Focus on Possible Constituent Replacements
The author is an analyst of NH Investment & Securities. He can be reached at dongkil.noh@nhqv.com. -- Ed.
Seegene and Alteogen will likely be added to the MSCI Korea Index. We estimate the probability of SK Biopharm’s inclusion in the MSCI Korea as being less than 50%, as it slightly fails to satisfy the MSCI’s free float-adjusted market cap requirement. In addition, a potential hike in free float estimate for ARAMCO and a likely weighting increase for SKT in the MSCI Korea should be also events that deserve special attention.
Key issues for August quarterly index review
In the run up to the Aug 2020 quarterly index review, we advise investors to focus on possible constituent replacements. Weighting changes for stocks with foreign ownership limits also warrant attention, given that foreign capital outflows from the Korean stock market seen this year will likely lead to changes in the MSCI’s adjustment factor applied to stocks with foreign ownership ceilings. Lastly, a potential hike in the free float estimate for ARAMCO (listed in Dec 2019) could also affect passive capital flows in the Korean stock market.
MSCI Korea Index rebalancing for August; investment strategy
A major investment strategy using rebalancing events for the MSCI Korea Index is to buy stocks on the announcement dates and sell stocks on the rebalancing dates. The selling on the rebalancing dates is attributable to the fact that passive funds flow in during closing auction on the rebalancing dates. This strategy has generated sound results. The absolute and relative returns have averaged 4.7% and 5.9%, respectively, since 2007. The probability of generating positive absolute returns from investment based on 82 additions (addition case of Kumho Industrial excluded) since 2007 is estimated at 63.4%.
Another strategy that works well is buying constituent candidates prior to the announcement dates and offloading the stocks at the closing prices during closing auction on the rebalancing dates. When prospective constituents are actually added to the index (ie, prediction turns out to be correct), both absolute and relative returns turn out to be better than those under the first strategy. When stocks are bought on 20th trading day before the announcement dates and sold on the rebalancing dates, the absolute and relative returns have averaged 11.1% and 11.9%, respectively, since 2007. To bolster returns, accurate prediction of constituent candidates is crucial. Based on the expected cutoff, no existing constituent is likely to be excluded from the MSCI Korea Index during the August quarterly review, while Seegene and Alteogen are likely to be added to the index. But, addition to the index is to hinge upon stock movements during the last 10 trading days of July, given that for the August review, market caps are checked as of a randomly selected trading day in the last ten trading days of July.
Impact from change in free float estimate for ARAMCO to be smaller than expected
The MSCI has announced it will revise up the free float rate currently assigned to Saudi ARAMCO (ARAMCO) during the Aug 2020 quarterly index review. Given that the rate could be adjusted from the present 0.6% to 1.2% at the highest, we forecast subsequent passive capital outflow from the Korean stock market at around W50~60bn, a level that is unlikely to have a notable impact upon the Korean stock market.