MSCI Quarterly Rebalance Puts Spotlight on Indian Equities

The upcoming quarterly reconstitution of MSCI's benchmark indices will trigger significant portfolio adjustments for the vast array of exchange-traded funds (ETFs) that track them. The changes take effect at the market close on February 27, with a particular focus this quarter on the Indian market, which sees two additions and one deletion.

• Effective Date: Changes are implemented at the close of trading on February 27.
• Indian Market Impact: Two companies join the MSCI Global Standard Index, while one is removed.
• Overall Weighting: India's total weighting in the index is projected to remain stable at 14.1%.

Anticipated Fund Flows for Indian Constituents

The rebalancing mechanism forces passive funds that mirror the index to buy and sell specific securities, creating predictable capital flows. According to analyst projections, the inclusion of Aditya Birla Capital is expected to generate passive inflows of approximately $257 million. Similarly, the addition of L&T Finance could attract around $238 million from these index-tracking vehicles.

Conversely, the removal of the Indian Railway Catering and Tourism Corporation (IRCTC) from the index is likely to prompt selling by passive funds, with estimated outflows of $142 million. In a separate adjustment, AU Small Finance Bank is set to receive a higher weighting within the index.

Despite these individual changes, the total number of Indian constituents in the MSCI Global Standard Index will increase from 164 to 165. The overall representation of the Indian market within the index is forecast to hold steady at 14.1%.

Should investors sell immediately? Or is it worth buying MSCI World ETF?

The Mechanics Behind Index-Driven Trading

ETFs, such as the iShares MSCI World ETF, are obligated to replicate their underlying benchmark index as closely as possible. Consequently, when MSCI alters the index composition or constituent weightings, these funds must execute corresponding trades. A substantial portion of this trading activity typically clusters in the final hours of the effective date, as fund managers align their portfolios with the new index structure.

Objective Rules Govern Index Composition

MSCI's quarterly reviews are governed by a transparent set of quantitative criteria, including market capitalization, free-float availability, and trading liquidity. The promotion of Aditya Birla Capital and L&T Finance primarily reflects their increased market size and accessibility to international investors. Similarly, the deletion of IRCTC results from the application of these standardized rules, not a discretionary decision.

With the official implementation set for the market close on February 27, a concentration of the anticipated buying and selling activity is expected to occur around this deadline.