Today, there’s over $15 trillion in these passively managed index funds. In India, the trend is catching on. 14 years ago, there were just 8 index-based products in India. Today, there are over 200. And in just the past year and a half, the total corpus in index funds has doubled from ₹3 trillion to ₹6.25 trillion. (View Highlight)
Well, in India, the Nifty 50 is owned and managed by NSE Indices (previously known as India Index Services & Products Limited). This company in turn is a subsidiary of the National Stock Exchange. So when NSE decides to throw one stock out of the index, all those index funds carrying the stock will also have to inevitably sell it. This could have a detrimental impact on the stock. If they decide to add a company into the mix, the stock price can soar considering several index funds will now be forced to buy the stock. This movement in stock price due to a change in the index is collectively termed the ‘index effect’. (View Highlight)
In 2018, the Anglo-Dutch company Unilever decided to shift its headquarters from London and stick to just the Netherlands. It wanted to streamline its business operations. But shareholders revolted and Unilever shelved the plan.
Why were people annoyed with Unilever’s plan, you ask?
Well, if Unilever left the UK, the company’s stock would have been removed from the FTSE 100 stock market index — a popular market index in the UK. And considering this is a global index tracked by fund managers all over the world, it would have had massive repercussions. All these people would have been forced to sell the stock and it would’ve hurt Unilever shareholders. At least in the short run. (View Highlight)
For instance, in the US, index makers operated under something called the ‘Publishers Exclusion’. Remember how we said indices originated in newspapers? Well, these folks were exempt from regulations since the law protected newspapers and writers. But, last summer the US Securities and Exchange Commission (SEC) began considering whether it should classify index providers as “investment advisers”. (View Highlight)
Note: Regulating index funds
Well, constructing an index seems objective and mathematical at first. And usually, they outline rules on how to make up the index. There’s a monthly factsheet that shows everything too. It seems transparent. But…there’s some human interference too. And that is subjective and discretionary. (View Highlight)
Like in the case of Tesla. Back in 2020, everyone expected the EV car maker to be added to the S&P 500 index. It ticked all the right boxes. But the committee said, “No!” The reason? One theory was that not everyone was convinced about the ‘quality’ of Tesla’s earnings. But the damage was done and the stock fell by 16% in a single day. (View Highlight)
Essentially, an index provider can also make discretionary calls. So why not classify them as advisers? Since their decision has so much bearing on the movement of funds. (View Highlight)
And that’s why globally, regulators are now turning their eye towards index providers. (View Highlight)
