Leading brokerage Macquarie predicts that HDFC Bank’s weight in the MSCI India Index could double in the next index rebalancing due in August, potentially bringing in passive buying of $5.2 billion or 281 million shares into the stock. In a sale note circulated to clients, Macquarie said, “HDFC Bank missed MSCI weight increase by a very small margin in the May rebalance. However, looking at the FII selling in the last two months, HDFC Bank's MSCI India weight should double in the August rebalance.”
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Currently, HDFC Bank ranks No. 4 in the MSCI India Index, commanding a weight of 3.89%. Based on Macquarie’s calculation, this number could double, which will then close the technical overhang in the stock that was created post-merger with funds ending up with outsized positions in the combined entity compared to the index weight for the bank. Foreign investors were overweight by approximately 800 basis points in March 2023, which is currently down to roughly 500 basis points. As the MSCI weight of HDFC Bank doubles from 3.82% currently to 7.64%, this 500 basis points overweight position would go below 100 basis points because of the combined effect of index weight going up and foreign holdings increasing on passive buying. “I feel finally the technical overhang will be behind us,” the note read.
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MSCI index weights are calculated based on free-float adjusted market-cap available for investment by foreign investors. According to the MSCI index construction methodology, for a security subject to foreign ownership limits to be included in the investable market index at its entire free-float adjusted market-cap, the proportion of shares available to foreign investors – called foreign room – relative to the maximum allowed must be at least 25%. If a security’s foreign room is less than 25% and equal to or higher than 15%, MSCI uses an adjustment factor of 0.5 to calculate the final foreign inclusion factor or weight in the index. Securities are not eligible for inclusion in the investible universe if the foreign room is less than 15%.
As of March 2024, the investment headroom for foreign portfolio investors in India’s leading private sector bank stood at 24.95%, five basis points short of the threshold required for the index provider to hike its weight in the global indices to a full weight. Foreign holding in the stock stood at 55.54%, while the required holding is 55.50%, indicating a required foreign selling of 3 million shares ($60 million) for foreign room to shoot to beyond 25% and trigger a doubling of the stock’s weight in the index.
The crucial question is if foreign room can indeed go up to 25% in the June quarter, which will be the threshold considered for the August rebalancing. Macquarie noted that data for the period April 1 to May 15 reveals that foreign investors have been net sellers in financial stocks to the tune of $2.2 billion. “Quite possible, HDFC Bank would have seen net selling of more than $60 million.” Beyond May 15, too, foreign investors have been net sellers in the market, although the sectoral break-up of where they have sold is not yet available. “Base case is that the August rebalance should see HDFC weight double in MSCI,” Macquarie noted.
Macquarie also explained that the downside from any potential reduction in weight if the trend were to reverse quickly and increase foreign holding once again is limited. The note said that once the adjustment factor is changed to 1 from 0.5, it will be changed back to 0.5 from 1 only if the foreign room reduces below 15% (and not the current threshold of 25%). According to Macquarie, the index methodology is designed to avoid frequent flip-flops. Otherwise, “if foreign room goes above 25% => weight will double in MSCI => Passive funds will buy => foreign room will go below 25% => MSCI weight will halve => passive funds will sell and then the same cycle will continue,” the note said. “To avoid this flip flop, the foreign room threshold for weight reduction is lower than the threshold for weight increase.” This rules out any risk of weight in MSCI reversing on some buying post-MSCI event by foreign investors.
The Macquarie note said, “With technical issues almost behind us, I would recommend buying HDFC Bank! Any market sell-off by FIIs will mean HDFC Bank for sure sees MSCI weight doubling in August. Any market buying by FIIs is anyway good for the stock.”
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