What does it mean for an index to “rebalance”?
Enterprise Explains: Index rebalancing. Last month, the Egyptian Exchange released new criteria for inclusion in the EGX30 in a bid to make the benchmark index more attractive to foreign investors. The new criteria came into effect on 1 February, which is when the first periodic rebalancing of each year typically reflects on the index.
So what exactly is rebalancing, you ask? Rebalancing is a form of index maintenance that adjusts the constituents (fancy-talk for the traded companies that make up the index) to make sure representation is in line with the index’s overall goal, whatever it might be.
The criteria for inclusion in the EGX30 in each rebalancing: The EGX30 — which is Egypt’s most visible stock index — sets inclusion rules based on freefloat market capitalization and trading activity, which are designed to create an index that includes companies or constituents that are both large and actively traded.
As of this month, the constituents are required to meet a freefloat market cap equal to or above the index’s adjusted market capitalization. A company’s freefloat market cap is the number of shares in freefloat multiplied by its share price, while the adjusted market cap is calculated by finding the median of the top 60 most actively-traded companies’ freefloat market cap.
The constituents are then chosen from the 33 companies on the bourse with the highest liquidity. The 27 companies with the largest freefloat market cap will be automatically included. The remaining three companies will be selected from companies ranked #28-33 — with these six companies, the only additional criterion will be that the company was already included on the index.
How does it work? Let’s say company #28 wasn’t included in the index, but #29 was. Even though #28 has more liquidity, #29 will take the spot because it’s already on the index, meaning there will be less volatility.
What’s the point of all this rebalancing business? Without regular rebalancing, an index can become overly weighted toward a particular sector or one group of stocks, or its representation could be based on factors that aren’t best suited to the market. For example, the EGX30’s new criteria are meant to make the index more attractive to institutional (rather than retail) investors by representing large-cap Egyptian companies with stronger fundamentals, as opposed to highly volatile and actively traded companies whose fundamentals may not be as sound.
For the EGX30, the rebalancing process happens twice a year, with the changes taking effect every February and August. The changes in the methodology will be felt next week, when companies will be removed and added to the index based on the past six months of trading activity.
When do other indices rebalance? The S&P is “rebalanced as needed” but has scheduled quarterly rebalances in March, June, September and December. Just like the EGX, the MSCI rebalances in February and August, but also has semi-annual reconstitutions in May and November.
So, who was in and who was out in this month’s rebalancing? Payments giant Fawry, investment bank and NBFS player CI Capital, consumer stalwart MM Group, state-owned Abu Qir Fertilizers, and Alexandria Mineral Oils Company (AMOC) are now EGX30 constituents. Education outfit CIRA, dairy producer Juhayna, soon to be defunct Egyptian Iron and Steel, clothing manufacturer Dice, and Beltone Financial Holding have all rotated out of the benchmark index.
The EGX30 rose 1.1% at today’s close on turnover of EGP 1.63 bn (11.3% above the 90-day average). Foreign investors were net sellers. The index is up 6.5% YTD.
In the green: Eastern Company (+3.0%), Fawry (+2.5%) and Cleopatra Hospital (+2.2%).
In the red: Orascom Investment Holding (-2.7%), Sodic (-1.4%) and Alexandria Mineral Oils Company (-1.2%).