HMM, Big Hit Entertainment, SKC Likely to Join MSCI Korea Index
The authors are derivatives/ETF analysts of Shinhan Investment Corp. They can be reached at seonghun.k@shinhan.com and buykkang@shinhan.com, respectively. – Ed.
Focus on stocks expected to join MSCI Korea Index
The Morgan Stanley Capital International (MSCI) is set to announce the results of the May 2021 Semi-Annual Index Review (SAIR) on the morning of May 12 in Korean time. Any changes (inclusion/exclusion of constituents) will take effect as of the close of market on May 27. We typically see more changes at a semi-annual review than at a quarterly review due to lower market cap thresholds. The price cutoff date for the May SAIR is any of the last ten trading days of April.
HMM (A011200), Big Hit Entertainment (A352820) and SKC (A011790) will highly likely be added to the MSCI Korea Index at the May SAIR as they top both the full and free float market cap thresholds by more than 20% as of March 30. The inclusion of Green Cross (A006280) should hinge on its share price performance through end-April, with its full market cap currently hovering around the threshold.
SK Bioscience (A302440), listed on March 18, 2021, fails to meet the minimum length of trading requirement (three months before SAIR), but may be added to the index if it satisfies additional requirements.
SK Bioscience: Possibility of inclusion for May/Aug/Nov review
In order for an IPO like SK Bioscience to quality for inclusion into the MSCI Korea Index despite its failure to meet the minimum trading length requirement, it must satisfy the following requirements: 1) listed on or before the price cutoff date for the May SAIR; 2) full market cap above 1.8 times of the Market Size-Segment Cutoff; and 3) free float-adjusted market cap exceeding 1.8 times one-half of the Cutoff.
The price cutoff date will be end of April. SK Bioscience went public in March and thus meets the first requirement. With the Market Size-Segment Cutoff estimated at KRW2.7tr for the May SAIR, the company needs a full market cap of KRW4.1tr or higher and a free float-adjusted market cap of KRW2.4tr or higher to join the MSCI Korea Index.
Bioscience’s potential free float, including IPO shares sold to individual investors or institutional investors with a lock-up period of one month or less, amounts to 16.2% of total shares. The Foreign Inclusion Factor (FIF), one of the factors used in the MSCI review, is estimated at 20%. Considering this, the company needs a share price gain of at least 20% by end-April for inclusion at the May SAIR.
The possibility of index inclusion rises for the August 2021 Quarterly Index Review (QIR), with the FIF estimated at 25%. But even so, the possibility is not high given that SK Bioscience’s market cap as of March 30 fails to exceed the August QIR thresholds by a wide margin. The stock will likely join the MSCI Korea Index at the November 2021 SAIR at the latest upon the expiration of all lock-up agreements for institutional investors.
Buying demand estimation for potential entrants based on past data
Passive funds tracking the MSCI Korea Index are estimated at KRW80tr, based on the figure calculated by the MSCI in June 2019 and the changes in the total market cap of 18 US-listed ETFs tracking the MSCI EM Index.
For Big Hit Entertainment (A352820), SKC (A011790) and Green Cross (A006280) among potential new entrants, we estimate buying demand from the passive funds (A) to be more than twice as large as the average daily trading value (B). Stronger buying demand vs. trading value should have a positive impact on short-term share performance upon inclusion.
We analyzed the performance of stocks that were newly added or removed from the MSCI Korea Index at the May/August/November 2020 reviews for the following four periods: 1) 45 days running up to the announcement of review results; 2) announcement date; 3) period from the announcement date to the actual inclusion/exclusion date; and 4) periods after inclusion/exclusion. The new entrants outperformed the market for the 45 days up to the announcement date (Period A) and during the period from the announcement to the actual inclusion date (Period B).
HMM shares gained 54% in March, partially reflecting expectations for the index inclusion. While Big Hit Entertainment and SKC shares also rose by 17% and 8%, respectively, Green Cross shares fell 3%. We see further upside for Big Hit Entertainment, SKC and Green Cross given the average excess return (48%) over the market seen during Period A of 2020 and stronger buying demand expected from index-tracking funds vs. average daily trading value.
Change in foreign passive fund trading pattern from Aug. 2020 rebalancing
We looked into the influence of MSCI index rebalancing on foreign passive (program) funds tracking the KOSPI in the eight previous rebalancing events. It is worth noting that foreign funds have unloaded their stock holdings on the rebalancing date since August 2020, with net selling amounting to KRW1.5tr in August, KRW2.3tr in November, and KRW2.4tr in February. Stock selling on that scale had never been seen during the five rebalancing events before August 2020.
We believe this trend is not caused by an increase in funds passively tracking the MSCI Korea Index. A fourfold increase in net program buying was seen on the three recent rebalancing dates vs. five reconstitution events before May 2020. Combined market cap of the 18 MSCI Emerging Markets (EM) ETFs listed in the US jumped 34% from USD90.2bn in January 2019 to USD120.7bn in January 2021, but the figure is not enough to explain the heavy net program selling. We find no clear correlation between program trading by foreign investors and changes in Korea’s weight in the MSCI EM Index before/after rebalancing events.
Growing inflow of funds tracking MSCI events; foreign capital outflows from Korea
In February 2021, MSCI opened a consultation around a proposal to employ additional screening for any potential additions to the Standard Indexes of the MSCI Global Investable Market Indexes, which exhibit extreme price increase for a defined time period that precedes an MSCI Index Review. The number of new constituents exhibiting exceptionally high price returns has gone up since May 2020. MSCI proposed to postpone the inclusion of stocks that meet the criteria for extreme price increase, which is defined excess returns over the MSCI ACWI MIM country sector mean on the price cutoff date of a given index review of at least 100%, 200%, or 400% for one, two or three months respectively. MSCI will announce the results of this consultation on April 16.
We can assume from the MSCI’s proposal that there has been a growing inflow of funds tracking MSCI’s rebalancing events since May 2020, and this may explain heavy net program selling seen during the three previous events.
There is one more thing to consider, which is the relationship between cumulative program trading of KOSPI-listed stocks by foreigners and MSCI EM-related fund flows. MSCI EM ETFs have seen an inflow of funds since September 2020, while the KOSPI has been weighed by continuing program selling by foreign investors. Foreigners are known to manage their portfolios based on long-term strategies, like high-frequency trading (HFT), market making, and hedge funds. The extended short-selling ban in place since 2020 may have caused foreign investors to pull their money out of Korea.
The prohibition of short-selling was imposed on March 13, 2020 and will be partially lifted for KOSPI 200 and KOSDAQ 150 stocks from May 3, 2021. The ban is removed in most of the major countries except for Korea and Indonesia.
Assuming that the ban has triggered foreigners to sell shares in large quantities on rebalancing dates, the partial resumption of short-selling should help slow the outflow of foreign capital. We need to keep an eye on reconstitution events, considering the rising influence of foreign investors on short-term share prices at the time of MSCI index rebalancing.