MSCI boosted India’s weighting in the MSCI Emerging Markets Index 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 World Index, 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 tracking error 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.
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 share float (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.
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 China with a decrease of 0.43% followed by Taiwan, which decreased 0.34%.
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.
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%.
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
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