RIL index weight=investors' woes

Reliance Industries' increasing weight in the benchmark indices is causing problems for long-term institutional investors as they are facing regulatory hurdles, a report says.

According to financial services major Credit Suisse' research report, Reliance Industries' neutral weight, which has been rising rapidly, is causing problems for all types of 'long-only' institutional investors.

The report said domestic index investors are constrained by rule imposed by the regulator that they cannot own more than 10 per cent of their assets under management in a single stock.

"The weights in Nifty (National Stock Exchange's 50-share benchmark index) and MSCI India have crossed 13 per cent and 17 per cent, respectively, and could rise further by 100-200 basis points (bp) in the months ahead," Credit Suisse research analyst Nilesh Jasani said in the report.

Majority of global index providers like Morgan Stanley Composite Index, FTSE, Standard & Poor's and Dow Jones use free-float market capitalization weighted methodology for index construction process.

As per this methodology, weight of a stock in the index is based on the size of the company and thus a relatively small shift in the price of a large company would heavily influence the value of the index. Such investors, holding less than 10 per cent of assets under management in RIL stock, have lost over 130 bp of relative performance so far this year due to such rules.

Similar regulatory limits do not exist for foreign investors. However, FIIs have such limits either self-imposed or compelled by clients for their Indian portfolio, the report stated.

Interestingly, Reliance Industries' stock has become so big in global indices that it has begun to dwarf the weights of a few small emerging markets as well, the report added.

The Credit Suisse report pointed out that the problem could grow further as with the completion of RIL-Reliance Petroleum merger, the stock's weightings in MSCI India and Nifty could rise by 100 bp and 200 bp, respectively.

Further, with around $6 billion of cash on its balance sheet and nearing the end of its major capital expenditure cycle, there is a possibility that it acquires some large-sized assets globally in the next few quarters.

"Effectively, one cannot rule out the possibility of the stock's neutral weights moving into the twenties in MSCI India in 2010," Jasani added.

The report suggested that the market regulator should review the problem and consider allowing eventual investors to permit investments up to neutral weight for large stocks.