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Point of View · 09.13.24
MSCI Index Rebalances: China’s Weight Continues Decline
MSCI boosted India’s weighting in the MSCI Emerging Markets Index and reduced China’s in its latest quarterly rebalance, continuing long-term trends.
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MSCI Index Rebalances: China’s Weight Continues Decline
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Key Points
What it is
We analyze changes to the MSCI World Index and MSCI Emerging Markets Index in MSCI’s latest quarterly index rebalance.
Why it matters
Investors who use indexes for benchmarks or as passive investments should understand how these rebalances change exposure to sectors or regions.
Where it's going
China’s weighting in the MSCI Emerging Markets Index has continued dropping and now sits at 24% from a peak of around 40% in 2020.
MSCI boosted India’s weighting in the and reduced China’s in its latest quarterly rebalance effective on Friday, August 30, continuing long-term trends. India’s weighting sits at 20% from 8% in 2020 while China has continued dropping and now sits at 24% from a peak of around 40% in 2020.
Between the MSCI Emerging Markets Index and the , MSCI added 27 companies and removed 96. Along with adds and deletes, the broader rebalance often triggers a significant amount of trading activity given an estimated $15.6 trillion in assets benchmarked to MSCI equity indexes.1
While implementing rebalances in index strategies, portfolio managers focus on minimizing the cost and to avoid wealth erosion throughout the event. Additionally, investors in active strategies who use indexes for benchmarks need to reassess their exposure to specific sectors or regions because of changes in index composition.
Tracking Error
Tracking error is the difference in performance between a portfolio and its benchmark, often used to determine the degree of active management of an investment strategy.
MSCI Emerging Markets Index
The index measures the performance of large- and mid-cap stocks across 24 emerging markets countries.
MSCI World Index
The index measures the performance of large- and mid-cap stocks across 23 developed-markets countries.
MSCI World: Flutter Entertainment Country Reclassification
MSCI added five companies to and removed 24 companies from the MSCI World Index, representing a somewhat benign 0.29% in turnover. The largest addition and deletion were both casino and gaming company Flutter Entertainment, which MSCI reclassified from a U.K. company to a U.S. company with a weighting of 0.05% (see Exhibit 1). MSCI considers this a deletion of a U.K. company offset by the addition of a U.S. company.
While this will unlikely impact MSCI World Index managers and their investors that may be able to transfer their shares, the change sparked trading related to other MSCI indexes. We expected and saw a surge in trading from sales of Flutter by managers for ex-U.S. MSCI indexes such as the MSCI World ex-U.S. Index or MSCI EAFE Index and buying from those tracking MSCI U.S. Index. In the U.K., Flutter traded 11.7 million shares, nearly 27 times the average volume from the 60 trading days prior to the announcement.
MSCI Emerging Markets: 60 Chinese Companies Removed
MSCI added 22 companies to and removed 72 companies from the MSCI Emerging Markets Index, representing a more significant 1.68% in turnover. Of the 72 deletions, 60 of them were in China, continuing a trend in China deletions over the past several rebalances. MSCI removed Chinese companies because they failed to meet higher requirements for market capitalization or the minimum required (percentage of shares available to the public), among other requirements set by MSCI’s methodology. On the addition side, following an announcement earlier this year that Brazilian foreign listings (shares of Brazilian-based firms listed in exchanges outside of Brazil) would be eligible for index inclusion. MSCI added six new Brazilian companies (primarily foreign listings) to the emerging markets index.
Share Float
The float is the amount of total shares that are available for trading in public markets. A company’s float changes as long-term strategic shareholders change the positions they hold, affecting shares available for public trading. For example, company insiders may buy or sell shares on the open market, increasing or decreasing the float.
EXHIBIT 1: BIGGER CHANGES IN EMERGING MARKETS
The MSCI Emerging Markets Index rebalance adds and deletes created 1.68% of turnover, a more significant weighting change than in the MSCI World Index.
Source: MSCI, Bloomberg, Northern Trust Asset Management. Weightings as of August 12, 2024 in U.S. dollars. MSCI reclassified Flutter Entertainment as a U.S. company from a U.K. company in the MSCI World Index, which MSCI considers a deletion and addition that offset. The float is the amount of shares available to the public, which may change because of transactions by insiders. Share changes may occur as companies issue or repurchase shares. Index holdings are provided for information only and should not be construed as a recommendation of any security. It is not possible to invest directly in any index.
Countries: U.S., Brazil, and India Rise
In the MSCI World Index, the rebalance caused modest changes to country weights. Notably, the U.S. weighting rose 0.05% and the U.K. dropped 0.06%, largely because of the Flutter Entertainment country reclassification. No other countries changed by more than 0.02%.
The rebalance caused more significant changes in country composition to the MSCI Emerging Markets Index, reflecting evolving market dynamics and shifting investor preferences. The benchmark's weight to Brazil increased by 0.62% as foreign listings became newly eligible. Meanwhile, India’s weight increased by 0.45%, although the increase was largely confined to HDFC Bank which saw more shares eligible due to changes in foreign ownership. The largest country decline was once again with a decrease of 0.43% followed by Taiwan, which decreased 0.34%.
EXHIBIT 2: NEAR RECORD HIGH COUNTRY WEIGHTING FOR INDIA
The benchmark’s weight to India increased by 0.45%, now near a record high 20% for the country.
Source: MSCI, Bloomberg, Northern Trust Asset Management. Weightings as of August 12, 2024 in U.S. dollars.
Sectors: Information Technology Shifts Composition
In the MSCI World Index, sector weightings shifted very slightly. Information technology decreased by 0.04% and consumer discretionary declined 0.02%. Within information technology, Nvidia’s weight declined a modest 0.05% while Microsoft’s increased by a modest 0.02%. In the MSCI Emerging Markets Index, the financial sector increased 0.75% with newly eligible Brazilian American depositary receipt (ADR) Nu Holdings (+0.49%) and HDFC Bank (+0.37%) contributing the most. Information technology decreased the most, with mega-caps Taiwan Semiconductor (-0.15%) and Tencent Holdings (-0.11%) declining the most.
EXHIBIT 3: MSCI METHODOLOGY HAVING AN IMPACT
The addition of Brazilian financial companies and changes in foreign ownership for HDFC Bank drove the increase to the financial sector in emerging markets. Sector changes in the MSCI World Index were quite modest.
Source: MSCI, Bloomberg, Northern Trust Asset Management. Weightings as of August 12, 2024 in U.S. dollars.
Performance Analysis: Adds Outperformed Deletes
As expected, we observed substantial trading during the rebalance period from the August 12 MSCI announcement of the rebalance details to the August 30 effective date of the rebalances, peaking on the effective date. Historically, stocks of added companies see “buy” pressure as indexers need to add those names to their portfolios while those of deleted companies experience the opposite effect. Intuitively, but not always in reality, this can lead to outperformance as added companies trade the “right way,” in line with expected flows in (buys) and out (sells) of the indexes. We analyzed to what extent performance went the right way for the adds and deletes for indexes during the rebalance period.
MSCI World Index
Adds rose 10.3% while deletes rose 6.7%, leading to a positive spread of 3.6%. Most notable among adds and deletes was the performance of Flutter Entertainment. From announcement to effective date, Flutter, which as mentioned above was added as a U.S. company, rose 12.8% in U.S. trading. In trading in the U.K., where MSCI deleted Flutter as a U.K. company, Flutter rose 13.4% in U.S. dollar terms and 10.3% in British pound terms. Focusing on August 30 effective date, the U.K. listing was higher on the day but ticked down a notable 0.75% in the closing auction. The U.S. listing followed lower and did not move significantly move higher near the close although there was a pick-up in volume — about six times the average for the U.S. listing.
MSCI Emerging Markets Index
Additions significantly outperformed deletes by 9.5% in the MSCI Emerging Markets Index. Much of the performance can be attributed to Nu Holdings, which is one of the foreign Brazilian listings added to the MSCI Emerging Markets Index. Over the announcement to effective date, Nu Holdings rose 29.8%, including a 5.2% rally on the August 30 effective date. The stock was around 40% of the weight of the additions basket. Even controlling for this one stock, adds did meaningfully outperform the deletes. The average add was up 2.6% while the average delete was down 0.9% for a 3.5% spread.
Focusing on the additions in India and the deletions in China, the seven Indian adds were up 3.6% from announcement to effective date, in line with broader MSCI India Index which was up 4.1% over the same period. And regarding China, the 60 Chinese deletes were down 3.2% from announcement to effective date, underperforming MSCI China by 4.1%.
EXHIBIT 4: 'RIGHT WAY' PERFORMANCE
Companies added outperformed those deleted from the MSCI World Index and significantly so in MSCI Emerging Markets Index during the rebalance period from August 12 to August 30. We call this “right way” performance because it is in line with index fund flows that need to “buy” the additions to the indexes and “sells” deletions out of the indexes.
Source: MSCI, Bloomberg, Northern Trust Asset Management, from August 12, 2024 to August 30, 2024. Add and delete baskets are weighted based on market capitalization.
What the Rebalance Means to Investors and Index Managers
Index portfolio managers must remain vigilant during these periods to achieve the investment objective of replicating the risk and return metrics of the index and minimize tracking error. From an index tracking perspective, we believe it is crucial to understand the dynamics that surround an index rebalance — liquidity, risk environment, stock- specific news, and offsetting trade flows — to guide index portfolios through these kinds of events with as little wealth erosion as possible.
1 Source: MSCI, ACWI IMI's Complete Geographic Breakdown, as of December 23, 2023
Main Point
Evolving Emerging Markets Index Investing
MSCI added 22 companies to and removed 72 companies from the MSCI Emerging Markets Index, representing a more significant 1.68% in turnover. Of the 72 deletions, 60 of them were in China, continuing a trend in China deletions over the past several rebalances. Index portfolio managers must remain vigilant during these periods to achieve the investment objective of replicating the risk and return metrics of the index and minimize tracking error.
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