Thursday, June 4, 2009

How changes in Index constituents affect returns?

I will explain this by the example of Tata Power. As per the BSE website, Tata Power was replaced by RCOM on 12 June 2006. If we consider the market capitalization of both the companies at that time with their respective shareholding patterns of the previous quarter, Tata Power had a market cap of 8668.9 Crore with FF(Free Float) of .7 giving FF Market Cap of INR 6068.3 Crore while Reliance Communication had a market cap of 27018.95 Crore with a FF of .65 giving a FF Market Cap of 17562.32. Thus Sensex's FF Market Cap increased by 11494.02 Crore between 9 June and 12 June without giving any increase to the index (when a new company is introduced to Sensex, the FF market cap of the Sensex for the previous day is increased by difference in FF market cap of incoming and outgoing companies).

Now the same Tata Power entered the Sensex back on 28 July 2008 replacing Cipla but the scenario was different. Cipla had a market cap of 17535.69 Crore with a FF of .65 giving a FF market capitalization of 11398.2 Crore. Tata Power had a market cap of 22419.18 Crore with a FF of 0.7 giving FF market cap of 15693.42 Crore. Thus Sensex FF market cap increased by 4295.22 Crore between 25 July and 28 July without giving any increase to the index.

Thus, the increase in FF market cap of Tata Power company between 12 June 2006 and between 28 July 2008 amounting to 9625.12 Crore didn't contribute anything to the Sensex since it was moved out and then moved in again, which amounts to around 1% of 9 lakh Crore worth of FF market cap for Sensex. This is significant loss to the Sensex Index plan investors.
Bookmark and Share

No comments:

Related Posts with Thumbnails