Profiting From Stock Index Changes

Change by Sebastien Wiertz

27 Sep Profiting From Stock Index Changes

Straits Times Index (STI) had 3 new members in the 30-stock index.

SATS, UOL and Yangzijiang have replaced Jardine Matheson, Jardine Strategic and Olam.

The announcement was made on 3 Sep 2015 and the change have taken effect on 21 Sep 2015.

It is common belief that stocks that were added into the index could be bidded up in price while the exited stocks would experience sell downs. But we need to verify if this is true for STI.

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I went to Yahoo! Finance to chart the comparison among these stocks and also use STI ETF as a reference point. Below is how the chart looks like and you can click to enlarge the image:

New STI Components 21 Sep 2015

Let me indicate the percentage changes in stock prices for the period 3-21 Sep 2015:

  • SATS: +12%
  • YangZiJiang: +11%
  • STI ETF: 0%
  • UOL: -1%
  • Olam: -2%
  • Jardine Strategic: -4%
  • Jardine Matheson: -5%

As a group, new STI entrants gained 7% while STI exits lost 4%. There was indeed an effect on the STI components as they got switched in and out of the index.

Why This Phenomenon?

The favourite explanation was that index funds and ETFs, which are replicating the index stocks, would make big transactions that could move stock prices. These funds have to buy the new entrants regardless of what prices they were quoted at, and also sell the exited components at whatever prices.

The two obvious culprits who came to mind were SPDR STI ETF (ES3) and Nikko AM STI ETF (G3B). We can examine the individual funds’ purchases and sales in proportion to the traded volume of these stocks within a period to verify if they are indeed the culprits.

The period I selected was 3 Sep 2015 (announcement of change was made) to 21 Sep 2015 (STI change took effect) and below are the trading value and estimated buying and selling by the two STI ETFs:

  • UOL – STI ETFs bought $6.1m versus traded value of $116m (5%).
  • SATS – STI ETFs bought $5.4m versus traded value of $94m (6%).
  • Yangzijiang – STI ETFs bought $5m versus traded value of $239m (2%).
  • Jardine Matheson – STI ETFs sold $30m versus the traded value of S$355.6m (8%).
  • Jardine Strategic – STI ETFs sold $15m versus the traded value of S$167.6m (9%).
  • Olam – STI ETF sold $1.7m versus the traded value of $467m (0.3%). This was due to a large transaction by a substantial shareholder, Orbis Trust, who bought $446m on 15 Sep 2015.

Even though the two STI ETFs contributed to part of the volume, they couldn’t be accused of bidding up stocks added to the index, or selling down stocks removed from the index. In fact, the STI ETFs are not very big funds considering SPDR STI ETF had $344.6m and Nikko AM STI ETF had $87.4m as assets under management.

Besides these two funds, other international funds or even actively managed funds may buy the new STI stocks as they wanted to play safe by adding these stocks and not risk underperforming the index by a large extent. This could be a plausible explanation. Goh Eng Yeow shared the same sentiment in his article.

Capitalise On the Next Index Change?

We have showed that the STI ETFs are unlikely the main drivers for the changes in stock prices even as index component stocks got switched. Although we do not know who are the drivers, we witnessed that the new STI stocks did much better than the stocks that exited the Index. If so, would you be able to profit during the next index change?

The answer is yes and no.

Yes, if the stocks had yet to rise in price after the announcements had been made. You can invest and wait for the buyers to bid the prices up. Given that this is public news and the markets are pretty efficient, the chances are slim.

No, if the stocks prices have jumped immediately after the announcements were made public. This means that the likelihood of the stocks rising further would diminish.

That said, you can study the index changes beyond the shores of Singapore. S&P 500, Nikkei, and Hang Seng are indices and have a lot more index Funds tracking them. If you want to formulate this trading strategy, look for the Funds that would dominate the trading value of the index component stocks. You will have a higher chance of profiting from it.

Photo Credit: Sebastien Wiertz



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