THE FBM KLCI was introduced in 2006 in collaboration between FTSE and Bursa Malaysia as the new benchmark index for the Malaysian stock market that constitutes the top 30 market capitalised stocks and free-float adjusted.
In addition to the benchmark index, the FTSE Bursa Malaysia index series also cover 14 other indices to replace the old index series which was previously managed by Bursa Malaysia.
The FBM KLCI has over the years gone through some changes, especially those related to the liquidity of the index constituents. Every six months, the benchmark index is reviewed to ensure it remains relevant and there are ground rules that decide how a constituent is included or excluded, other than passing the liquidity test.
Over the years, the FBM KLCI has seen numerous ins/outs of constituents and what we have today is a reflection of the changing landscape of the market’s breadth and depth. For example, if one were to review the FBM KLCI index based on the latest fact sheet from FTSE and as at April 30,2021, the index represents 10 out of 19 super-sectors defined under the Industrial Classification Benchmark (ICB).
If we were to look at another index, the FTSE Bursa Malaysia EMAS Index, that index has a representation of all the 20 super-sectors, but of course, that is because this index covers some 283 constituents. Table 1 and Table 2 summarises the current composition of the FBM.
As can be seen from Table 1, the top 5 sectors alone account for some 78.8% of the index and that 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 stocks in the healthcare sector represent 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 making up almost half of the top 10 stock’s total weight.
Due to the pandemic, we have observed the FBM KLCI’s volatility like never before. Last year’s big winners are this year’s biggest losers as glove counters turned from market darlings to unloved stocks, not only due to the perception of environmental, social and corporate governance (ESG) practices by certain corporates but also related to the fundamentals of the sector itself, driven by demand-supply factors and lower average selling prices.
While the volatility of the index is good for trading, it begs the question of whether the index is representative of the market or the economy as a whole. Hence, although the FBM KLCI is seen as largely a concentrated index and top-heavy, the nature of benchmark indices is in fact as such due to the way the index is constructed, which is mostly the market capitalised weighted index.
Should it be extended with more constituents?
Two major global indices have announced that they are revamping their benchmark index. This includes Germany’s DAX 30 (DAX) and Hong Kong’s Hang Seng Index (HSI). For DAX, the regulators are set to expand the number of constituents by adding 10 new constituents and bringing the total constituents to 40.
The move, which is to be implemented in September this year, will see the DAX moving away from the domination of the automotive and chemical sectors. As for the HSI, changes include raising the number of constituents to 80 by mid-2022 from 55 presently; lowering the weighting cap of an index constituent from 10% to 8%; and a more balanced representation based on target coverage ratio for each industry group, among others.
In HSI’s case, the changes to the index are not only to ensure Hong Kong-based companies continue to be represented in the benchmark index but to ensure that large Chinese-based companies are not overly weighted in the index itself.
From here, we can see that in certain jurisdictions, regulators are beginning to realise the shortcomings of their benchmark indices and are changing with market dynamics.
Similarly, the question here is whether the FBM KLCI too should undergo changes that we have seen in other markets.
Currently, the 30-stock FBM KLCI represents about 60.4% of the overall market capitalisation and here the largest weighted stock, which is Public Bank, has a weighting of about 12.24% in the 30-stock index. There has been an argument that the FBM KLCI should be expanded to 50 or 60 or even 100-stock index but simulation shows the impact is negligible.
For example, if the FBM KLCI is a 50-stock index, it will represent 71.7% of the market (i.e. an increase of 11.3 percentage points or pps) with the highest weighted stock seeing its weight reduced by meagre 179bps. If the FBM KLCI were to expand to 60 or 100 constituents, the index would then represent 75.2% and 82.4% of the total market capitalisation. The incremental gain in market representation is a meagre 14.8 pps for the next 30 stocks to be added and just 22 pps more for the following 40 stocks. At the same time, Public Bank’s weight in the index will just fall by another 46bps to 9.99% (if the FBM KLCI is a 60-stock index) and to 9.15% (if the FBM KLCI is a 100-stock index).
In addition, Public Bank’s high weighting on the FBM KLCI is not extraordinary either if one were to compare with other jurisdictions. For example, in Singapore, the STI has DBS Bank as the largest constituent with 17.46% weight while the banking sector’s total weight on the 30-stock index is 42.6% as at April 30,2021, according to its fact sheet. In Taiwan, the Taiwan Weighted Stock Index (TAIEX) with some 923 constituents has a total market capitalisation of 49,756 billion Taiwanese dollars, and Taiwan Semiconductor Manufacturing Co (TSMC) has the highest weight of staggering 31% as at March 31,2021, according to TAIEX fact sheet.
Weighing between the incremental representation by adding more constituents versus the number of stocks that the benchmark index represents it does seem that the FBM KLCI is well represented already by the 30-stock index itself. In addition, adding unrepresented sectors like the technology or property sector in the index may not work for the FBM KLCI itself, as the percentage of representation by these two sectors if the FBM KLCI is a 50/60/100-stock index is just at 1.3%/2.3%/3.4% and 0.0%/0.5%/1.6%, respectively.
Hence, judging by the current composition of the FBM KLCI based on the number of constituents and representation, it appears that the incremental benefit by adding more constituents is rather small to make any significant difference. In addition, allowing non-representative sectors to be added will not make much of a difference for the FBM KLCI nor will index-capping as only one stock presently has a weight that is more than 10% – a general internal yardstick deployed by fund managers to manage concentration risk.
Bursa Malaysia could explore more index variants
Of course, constructing an index is based on a certain methodology, and in FBM KLCI’s case, it is a market capitalised-based index. Most indices are based on similar concepts but some indices are price-weighted indexes. In this case, companies like Nestle would have the highest weight stock in the 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. Price-weighted index includes the Dow Jones Industrial Average and the Nikkei 225.
We also have some indices which are equal weight indexes whereby all constituents are given equal weight, irrespective of the market capitalisation or price. In this case, every company in the index has an even chance to be represented but of course, this means large capitalised stocks are under-weighted while lower capitalised stocks are over-weighted. For the FBM KLCI, it would mean that every stock in the current 30-stock index would weigh 3.33%.
The S&P500 today has an equal weight index running parallel with the widely followed market-capitalised index and what is interesting is the fact that the S&P500 Equal Weight Index (SPEW) outperformed the S&P500 Index (SPX) for the 3-month, 6-month and 1-year period, but on other time horizons, the underlying SPX outperformed the SPEW.
The SPX has also two other indices that are interesting to look at whereby the universe of stocks is broken into value and growth. Hence, the SPX has created the S&P500 Value Index (SPXV) and S&P500 Growth Index (SPXG). Here, the SPXG has outperformed the SPXV and the underlying SPX over the 3-year, 5-year, and 10-year horizons but for the shorter term, i.e. for the year-to-date and 1-year performance, the SPEW has outperformed all the rest of the three indices.
Similar to what we have seen in the spin-off of the benchmark SPX, Bursa Malaysia may explore introducing Factor-based or Style Indices such as Growth Index and Value Index based on the FTSE Bursa Malaysia EMAS Index which will take into account certain parameters that will dissect the index into two distinct groups. It is likely, based on the past performance of the SPXG, the Growth Index too will the sub-benchmark index to watch out for due to the nature of the index itself, being a growth index. With this, the market may see more new products being developed as there is an active underlying index tracking the strategy adopted.
After all, Malaysia is a developing and emerging market and we continue to see a nice pipeline of companies that are coming to market which are all driven by their growth stories. At the same time, we also have value stocks that are darlings of the market as investors seek stability and income from these matured companies. Hence, asset managers can craft portfolio strategies to attract a different set of investors based on these Style Indices.
In conclusion, index methodology and how an index is constructed move with time and with the changing landscape that we see today. The potential introduction of Style Indices or even the current ESG-driven theme via the FTSE4Good index would be good for market participants as Bursa would then be able to provide greater flexibility for fund managers to structure new products offerings and for investors to be driven by relevant market themes.
The FTSE4Good can also be further developed with the syariah-compliant FTSE4Good Index series and of course, even one that is focus solely on climate change as well, which can be named FTSE4Good Green Index.
Pankaj C. Kumar is a long-time investment analyst. The views expressed here are his own.