Treasure Chest | Nov 28 2011
By Greg Peel
The ASX stock indices are calculated and published by Standard & Poor's. In short, the ASX 100 index, for example, comprises the top 100 Australian companies listed on the ASX by market capitalisation (number of shares x share price). However the methodology adopted by S&P to select stocks for inclusion into an index and to assign a weighting are rather more complex.
Market capitalisation is the most fundamental consideration, but liquidity of stock trading is also an issue. S&P considers market cap on “free float” basis such that companies with a register including tightly held substantial shareholdings will have their effective market cap reduced in the index calculation to reflect only those shares realistically open to trading.
There is also a somewhat more subjective element involved. The purpose of an index such as the ASX 100 is to provide benchmarking of the Australian market for the benefit of fund managers and other investors. S&P thus seeks to include a sufficiently wide spread of industry sector representations within its indices such that they are more representative of the economy in general rather than simply being the “one hundred biggest” companies. This assessment applies across all ASX indices.
Given share prices are constantly on the move, realistically companies could be jumping in and out of the ASX indices on a regular basis. It would nevertheless be of little use to anyone if S&P were to change the make-up of its indices day by day. Fund managers use these indices for benchmarks in their mandated funds. If an institution's equity fund declares that its goal is deliver the return on ASX 100 then that fund must adjust the constituents and weightings of that index as is necessary to remain objective and satisfy its published goal. If one stock is added to the ASX 100 and another is removed, that fund must buy the former and sell the latter accordingly, without prejudice.
To avoid such changes being made constantly, S&P only changes the constituents of its indices periodically and with plenty of warning. Aside from price movements, indices will be impacted by capital changes occurring over time. These include takeovers and mergers, capital raisings, share buybacks and so forth – anything that impacts on the above-noted criteria for a company.
S&P will announce its next round of index changes on December 2. The changes will then come into effect after the close of December 16. Once the changes are announced, fund managers will act accordingly, selling and buying relevant stocks to remain within mandate. Clearly such action can lead to major share price moves for the companies involved.
Given stock trading is all about being ahead of the pack, analysts will attempt to second-guess S&P ahead of the announced changes by crunching numbers according to S&P's published methodology and by also speculating on just how the S&P committee might act on the more subjective elements of its criteria.
JP Morgan's expectations are for Santos ((STO)) to be included in the ASX 20 index, Goodman Group ((GMG)) to be added to the ASX 50 and Graincorp ((GNC)) to be added to the ASX 100. There will be no replacements in the ASX 200 given its constituents currently number 201 as a result of the Telecom NZ ((TEL)) demerger which introduced new listed entity Chorus ((CNU)).
JP Morgan has not declared which stocks it believes will leave the indices. Complicating the issue for this round of changes is the current bid on the table for Foster's Group ((FGL)) from SABMiller. If the takeover proceeds, FGL will leave the ASX indices.
If the takeover proceeds, Goldman Sachs expects both Graincorp and Perseus Mining ((PRU)) to be added to the ASX 100. If it does not proceed, Goldmans expects Graincorp to replace Billabong ((BBG)) and Perseus not to be added.
Speculation was clearly rife last week that Billabong is to be removed from the ASX 100. Goldmans notes that very high volume in BBG, which saw the share price fall from around $4.20 on Wednesday to under $3.60 on Friday is implicit of institutional selling.
One presumes that such selling may well be index-change related given there was no “new news” announced by the company.
JP Morgan also expects Dexus Property ((DXS)) to be added to the All Australia 50 index and Saracen Minerals ((SAR)) to be added to the All Australia 200.
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