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.
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