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Nifty, Sensex a long way from truly representing the economy

Rajesh Bhayani / Mumbai April 14, 2010, 0:28 IST

Nifty, the benchmark index of the National Stock Exchange (NSE), replaced Grasim with Kotak Mahindra Bank last week. With this, the percent weight of the banking and financial services (including housing finance) sector in the index increased from 22.97 to 23.86. In 2005, it was 19.78. The sector has the highest weight in Nifty as well as Sensex, the benchmark index of the Bombay Stock Exchange, followed by oil & gas. However, going by the weights of various sectors in these indices, they no more look like barometers of the economy, as various heavyweights in the economy are almost not represented.
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5,353 - Infy results fail to boost markets - Techies shine in a stagnant market - IT stocks lead recovery in markets - Sensex remains weak... - Infy results fail to cheer markets For instance, in the country¶s gross domestic product, agriculture contributes 20.14 per cent and the trade sector 23.57 per cent. But, both are almost absent from these benchmark indices. Vikash Khemani, co-head, institutions sales, Edelweiss Capital, said: ³These fairly represent the economy. However, one

should look at indices as representing the market. Within the listed companies, they should be fairly representative, and that is there.´ Said Chetan Majithia, head of equities, Crisil, ³Our study has shown that among BRIC (Brazil, Russia, India and China) nations, Indian markets are more diversified, and that is reflected in the indices.´

MEASURING WEIGHTS
Weight in Nifty 2005 Banks & Finance Oil & Gas IT Capital Goods Metals & Steel FMCG Automobile Power Generation Telecom-Service Construction & Realty Pharmaceuticals Gas Distribution Cement Others 19.79 16.23 15.99 4.39 8.18 8.98 6.84 2.33 4.93 5.16 1.53 4.02 1.62 2009 18.22 21.63 10.72 8.74 3.86 11.81 3.80 5.71 7.85 0.67 2.69 1.50 2.80 0.00 2010 23.86 17.22 12.10 9.94 8.56 7.72 5.20 4.32 3.75 2.41 2.28 1.42 1.20 0.00 Weight in Sensex 2005 22.21 17.50 15.52 4.48 8.26 9.84 5.05 2.65 4.57 4.70 4.57 0.64 2009 18.82 21.29 12.08 8.75 3.50 13.67 4.39 5.21 7.43 1.28 1.20 0.00 2.37 0.00 2010 22.31 18.25 13.84 9.98 7.22 9.18 6.18 4.24 3.62 2.11 0.96 0.00 2.12 0.00

For example, the Russian market¶s composite index, MICEX, gives 50.01 per cent weight to oil and gas and 19.56 per cent to the basic raw material sector. Over two-thirds weight is of commodity-related sectors. Brazil¶s Bovespa index is heavy on basic raw materials (33.93) and oil and gas (15.47). China¶s Shanghai Stock Exchange¶s index gives 32.35 per cent weight to the financial sector but oil and gas, basic raw materials and industrials account for nearly 48 per cent. Compared with these, Nifty and Sensex are widely distributed and diversified.

´ In terms of weights globally.15 per cent to the financial sector. there was no scale to measure the ups and downs in the Indian stock market. Nikkei 225 gives 28. 20. you go long on Russia.16 per cent to consumer goods and only 6. Mumbai´ by paying a princely amount of Re1. the country¶s capital markets have passed through both good and bad periods. The base year of SENSEX is 1978-79 and the base value is 100. The index is widely reported in both domestic and international markets through print as well as . and long on Brazil if commodity prices are moving up. If you want to diversify risk. Till the decade of eighties. most developed markets¶ indices differ. Mumbai (BSE) in 1986 came out with a stock index that subsequently became the barometer of the Indian stock market. ³If you feel crude oil prices are going up.15 per). A lot has changed since 1875 when 318 persons became members of what today is called ³The Stock Exchange. India is a better bet among BRIC nations. SENSEX is a basket of 30 constituent stocks representing a sample of large. FTSE gives the highest (21 per cent) weight to financials. The Stock Exchange.08 weight to industrials. liquid and representative companies.Chetan says. The journey in the 20th century has not been an easy one. 128 years of experience seems to be a proud milestone. while the Hang Seng is overweight on the financial sector (58. Since then. SENSEX is not only scientifically designed but also based on globally accepted construction and review methodology. For the premier Stock Exchange that pioneered the stock broking activity in India. First compiled in 1986.

The Index was initially calculated but based on the to ³Full the Market Capitalization´ methodology was shifted free-float methodology with effect from September 1. The ³Free-float Market Capitalization´ methodology of index construction is regarded as an industry best practice globally. Small wonder. 2003. The market capitalization of a company is determined by multiplying the price of its stock by the number of shares issued by the company. The SENSEX captured all these events in the most judicial manner. Right from early nineties the stock market witnessed heightened activity in terms of various bull and bear runs. One can identify the booms and busts of the Indian stock market through SENSEX. SENSEX is regarded to be the pulse of the Indian stock market. The growth of equity markets in India has been phenomenal in the decade gone by.electronic media. As per this methodology. All major index providers like MSCI. STOXX. SENSEX Calculation Methodology SENSEX is calculated using the ³Free-float Market Capitalization´ methodology. the level of index at any point of time reflects the Free-float market value of 30 component stocks relative to a base period. it provides the time series data over a fairly long period of time (From 1979 onwards). Due to is wide acceptance amongst the Indian investors. the SENSEX has over the years become one of the most prominent brands in the country. This market capitalization is further . FTSE. As the oldest index in the country. S&P and Dow Jones use the Free-float methodology.

multiplied by the free-float factor to determine the free-float market capitalization. Free-float market capitalization is defined as that proportion of total shares issued by the company that are readily available for trading in the market. (For more details click µDollex series of BSE indices¶) Understanding Free-float Methodology Concept: Free-float Methodology refers to an index construction methodology that takes into consideration only the free-float market capitalization of a company for the purpose of index calculation and assigning weight to stocks in Index. prices of the index scrips. The calculation of SENSEX involves dividing the Free-float market capitalization of 30 companies in the Index by a number called the Index Divisor. It keeps the Index comparable over time and is the adjustment point for all Index adjustments arising out of corporate actions. Dollex-30 BSE also calculates a dollar-linked version of SENSEX and historical values of this index are available since its inception. The Divisor is the only link to the original base period value of the SENSEX. replacement of scrips etc. strategic holding and other locked-in . This is often indicated by the notation 1978-79=100. It generally excludes promoters¶ holding. at which latest trades are executed. The base period of SENSEX is 1978-79 and the base value is 100 index points. During market hours. are used by the trading system to calculate SENSEX every 15 seconds and disseminated in real time. government holding.

BSE pioneered the concept of Free-float by launching BSE TECk in July 2001 and BANKEX in June 2003. Being a perfectly replicable portfolio of stocks. In India. While BSE TECk Index is a TMT benchmark. a Free-float adjusted index is best suited for the passive managers as it and broad-based. the concentration of top five companies in SENSEX has fallen under the free-float scenario thereby making the SENSEX more diversified * A Free-float index aids both active and passive investing styles. BANKEX is positioned as a benchmark for the banking sector stocks. SENSEX becomes the third index in India to be based on the globally accepted Free-float Methodology. This enables an apple-to-apple comparison thereby facilitating better evaluation of performance of active managers. market. .shares that will not come to the market for trading in the normal course. the market capitalization of each company in a Free-float index is reduced to the extent of its readily available shares in the market. For example. Major advantages of Free-float Methodology: * A Free-float index reflects the market trends more rationally as it takes into consideration only those shares that are available for trading in the * Free-float Methodology makes the index more broad-based by reducing the concentration of top few companies in Index. In other words. It aids active managers by enabling them to benchmark their fund returns vis-à-vis an investable index.

under the Free-float Methodology. In specific. NASDAQ-100. For example. the following categories of holding are generally excluded from the .enables them to track the index with the least tracking error. is also based on the Free-float Methodology. The MSCI India Standard Index. * Globally. S&P and STOXX have adopted the same. under a Fullmarket capitalization methodology. shifted all its indices to the Free-float Methodology in 2002. which is followed by Foreign Institutional Investors (FIIs) to track Indian equities. MSCI. FTSE. However. since only the free-float market capitalization of each company is considered for index calculation. the underlying index to the famous Exchange Traded Fund (ETF) ± QQQ is based on the Free-float Methodology. in the normal course come into the open market for trading are treated as µControlling/ Strategic Holdings¶ and hence not included in free-float. * Free-float Methodology improves index flexibility in terms of including any stock from the universe of listed stocks. a leading global index provider. This improves market coverage and sector coverage of the index. the Free-float Methodology of index construction is considered to be an industry best practice and all major index providers like MSCI. it becomes possible to include such closely held companies in the index while at the same time preventing their undue influence on the index movement. companies with large market capitalization and low free-float cannot generally be included in the Index because they tend to distort the index by having an undue influence on the index movement. Definition of Free-float: Share holdings held by investors that would not.

The remaining shareholders would fall under the Free-float category.definition of Free-float: * Holdings by founders/directors/ acquirers which has control element * * * * * * Holdings by persons/ bodies with as the corporate Employee companies ³Controlling FDI bodies/ Welfare Interest´ Route individuals Trusts Government Holdings Strategic Equity Equity stakes by held held by holding through private by associate/group promoter/acquirer (cross-holdings) * Locked-in shares and shares which would not be sold in the open market in normal course. A Free-float factor of say 0. which is filled and submitted by all index companies on a quarterly basis with the Exchange. it is rounded-off to the higher multiple of 5 and each company is categorized into one of the 20 bands given below. (Format available on www. Once the Free-float of a company is determined.bseindia.55 means that only 55% of the market capitalization of the company will be considered for index calculation. Free-float factor is a multiple with which the total market capitalization of a company is adjusted to arrive at the Free-float market capitalization. Free-float Bands: . Determining Free-float factors of companies: BSE has designed a Free-float format.com) The Exchange determines the Freefloat factor for each company based on the detailed information submitted by the companies in the prescribed format.

15 >60 ± 65% 0.65 >15 ± 20% 0.10 >55 ± 60% 0.05 >50 ± 55% 0.20 .60 >10 ± 15% 0.55 >5 ± 10% 0.% Free-Float Free-Float Factor % Free-Float Free-Float Factor >0 ± 5% 0.

85 >35 ± 40% 0.75 >25 ± 30% 0.80 >30 ± 35% 0.70 >20 ± 25% 0.35 >80 ± 85% 0.40 >85 ± 90% 0.>65 ± 70% 0.90 .30 >75 ± 80% 0.25 >70 ± 75% 0.

the last traded price is taken for computation of the Index closure. do not . Maintenance of SENSEX One of the important aspects of maintaining continuity with the past is to update the base year average.00 Index Closure Algorithm The closing SENSEX on any trading day is computed taking the weighted average of all the trades on SENSEX constituents in the last 30 minutes of trading session.45 >90 ± 95% 0. If a SENSEX constituent has not traded at all in a day. then its last day¶s closing price is taken for computation of Index closure. If a SENSEX constituent has not traded in the last 30 minutes.>40 ± 45% 0.95 >45 ± 50% 0. The base year value adjustment ensures that replacement of stocks in Index. The use of Index Closure Algorithm prevents any intentional manipulation of the closing index value.50 >95 ± 100% 1. additional issue of capital and other corporate announcements like µrights issue¶ etc.

Independent Governing Board members. The Index Cell of the exchange does the day-to-day maintenance of the index within the broad index policy framework set by the Index Committee. at which trades are executed. The Index Committee of the Exchange comprises of experts on capital markets from all major market segments. On-Line Computation of the Index: During market hours. The beauty of maintenance lies in the fact that adjustments for corporate actions in the Index should not per se affect the index values. The Index Cell ensures that SENSEX and all the other BSE indices maintain their benchmark properties by striking a delicate balance between frequent replacements in index and maintaining its historical continuity. Fund-managers from leading Mutual Funds. If no adjustments were made. They include Academicians. a discontinuity would arise between the current value of the index and its previous value despite the non-occurrence of any economic activity of substance. are automatically used by the trading computer to calculate the SENSEX every 15 seconds and continuously updated on all trading workstations connected to the BSE trading computer in real time. which is used to alter market capitalization of the component . Market Participants. Finance-Journalists. and Exchange administration. At the Index Cell of the Exchange. Adjustment for Bonus. the base value is adjusted.destroy the historical value of the index. Rights and Newly issued Capital: The arithmetic calculation involved in calculating SENSEX is simple. prices of the index scrips. but problem arises when one of the component stocks pays a bonus or issues rights shares.

Therefore. An offsetting or proportionate adjustment is then made to the Base Market Capitalisation (see µBase Market Capitalisation Adjustment¶ below).stocks to arrive at the SENSEX value. issues right shares. issues bonus shares. there is no change in the Base Market Capitalisation. * Adjustments for Bonus Issue: When a company. * Other Issues: Base Market Capitalisation Adjustment is required when new shares are issued by way of conversion of debentures. the market capitalisation of that company does not undergo any change. or when equity is reduced by way of buy-back of shares. . the free-float market capitalisation of that company is increased by the number of additional shares issued based on the theoretical (ex-right) price. mergers. included in the compilation of the index. The Index Cell of the Exchange keeps a close watch on the events that might affect the index on a regular basis and carries out daily maintenance of all the 14 Indices. corporate restructuring etc. spin-offs etc. only the µnumber of shares¶ in the formula is updated. * Adjustments for Rights Issues: When a company. included in the compilation of the index.

* Base Market Capitalisation Adjustment: The formula for adjusting the Base Market Capitalisation is as follows: New ²²²²²²²²²²²² Old Market Capitalisation To illustrate.24 will then be: (4781+100) crores Market Capitalisation New Base Market Capitalisation = Old Base Market Capitalisation x ² The scrip should have a listing history of at least 3 months at BSE. suppose a company issues right shares which increases the market capitalisation of the shares of that company by say. The ³New Base Market Capitalisation 2450 ²²²²²²²²± 4781 This figure of 2501. Back SENSEX ± Scrip selection criteria: The general guidelines for selection of constituents in SENSEX are as follows: * Listed History: = ´ x Rs.4781 crores. say. say Rs. . Rs.2501. is Rs.24 will be used as the Base Market Capitalisation for calculating the index number from then onwards till the next base change becomes necessary.2450 crores and the aggregate market capitalisation of all the shares included in the index before the right issue is made is. The existing Base Market Capitalisation (Old Base Market Capitalisation).100 crores.

5% of the Index. The final rank is arrived at by assigning 75% weightage to the rank on the basis of three-month average full market capitalisation and 25% weightage to the liquidity rank based on three-month average daily turnover & three-month average impact cost. * a company is listed on account of merger/ demerger/ Frequency: amalgamation. * Scrip * acceptable track record. Exceptions can be made for extreme reasons like scrip suspension etc.Exception may be considered if full market capitalisation of a newly listed company ranks among top 10 in the list of BSE universe. * Final Rank: The scrip should figure in the top 100 companies listed by final rank. selection would Industry generally Track take into Representation: account a balanced Record: representation of the listed companies in the universe of BSE. Index Review Frequency: The Index Committee meets every quarter to discuss index related issues. In the opinion of the Committee. minimum listing history would not be required. the announcement of the incoming and outgoing scrips is made six weeks in advance of the actual implementation of the revision of the Index. In case of a revision in the Index constituents. In case. Trading The scrip should have been traded on each and every trading day in the last three months. the company should have an . * Market Capitalization Weightage: The weightage of each scrip in SENSEX based on three-month average free-float market capitalisation should be at least 0.

08.1992 Zenith Ltd.Shipping 03.08.Back History of replacement of scrips in SENSEX Date Outgoing Scrips Replaced by 01. Scinda G.1986 Bombay Burmah Voltas Asian Cables Peico Crompton Greaves Premier Auto.01.1996 . Bharat Forge 19.E.

Ballarpur Inds. Arvind Mills Bharat Forge Bajaj Auto Bombay Dyeing BHEL Ceat Tyres BSES Century Text. Amb. Cement Hind. Colgate GSFC Guj. Motors HPCL Indian Organic ICICI Indian Rayon IDBI .

Kirloskar Cummins IPCL Mukand Iron MTNL Phlips Ranbaxy Lab. Premier Auto State Bank of India Siemens Steel Authority of India Voltas Tata Chem 16. Shipping Infosys Technologies IPCL .1998 Arvind Mills Castrol G.11. E.

NIIT Ltd.I Dr. Steel Authority of India Novartis 10.D.01.01.2002 NIIT Ltd. Reddy¶s Laboratories Indian Hotels Reliance Petroleum Tata Chem Satyam Computers Tata Power Zee Telefilms 08. 07.2001 Novartis Cipla Ltd.B. HCL Technologies .2000 I.04.

Nestle (India) Ltd. ICICI Bank Ltd. . Glaxo Smithkline Pharma. HCL Technologies Ltd. 10.10. 31. Tata Power Company Ltd.2002 Reliance Petroleum Ltd.2002 ICICI Ltd. ONGC Ltd. 10. HDFC Ltd. Bharti-Tele-Ventures Ltd. Ltd.2003 Castrol India Ltd.05.11. Colgate Palomive (India) Ltd.Mahindra & Mahindra Hero Honda Motors Ltd. HDFC Bank Ltd.

2006 Tata Power Ltd.09. 06. 27. 12.2004 Mahanagar Telephone Nigam Ltd. Maruti Udyog Ltd. Ltd.2005 Hindustan Petroleum Corp Ltd. Mahindra & Mahindra Ltd. . Larsen & Toubro Ltd.06. 19. Reliance Communiation Ventures Ltd. 09.Wipro Ltd.2007 Hero Honda Motors Ltd.06.05. Zee Telefilms Ltd.07. Tata Consultancy Services Ltd. National Thermal Power Corpn.2004 Larsen & Toubro Ltd.

2007 Dr. Cipla Ltd.07.03.11. 14. .2008 Ambuja Cements Ltd. Sterlite Industries Ltd. Tata Power Co. Jaiprakash Associates Ltd. Ltd. DLF Ltd.2008 Bajaj Auto Ltd. 28. Reddy¶s Laboratories Ltd.19.