Time to eliminate double counting in FBM KLCI

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COME Monday, Dec 18, 2023, YTL Corp Bhd and YTL Power International Bhd (YTLP) will be auto-added into the widely followed FBM KLCI, a move that will kick out two other index constituents, that is, Dialog Group Bhd and Westports Holdings Bhd.

As at Thursday’s market close, the market capitalisation of both YTL and YTLP were RM21.05bil and RM19.99bil, respectively, placing the two companies as the 20th and 23rd largest listed companies on Bursa Malaysia.

This is not the first time YTL and YTLP will be in the 30-stock index as both were part of the index series back in July 2009 when the then-KLCI was revamped into FBM KLCI.

YTLP was subsequently removed in the June 2013 semi-annual review, while YTL suffered a similar faith five years down the road, as it got booted out in June 2018.

The mechanics of how a constituent is included or excluded are driven by two main factors, that is, the ranking based on the full market capitalisation of the constituents as well as liquidity factors, whereby a certain percentage of the company’s shares must be traded during the period under review to be considered into the index, or to be removed from the index due to failure to meet the liquidity requirement.

The liquidity factor was a telling point for two stocks at one time or another whereby Nestle (M) Bhd was at one time ineligible for inclusion while KLCC Property & REITs-Stapled Securities (KLCCSS) was removed due to failure to meet the strict liquidity rule.

In and out

With so many changes over the years, the FBM KLCI has suffered massive index losses as constituents that get booted out when share prices collapse while others get added in when the full market capitalisation reaches either an auto-entry level (meaning ranked 25th and above based on full market capitalisation) or due to auto-deletion of an existing constituent as it falls off to number 36th in ranking and below.

Hence, over the years we have seen how companies were included and excluded, mainly the ejection of Dialog and Westports in the latest review, and the deletion of Inari Amertron Bhd in the previous review, which incidentally was replaced by Westports as can be seen from the table.

In essence, Westports’ lifespan in the FBM KLCI lasted just six months after it was included, and in the previous entry in June 2015, the company was removed from the 30-stock index after the completion of the Sime Darby Bhd demerger exercise.

Over the years, other than Westports’ experience with two exits and two entries on the FBM KLCI, several companies too made double entries and exits, and this includes AMMB Holdings Bhd and KLCCSS.

Single entry and exits were made by three glove makers, namely, Supermax Corp Bhd, Hartalega Holdings Bhd and Top Glove Corp Bhd, as well as others like IJM Corp Bhd, Inari, Hap Seng Consolidated Bhd, Dialog, Telekom Malaysia Bhd, Malaysia Airports Holdings Bhd (MAHB), and SapuraKencana Petroleum Bhd (now known as Sapura Energy Bhd).

Constituents that were once included and never left the index over the last 10 years include companies like MISC Bhd, Press Metal Aluminium Holdings Bhd, Nestle, MR DIY Group (M) Bhd, and QL Resources Bhd.

At the same time, some constituents left the benchmark index and never returned, including companies like Bumi Armada Bhd, IOI Properties Bhd, Sime Darby Properties Bhd, Felda Global Ventures Bhd, UMW Holdings Bhd, SapuraKencana Petroleum, IJM, British American Tobacco (M) Bhd, and Astro Malaysia Holdings Bhd.

Some may return in the future, especially companies like MAHB, Westports, Inari, Dialog and Gamuda Bhd, if their market capitalisation surges past the critical cut-off points or other index constituents drop out.

Double counting

While the FBM KLCI is impacted by lost index points when a constituent is added at high market capitalisation and subsequently removed by being ranked outside the top 30 index, either by auto-deletion or removal, there are other pressing issues as we will now have three companies with their main subsidiaries as index constituent.

Although the FBM KLCI is adjusted for free float and thus removes the element of double counting in terms of effective weight, this process is only applied after the 30-stock index is ranked by full market capitalisation.

In other words, the index does not differentiate if a company is a subsidiary of another holding company when the ranking is carried out.

This includes YTLP under YTL, Hong Leong Bank Bhd (HLB) under Hong Leong Financial Group Bhd (HLFG), and Genting Malaysia Bhd (GenM) under Genting Bhd. In the case of HLFG, which owns 64.4% of HLB, the current market capitalisation of the company itself of RM18.8bil is less than the value of its equity interest in the bank, which is valued at some RM27bil.

Furthermore, based on the latest quarterly results, almost 90% of HLFG’s first-quarter profit alone is attributable to HLB.

In the case of YTL and Genting, the two companies’ subsidiaries are also significant, as based on YTL’s 55.1% held in YTLP, the current market capitalisation of its subsidiary company is 52% of the parent company’s market capitalisation and almost 75%-80% of its earnings.

For Genting, 43% of the company’s current market capitalisation is derived from its effective interest in GenM, although in terms of earnings contribution, the effective share is just about 20%.

Based on the three pairs of inter-related companies now on the FBM KLCI, perhaps it is time to revise the ground rules for the index to be more representative of wider market reach and to eliminate double counting.

If three of the index members are eliminated, that is, YTLP, GenM and HLFG (as HLB has a larger market capitalisation), it will make way for the top three reserve list to be on FBM KLCI, namely, companies like MAHB, Gamuda and Westports.

This will provide greater appeal to the index in terms of diversification and representation. A potential re-entry of Westports back into the FBM KLCI in the future would be a record of sorts as it will then be a hattrick for the port operator to be included yet again in the 30-stock index.

The issue of a particular constituent being added and removed cannot be helped by changes in ground rules as they are designed as such to provide objectivity in the assessment of any inclusion or removal of an index constituent. Hence, even in years to come, we will continue to see this swing of particular constituents being added, removed, and re-added back, depending on their full market capitalisation ranking.

However, changes to the ground rules can be made to remove companies in the full market capitalisation ranking if they are a subsidiary of another constituent, or in the case of HLB, to be included as the main index constituent as HLFG has a smaller full market capitalisation.

Pankaj C. Kumar is a long-time investment analyst. The views expressed here are the writer’s own.