Make the KLCI FBM more dynamic


The FBM KLCI was introduced in 2006 in collaboration between FTSE and Bursa Malaysia as a new benchmark for the Malaysian stock market which constitutes the top 30 market capitalized and float-adjusted.

In addition to the benchmark, the FTSE Bursa Malaysia index series also covers 14 other indices to replace the old index series that was previously managed by Bursa Malaysia.

The FBM KLCI has undergone some changes over the years, notably those related to the liquidity of the index components. Every six months, the benchmark is reviewed to ensure it remains relevant and there are ground rules that determine how a constituent is included or excluded, other than passing the liquidity test.

Over the years, the FBM KLCI has seen many inbound / outbound from its constituents and what we have today is a reflection of the changing landscape of the breadth and depth of the market. For example, if one were to review the FBM KLCI index based on the latest FTSE fact sheet and as of April 30, 2021, the index represents 10 of the 19 super-sectors defined in the Industrial Classification Benchmark ( ICB).

If we look at another index, the FTSE Bursa Malaysia EMAS index, this index has a representation of the 20 super-sectors, but of course, that’s because this index covers some 283 constituents. Table 1 and Table 2 summarizes the current composition of the FBM.


As can be seen from Table 1, the first 5 sectors alone represent some 78.8% of the index and this is only represented by 21 constituents.

Similar to what we see in some other jurisdictions, the banking sector is the largest weighted sector, accounting for almost a third of the FBM KLCI, while four healthcare stocks account for almost 14% of the ‘index. In detail, Table 2 shows that 10 stocks represent almost 60% of the index, with Public Bank, Maybank and CIMB representing almost half of the total weight of the 10 most important stocks.

Due to the pandemic, we have observed the volatility of the KLCI FBM like never before. Last year’s big winners are this year’s biggest losers as glove counters have gone from market darlings to unloved stocks, not only because of perceptions of environmental, social and governance practices. company (ESG) by certain companies, but also in connection with the fundamentals of the sector itself. , driven by supply and demand factors and lower average selling prices.

While the volatility of the index is good for trading, it raises the question of whether the index is representative of the market or the economy as a whole. Therefore, although the KLCI FBM is considered to be a largely concentrated and very heavy index, the nature of benchmarks is in fact as such due to the way the index is constructed, which is primarily the index. market capitalization weighted.

Should it be extended to more constituents?

Two major global indices have announced that they are reorganizing their benchmarks. This includes Germany’s DAX 30 (DAX) and the Hong Kong Hang Seng Index (HSI). For DAX, regulators should increase the number of constituents by adding 10 new constituents and bringing the total of constituents to 40.

The move, which is due to be implemented in September this year, will allow DAX to move away from dominance in the automotive and chemical sectors. For HSI, the changes include increasing the number of constituents to 80 by mid-2022, up from 55 currently; lowering the weighting cap of an index constituent from 10% to 8%; and a more balanced representation based on the target coverage ratio for each industry group, among others.

In the case of HSI, the changes to the index are not only intended to ensure that Hong Kong-based companies continue to be represented in the benchmark index, but to ensure that large Chinese companies are not. not too weighted in the index itself.

From here we can see that in some jurisdictions, regulators are starting to realize the shortcomings of their benchmarks and move with market dynamics.

Likewise, the question here is whether the FBM KLCI should also undergo changes that we have seen in other markets.

Currently, the 30-stock KLCI FBM represents around 60.4% of the overall market capitalization and here the largest weighted stock, which is the Public Bank, has a weight of around 12.24% in the 30-stock index. . There has been an argument that the FBM KLCI should be extended to an index of 50 or 60 or even 100 stocks, but the simulation shows that the impact is negligible.

For example, if the FBM KLCI is an index of 50 stocks, it will represent 71.7% of the market (an increase of 11.3 percentage points or pps), with the highest weighted stock seeing its weight reduced by 179 basis points. If the KLCI FBM were to expand to 60 or 100 constituents, then the index would represent 75.2% and 82.4% of the total market capitalization. The additional gain in market representation is a meager 14.8 percentage points for the next 30 stocks to be added and only 22 points more for the next 40 stocks. At the same time, the weight of Public Bank in the index will fall further by 46 bps to 9.99% (if the FBM KLCI is an index of 60 stocks) and to 9.15% (if the FBM KLCI is an index of 100 shares).

In addition, Public Bank’s high weighting on the FBM KLCI is also not extraordinary when compared to other jurisdictions. For example, in Singapore, STI has DBS Bank as its main constituent with a weight of 17.46% while the total weight of the banking sector on the 30 equities index is 42.6% as of April 30, 2021, according to its file. of information. In Taiwan, the Taiwan Weighted Stock Index (TAIEX) with some 923 components has a total market capitalization of 49,756 billion Taiwan dollars, and Taiwan Semiconductor Manufacturing Co (TSMC) has the highest weight with 31% as of March 31, 2021. , according to the TAIEX data sheet.

Weighing between the incremental representation by adding more constituents to the number of stocks that the benchmark represents, it looks like the FBM KLCI is already well represented by the 30-stock index itself. Also, adding unrepresented sectors like the tech or real estate sector in the index may not work for the FBM KLCI itself, as the percentage representation of these two sectors if the FBM KLCI is a 50/60/100 stock index is just 1.3% / 2.3% / 3.4% and 0.0% / 0.5% / 1.6%, respectively.

Therefore, judging by the current composition of FBM KLCI based on the number of constituents and the performance, it seems that the added benefit of adding more constituents is rather small to make a significant difference. In addition, allowing the addition of unrepresentative sectors will not make much of a difference for the FBM KLCI, nor the capping of the index, as a single stock currently has a weight above 10% – a general internal criterion deployed by companies. fund managers. to manage concentration risk.

Bursa Malaysia could explore more index variants

Of course, the construction of an index is based on a certain methodology, and in the case of FBM KLCI, it is an index based on market capitalization. Most indices are based on similar concepts, but some indices are price-weighted indices. In this case, companies like Nestlé would have the highest weight in FBM KLCI, followed by KL Kepong and Petronas Dagangan. Stuck in the bottom of the top 30 would be Sime Darby, Genting Malaysia and Dialog. The price-weighted index includes the Dow Jones Industrial Average and the Nikkei 225.

We also have some indices which are equal weight indices in which all constituents are given equal weight regardless of market cap or price. In this case, every company in the index has an equal chance of being represented, but of course that means large cap stocks are underweight while small cap stocks are overweight. For the FBM KLCI, that would mean that each stock in the current 30-stock index would weigh 3.33%.

The S & P500 today has an equal weight index in parallel with the widely followed market cap index and what is interesting is the fact that the S & P500 equal weight index (SPEW) has outperformed the index. S & P500 (SPX) for 3 months and 6 months. and over a period of one year, but over other time horizons, the underlying SPX outperformed the SPEW.

The SPX also has two other interesting indices to look at, in which the universe of stocks is divided into value and growth. Therefore, the SPX created the S & P500 Stock Index (SPXV) and the S & P500 Growth Index (SPXG). Here, the SPXG outperformed the SPXV and the underlying SPX on the 3-year, 5-year and 10-year horizons, but in the shorter term, i.e. for cumulative performance and 1 year, the SPEW has outperformed all other indices.

Similar to what we saw in the benchmark SPX spin-off, Bursa Malaysia could explore the introduction of factor or style indices such as growth index and value index based on l FTSE Bursa Malaysia EMAS index which will take into account certain parameters which will dissect the index into two distinct groups. It is likely, based on the past performance of the SPXG, that the growth index will also be the sub-benchmark to watch due to the nature of the index itself, which is a growth index. With this, the market can see more new products developed as there is an active underlying index that follows the adopted strategy.

After all, Malaysia is a developing and emerging market and we continue to see a good pipeline of companies coming into the market who are all driven by their growth stories. At the same time, we also have value stocks which are the darlings of the market as investors seek stability and income from these mature companies. Therefore, asset managers can develop portfolio strategies to attract a different set of investors based on these style cues.

In conclusion, the methodology of the index and the way an index is constructed evolves over time and with the changing landscape we see today. The potential introduction of style indices or even the current ESG theme via the FTSE4Good index would be beneficial for market participants as Bursa would then be able to offer greater flexibility to fund managers to structure new trading offerings. products and investors to be motivated by market themes.

The FTSE4Good can also be developed with the FTSE4Good series of syariah compliant indices and, of course, even the one that focuses only on climate change, which can be named FTSE4Good Green Index.

Pankaj C. Kumar is a longtime investment analyst. The opinions expressed here are his.

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