Facelift of Hang Seng Index (Business Times)

SINGAPORE MARKET
HSI’s facelift sparks calls to revamp STI to include key growth sectors

NEWS of the Hang Seng Index’s (HSI) soon-to-be facelift has led market watchers to voice support for a similar revamp of the Straits Times Index (STI) to include more representation in other key growth sectors, while easing its heavy bias towards real estate stocks and banks which make up 3/5 of the index’s market cap.

Suggested sectors that could be added include technology, healthcare, e-commerce, manufacturing, materials, logistics and consumer services, but they also caution that it would be an uphill task to nd a middle tier of companies with sufficient investor interest to fill the sector void.

FTSE Russell, Singapore Press Holdings (SPH), which publishes The Business Times, and Singapore Exchange (SGX) jointly calculate the STI.

The STI is widely followed by investors as the benchmark for the Singapore market and is used as the basis for a range of financial products including Exchange Traded Funds (ETFs), warrants, futures and other derivatives. FTSE Russell is the index administrator.

Kenneth Tang, senior portfolio manager from Nikko Asset Management’s Asian equity team, noted that it was the same issues of sector concentration and lack of representation faced by the HSI that led to its revamp.

This became more glaring following a wave of listings by big technology and pre-revenue biotech companies in recent years. “Short of these mega listings in Singapore, we hope the STI can have better representation in the service economy or what we term ‘New Singapore’… We do need some Singapore companies that are smaller but play strongly to Singapore’s economic strength.

“Many of them have also reacted well amid Covid-19 and have re-adapted their business models to overcome disruption byembracing innovation.” These companies not represented in the STI fall broadly within sectors such as technology, healthcare and consumer services, including food which has no or little representation in the index, he said.

While he cannot name stocks, BT understands that agri-food company Japfa and tech firm Venture Corporation are in the top active holdings of the NikkoAM Shenton Thrift Fund and Singapore Dividend Equity Fund. Mr Tang also noted that the key recalibration to the HSI is not so much in increasing the number of constituents, which does little to adjust the sector demography of the index. Rather, it is in the cutting of the weighting cap per stock to 8 per cent from 10 per cent, and setting of parameters for key sectors to be represented, while setting a number of 20 to 25 Hong Kong companies to be among the constituent stocks.

There are currently no weighting caps for stocks or sectors within the STI, nor any limits on the number of Singapore-incorporated companies. In theory, what HSI has done could work on the STI too, but the main challenge remains the lack of a middle tier of companies in the under-represented sectors that could ll the void.
“The key dierence between Hong Kong and Singapore lies in part with liquidity and a general lack of good mid-cap or smaller stocks in Singapore, outside the banking and property sectors,” Mr Tang said.

He broadly denes this middle tier as companies with a market capitalisation of more than US$5 billion and trading liquidity of more than US$3 million a day. The Singapore Exchange needs to ll this gap with good listings from under-represented sectors before a revamp can be viable. Liquidity providers also need to ramp up in providing market matching and facilitation, he added. “If a calibration is considered, I feel, as a bottom-up investor focused on the Singapore growth story, it can help to improve the investment case for investing in Singapore.”

For Terence Wong, chief executive of Azure Capital, the problem with these mid-cap stocks is not so much about a lack of quality as it is about insucient liquidity and interest, causing their valuations to languish.
“For example, tech manufacturers listed in Singapore are not getting the kinds of valuations they are getting in Hong Kong, US, China, even Malaysia where they are trading at 25 times price-to-earnings, versus 11 to 13 times in Singapore.”

One sign that the STI may not be the most comprehensive representation of the market could be the fact its constituents currently make up 63 per cent of the total market cap as at end-Feb 2021, Bart Zhou, assistant professor of nance at Insead, said. This is not far o from the 57 per cent that HSI’s market cap makes up of the total market value. After raising its constituent stocks to 80, however, the HSI will cover 71 per cent of Hong Kong’s total market cap. “To form a broad market index, the coverage should be high. For example, the S&P 500 index accounts for about 80 per cent market cap of all US equity and is considered as a comprehensive representation of the US market,” Prof Zhou said.

To be sure, no one debates the fact that banks and real estate are the key engines that power Singapore’s economy.
Attesting to this, Singapore Exchange market strategist Geo Howie noted that Singapore banks averaged annualised total returns of 8 per cent, which compared to an APAC average of one per cent, and the top quartile of global banks’ average of 6 per cent.

Real estate stocks also punch well above their STI weight in the global universe of real estate counters, with Singapore’s impact in the FTSE EPRA Nareit Global Index at 3.1 per cent, almost 10-fold its 0.34 per cent weightage in the FTSE All-World Index. Mr Howie said that “there is always room for more industries in the STI, and the index is designed to accommodate new entrants should they meet size and liquidity requirements.”

Case in point: the inclusions of Mapletree Industrial Trust and Keppel DC Reit last year, which receive “new economy” information and communications technology stocks such as data centre operators.

The FTSE adopts a market cap weighted methodology with an adjustment for free oat of the companies in the index.
Essentially, the size and liquidity parameters of constituents dictate what go in or out of the index, which is rebalanced quarterly. However, modifying this methodology cannot be a simple and isolated exercise, as any major change needs to be appropriately applied for all indices under FTSE, and not just for Singapore’s STI.

Mr Howie said index providers do not make frequent structural significant changes to a benchmark, and rather opt for stability. He also believes in the STI’s appeal to investors, given the S$7.5 billion of net retail inflows into STI stocks last year, coupled with the year-on-year doubling in the combined assets under management of the SPDR® Straits Times Index ETF and the Nikko AM Singapore STI ETF in Feb 2021.

Based on the current index guidelines and constituent sizes, for a stock to join the STI today and displace another constituent, it would have to maintain a market capitalisation within the vicinity of S$6.5 billion and S$7 billion, Mr Howie said. “Liquidity as it stands today is less of an issue, as we saw last year, a host of stocks including AEM Holdings, Suntec Reit, Frasers Logistics & Commercial Trust, NetLink NBN Trust, Frasers Centrepoint Trust, Riverstone Holdings, Keppel Reit, Mapletree North Asia Commercial Trust and Sembcorp Marine, generate more daily trading turnover than the least traded STI constituent.”

Already, MSCI is exploring the inclusion of foreign listings such as the US-listed Sea Inc and possibly even Grab in the MSCI Singapore index with effect from May this year, as hopes run high for an STI update to come.