• Investment World
• eWorld
• Catalyst
• Mentor
• Life
• Canvas
• Praxis
• Urban Pulse
• Brand Quest

Suresh Krisnamurthy

The shift to free-float methodology for calculating Sensex values leads to decline in weight of stocks such as HLL. These could consequently suffer a temporary decline in value.

SUDDEN and sharp changes in the value of a few stocks that are part of the Sensex may be on the cards. That may happen in the run-up to Sensex going free-float from September 1. Index reconstitution usually has that effect on stock prices. And, for all practical purposes, the shift to the free-float for calculating index values, amounts to reconstitution of the Index.

In addition, the Executive Director of the Stock Exchange, Mumbai, has said that Sensex will be reconstituted after the free-float index stabilises. That too should impact prices of stocks that are part of the reshuffle.

Reconstitution effect

Reconstitution of an index impacts stock prices because of the presence of Index Funds. Index Funds, which track the indices closely, have to rebalance their portfolio when indices are reconstituted.

This leads to changes in demand and supply for a stock occasioning sharp price movements.

Index Funds based on the Sensex managed about Rs 400 crore of assets at the end of June 2003. Given the market capitalisation of Sensex stocks, this may appear a small amount. However, given the daily volumes of delivery-based turnover of between Rs 100 crore and Rs 200 crore, this is sizeable. In this context, the shift to free-float will have its impact, which may, however, be limited to a handful of stocks.

In contrast, the full-blown reconstitution of the index which is likely after some time will have a more telling impact. That can lead to larger changes in demand and supply for stocks that are part of the reshuffle.

Free-float impact

The shift to the free-float will reduce the weight of a number of stocks in the index. The stock that is likely to be hit most is the stock of Hindustan Lever. Its weight in the Sensex is likely to decline from about 12.2 per cent to 9.4 per cent.

This drop will require index funds to offload close to 6.5 lakh HLL shares. During the last one-month, the daily trading volumes of HLL at the BSE and the NSE have been about 26 lakh shares. If delivery-based volumes are one-tenth of the traded volume, then index funds will need about three days to reduce the weight of HLL in their portfolio. This could lead to a sharp decline in the price of HLL stock in the days just prior to and after September 1.

Other stocks that may suffer include BSES, Castrol, Colgate and Nestle. The weight of these stocks in the Sensex will decline.

The daily traded volumes in these stocks are quite low. As such, any increase in supply of shares will suppress prices.

On the other hand, stocks of HDFC, ICICI, Satyam Computer and Infosys Technologies may rule firm. Their weight is likely to increase in the index.

Changing the components

Apart from the change in methodology for calculation of the Sensex, reconstitution of the index also appears to be on the cards. Stocks that are likely to be included in the index will see some interesting action.

There are four prominent candidates for inclusion — Maruti, Punjab National Bank, ONGC and Wipro. If TCS is listed before the end of the year, then it will emerge as a strong candidate for inclusion.

However, the free-float factor in the case of all these stocks will be low. This is because non-promoter holding in all these stocks will be low. This will reduce the extent of price increase in these stocks if they are included in the index.

A more prominent impact is likely in stocks that are excluded. Castrol is a prime candidate for exclusion.

Short-term effect

Overall, however, price action is only likely to be episodic. Inclusion or exclusion from the index is not likely to determine future price movements.

In fact, stocks such as Arvind Mills, GE Shipping and Tata Power have done well even after exclusion from Sensex while HCL Technologies has languished after inclusion.

Article E-Mail :: Comment :: Syndication

Stories in this Section
Raipur Alloys and Steel — To be cast away

Copyright © 2003, The Hindu Business Line. Republication or redissemination of the contents of this screen are expressly prohibited without the written consent of The Hindu Business Line