Sunday 8 January 2017

Betting Against the STI Component Stock Changes

Buying and holding a stock index is considered as passive investing. However, the STI is not entirely passive. Every quarter, the STI would be reviewed to determine whether certain stocks should be dropped from or added to the index. This can be likened to active stock selection. How have the stock selections of STI of the past 3 years performed?

Over the past 3 years, there have been 6 changes to the STI component stocks. 1 of them is a forced change, as CapitaMalls Asia (CMA) was privatised and its place in the STI was taken over by Ascendas REIT. All the other 5 changes are voluntary changes. The performance of the stocks removed from the index since their removal till 30 Dec 2016 is shown below.

Stock Replacement Date Price
Price 30/12/16 %
CMA 04 Jun 14 2.35 NA NA A-Reit
JMH 21 Sep 15 47.00 55.25 18% SATS/UOL/YZJ
JSH 21 Sep 15 27.01 33.20 23% SATS/UOL/YZJ
Olam 21 Sep 15 2.04 1.97 -3% SATS/UOL/YZJ
Noble 21 Mar 16 0.22 0.17 -21% CCT
SembMar 19 Sep 16 1.25 1.38 10% JMH


Please note that the price of Noble has been adjusted for a 1-for-1 rights issue at $0.11 in Jun 2016. The unadjusted price before the removal date is $0.32.

Among the 5 stocks removed from the index, 3 have gone on to register double digit gains in stock price, one is esentially flat and another is down by double digits. Overall, this portfolio of discarded index stocks have gained by 5.3% as at 30 Dec 2016.

The performance of the stocks added to the index since their addition till 30 Dec 2016 is shown below.

Stock Replacement Date Price
Price 30/12/16 %
A-Reit 04 Jun 14 2.38 2.27 -5% CMA
SATS 21 Sep 15 3.80 4.85 28% JMH/JSH/Olam
UOL 21 Sep 15 6.02 5.99 0% JMH/JSH/Olam
YZJ 21 Sep 15 1.17 0.81 -30% JMH/JSH/Olam
CCT 21 Mar 16 1.47 1.48 1% Noble
JMH 19 Sep 16 60.14 55.25 -8% SembMar


Among the 6 stocks added to the index, 3 are essentially flat, registering less than 5% gain or loss in stock price. 1 has outperformed with a 28% gain, but it is offset by another which underperformed with a 30% loss. Overall, this portfolio of added index stocks has lost 2.6%.

Please note that this analysis does not consider dividends. Among the 6 added stocks, 2 of them are REITs, which pay handsome dividends but fluctuate little in stock price. This partly explains why the portfolio of added index stocks is essentially flat.

If you had bought the discarded index stocks and sold the added index stocks, you would have gained 5.3% + 2.6% or 7.9%. Note that this is a market-neutral portfolio; you are neither long nor short the market. In other words, this 7.9% gain is alpha! It is not a gain because of a correct bet on the direction of the market. It is a gain independent of where the market moved! (Again, please note that dividends are not considered in this analysis.)

If you notice carefully, there is 1 stock that appears in both the discarded and added index stock lists. The stock is Jardine Matheson Holdings (JMH). When it was dropped from the index in Sep 2015, it price was $47.00. When it was added back to the index a year later, it had risen to $60.14. Its price as at end Dec 2016 was $55.25. Thus, on the 1 occasion when the STI carried out "market-timing", it performed poorly as well!

The main reason for the overperformance of discarded index stocks and underperformance of added index stocks is because changes to the STI component stocks are announced in advance. Hence, investors would have sold the discarded stocks and bought the added stocks before the changes take place, resulting in the discarded stocks outperforming and the added stocks underperforming subsequently. Nevertheless, the fact remains that this is a market inefficiency and investors who bet against the changes stand to profit from it.

In conclusion, the STI is not a very good stock picker. Investors who buy and hold the STI should be aware that changes to the STI component stocks would impact their performance to some extent. Also, betting against the STI component stock changes might be a fairly profitable move.

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  1. Thanks for sharing . It has been perceived that when a stock is added to the index, fund managers will load that stock to match the index and hence the logic is that it is bullish for that stock. What you shown above shows that this is not always true and in fact that opposite largely

    1. You're welcome. The main reason is that investors have loaded up on the newly added index stocks beforehand, hence they tend to underperform subsequently.