Exchanges lack clarity, consistency in selection of stocks for benchmark indices

The fitful manner in which stocks are included or dropped from the indices raises serious questions about the benchmarks

Both the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) claim they have sound logic for including, or excluding stocks in the indices. But, often, it is not clear what the logic is. Recently, some changes being made in the 30-share benchmark Sensex have raised doubts on the construction of the index itself, and for that matter other indices as well.

On 8th August, the Anil Ambani-promoted Reliance Communications and Reliance Infrastructure will be out of the Sensex and will be replaced by Sun Pharmaceutical and state-run Coal India. The stocks of the two Ambani companies have been down for many months now and the day after it was announced that they are to be removed from the Sensex, they crashed by around 8%. In fact, these stocks should have been out of the index long ago.

It is never clear which companies will be included and which will be excluded and why. The BSE and the NSE insist that they have strong selection criteria, but this is not transparent. Which is why there are so many questions: Why do companies that have performed poorly continue to be part of the group of elite index stocks? Why is one public sector company with a low floating stock being included and another equally large one left out?

According to the BSE's selection criteria, companies with a large market capitalisation, and a minimum listing history of at least three months on the BSE, are included in the Sensex, which is a collection of 30 stocks from different sectors. The listing history can be reduced by a month, if the average free-float market capitalisation of a newly-listed company turns out to be among the 10 largest listed on the BSE. In the event that a company is listed on account of a merger, or de-merger, perhaps even amalgamation, a minimum listing history is not required.

But the feature of large companies to be included in the index is merely on paper. If this was actually the case, instead of the newly-listed Coal India, the gigantic Indian Oil Corporation (IOC) should have been an easy choice. Today, Coal India is being included it appears, for its highly-publicised IPO, which was subscribed 15.28 times.

Reliance Power is another example. The stock was included in the Nifty in September 2008 even when the company had no revenues to show then. The stock has been languishing for a long time.

Another controversial company, Himachal Futuristic Communications Limited, was a part of the S&P CNX 500 for a long time. (The S&P CNX 500 is made up of 500 quality companies of certain size and liquidity on the NSE.) On 8 February 2011, the stock was removed from the index after Moneylife had written several times about this. The company was alleged to have been involved in market manipulation during the Ketan Parekh scam. Surprisingly, the company was recently included in the BSE-500 index.

Poor quality stocks in the indices would also lead index funds to buy such non-performing companies, as they are mandated to follow the indices mechanically. 



Ashok Mangal

6 years ago

Sensex should me made broad based, as it is very volatile by small market news, any index which is leader of market , should not be allowed to volatile so high, this can be achieved by inclusion of more scripts. BSE sensex is the most volatile world leading index.

EGoM on fuel price hike may happen next month

The oil ministry has suggested that the government cut customs duty on crude oil to zero from the current 5% and on diesel from 7.5% to 2.5%. It is also looking at a small reduction in excise duty

New Delhi: The much anticipated meeting of a panel of ministers on raising auto and cooking fuel prices may happen next month, reports PTI quoting a top oil ministry official.

The Empowered Group of Ministers (EGoM) headed by finance minister Pranab Mukherjee is being convened soon to discuss a combination of a price hike and a reduction in government duties.

“While we have been pushing for an early EGoM meeting for long, even the finance ministry is now keen on a meeting soon," he said.

The oil ministry is pushing for the burden arising from the rise in crude oil prices to be equitably shared between consumers, the government and state-owned companies, he said.

State-owned oil firms currently lose Rs15.44 per litre on the sale of diesel. One-third of this will have to be passed on to consumers in stages, while a similar amount will have to be borne by the government by way of either providing cash subsidy or reducing customs and excise duty. The remaining would be absorbed by upstream firms like ONGC and the fuel retailers.

A similar formula would apply to the Rs27.47 per litre loss on kerosene and Rs381.14 under-realisation on the sale of every 14.2-kg domestic LPG cylinder.

The government, the ministry feels, should cut customs duty on crude oil to zero from the current 5% and on diesel from 7.5% to 2.5%. Also, there should be a small reduction in excise duty.

With inflation at an uncomfortable 9%, a hike in the retail price of diesel should be kept to the bare minimum, the official said.

Without these measures, Indian Oil Corporation (IOC), Hindustan Petroleum Corporation (HPCL) and Bharat Petroleum Corporation (BPCL) are together projected to lose Rs166,712 crore in revenues on selling diesel, domestic LPG and kerosene rates at government-controlled rates, which are way below the market price.

Oil firms also appear to have applied the brakes on a hike in petrol price after inflation in May topped 9.06%. Oil firms, which last month hiked petrol price by a steep Rs5 per litre, are losing Rs1.98 a litre on a commodity which was freed from government control last June.

Oil minister S Jaipal Reddy has held meetings with prime minister Manmohan Singh and Mr Mukherjee on early convening of a meeting of the EGoM, which is the decision-making body on fuel price revisions.

The EGoM has not met since June last year even though crude oil prices have spiralled upward by over 50%.

The basket of crude that India buys was worth around $70-$72 per barrel in June last year, but the same averages $111.54 a barrel in June this year.

The official said IOC, BPCL and HPCL currently lose about Rs490 crore per day on fuel sales.

The three state-owned oil marketing companies are virtually living off borrowed money as current realisation on fuel sales is not sufficient to meet the cost of importing raw material (crude oil).

The oil ministry has been pushing for an increase in diesel, domestic LPG and kerosene rates and wants the government to muster the political will to take the hard decision.

The EGoM was originally scheduled to meet on 11th May, but was postponed at the last moment. There was talk of an EGoM—which comprises representatives of all major allies in the ruling UPA—meeting on 9th June, but the meet was never scheduled for that day.


Cap on bank exposure in liquid MFs will curb volatility: Crisil

RBI directive to banks to cap their investments in liquid MF schemes will help reduce volatility in the debt fund flows

The recent Reserve Bank of India (RBI) directive to banks to cap their investments in liquid mutual fund schemes at 10% is positive for the asset management industry, as it can help fund mangers make better decisions, feels leading rating agency Crisil.

The directive would reduce volatility in the market as it will help fund managers make more prudent investment decisions since they are sure of the investible corpus, Crisil director, capital markets, Tarun Bhatia said.

"Crisil Fund Services believes that this (RBI directive to banks to cap their investments in liquid MF schemes) will help reduce volatility in the debt fund flows," Bhatia said.

Banks normally park their surplus funds in liquid MF schemes and redeem them when credit offtake is good or to meet their advance tax outflows.

In the 3rd May annual monetary policy, RBI had said, "investment in liquid schemes of debt-oriented mutual funds (DoMFs) by banks will be subject to a prudential cap of 10% of their networth as on 31st March of the previous year".

The directive was issued as RBI fears that the circular movement of the same fund between banks and MoMFs can potentially lead to systemic risks.

The RBI also said liquid schemes continue to rely heavily on institutional investors such as commercial banks for investment. In turn, DoMFs invest heavily in certificates of deposit of banks.

"Such circular flow of funds between banks and the DoMFs could lead to systemic risk in times of stress/liquidity crunch. Thus, banks could potentially face a large liquidity risk. It is, therefore, felt prudent to place certain limits on banks' investments in MFs," RBI had said.

As of May 2011, total assets under management (AUM) stood at Rs7.31 lakh crore, out of which the liquid schemes stood at Rs1.83 lakh crore, as per the Association of Mutual Funds in India data.

Crisil envisages a significant reduction in the AUMs with banks withdrawing the surplus amount from these schemes in a phased manner.

According to Bhatia, as per the new RBI guidelines, banks' exposure to the MF industry should come down to around Rs30,000 crore from the current Rs1.3 lakh crore, by this October. As of May, the banks' exposure in DoMFs stood Rs1.3 lakh crore.


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