Ever since the Finance Ministry raised the foreign portfolio investment (FPI) limit for Indian companies to the applicable foreign direct investment sectoral limit (which is higher) from April 1, 2020, investors have been wondering when the MSCI would raise India’s weight in the widely-tracked MSCI EM Index. MSCI had said that it would wait for the implementation of the new limits before making any changes. The recent disclosure of foreign investment limits for Indian securities by Indian depositories, NSDL and CDSL provided the trigger.
MSCI is expected to modify India’s weight in the EM Index in its November review, which will take effect from December 1.
What is it?
The MSCI Emerging Markets (EM) Index is an equity index created by Morgan Stanley Capital International, a global index provider to capture large- and mid-cap companies across 26 emerging market countries. Launched in 2001, the index today covers 1,387 listed entities that account for 85 per cent of the free float market capitalisation in each country.
The index, which is reviewed quarterly, provides a ready set of emerging market investment opportunities to institutional investors world over, interested in taking EM equity exposure. Many global institutional investors use MSCI’s EM Index and several such indices covering other markets and themes as part of their globe-spanning passive investment strategy.
India has a weight of 8.1 per cent in the index. That is, all the listed Indian companies that form part of the MSCI Index together account for 8.1 per cent of the index.
Companies must satisfy certain minimum criteria relating to full market capitalisation, free-float market capitalisation, stock liquidity and foreign inclusion factor, among others to be included in the index.
The extent to which foreign investors can invest in a listed security of a country is an important determinant for its inclusion in the index. This in turn is a function of the company’s free-float market cap and applicable foreign ownership limits. With FPI limits raised up to match the full extent of foreign investment limits in Indian companies, the room available for investment has gone up.
Why is it important?
Many global asset management firms, foreign pension funds, sovereign wealth funds and the like, use indices such as the MSCI EM Index as the basis for deciding their weights in countries and individual companies.
An increase in India’s weight in the MSCI Index can result in large capital inflows into the Indian equity market. A Morgan Stanley report estimates these passive flows, which will pour in automatically once the index weights changes, to be worth $2.5 billion. According to the same report, Asian Paints, Bajaj Finance, Britannia Industries, Larsen and Toubro and Nestle India may turn out to be among the big beneficiaries of these flows. Flows are also expected into potential new index entrants such as Kotak Mahindra Bank, PI Industries and IPCA Laboratories.
Why should I care?
The MSCI rejig is another factor that has spurred the ongoing bull market. In anticipation of higher inflows into certain stocks, many investors have already bought into such stocks in the hope of making big bucks. So, while it may be tempting to invest in such stocks, it may already be too late for it.
But caution is warranted as many of these lists are guesstimates that cannot be relied upon. At the end of the day unless the company fundamentals are strong, the capital inflow-driven stock price rally may not sustain.
Bottomline
Joining the herd will not always work, especially if it has run ahead of you.
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