the financial sector weighting.

Performance of the MSCI World and Emerging Markets Index

In the MSCI World Index, adds outperformed deletes by 6.5% for a spread that went the “right way”, or the same direction as the expected flow. Most of the movement was concentrated in two names in the software industry. Notably, Applovin, the U.S. software and AI solutions provider, was up nearly 25% on February 15, the day it reported earnings. Separately, Screen Holdings, the Japanese semiconductor manufacturer was up 9.1% from announcement to rebalance day off the heels of Nvidia’s earnings and general AI excitement, but was actually down on the day of the rebalance.   These examples underscore the fact that stock price movements during rebalancing periods can be influenced by factors unrelated to the rebalance itself, such as reported earnings or other market events.

In MSCI Emerging Markets Index, deletes actually outperformed the adds by a modest 0.7%. This was largely due to the delete basket’s significant allocation (60% weight) to China. Despite the significant longer run underperformance, MSCI China outperformed MSCI Emerging Markets ex-China by 3.1% over the announcement to effective date period. The additions, which were more balanced at the country level, modestly outperformed the broader benchmark, modestly outperforming the index by 0.5% from announcement to effective date. 

EXHIBIT 4: Performance went different ways for MSCI World and Emerging Markets Indices

In MSCI Emerging Markets Index, deletes actually outperformed the adds by a modest 0.7%. This was largely due to the delete basket’s significant allocation (60% weight) to China. Despite the significant longer run declines, MSCI China outperformed MSCI Emerging Markets ex-China by 3.1% over the announcement to effective date period.

What the Rebalance Means to Investors and Index Managers

Although some of the headline turnover figures for this quarter's rebalance looked relatively small, there were still significant volumes that went through the market driving event related market impact. The February MSCI rebalance saw country, regional, and sector adjustments. As always, index portfolio managers must remain vigilant during these periods to achieve the investment objective of replicating the risk and return metrics of the index. We believe it is crucial to understand all of the dynamics that surround an index rebalance — liquidity, risk environment, stock specific news, off-setting trade flows — to shepherd index portfolios through the event with as little wealth erosion as possible.