Index-Provider Readiness: Will Indices Change Their Rules For IPO Stocks?

A lot has been written about the importance of indices.

Index providers, whether the large providers responsible for benchmark indices or smaller index providers, regularly develop and maintain a myriad of indices. These indices may be designed to reflect an investment thesis; the performance of a sector, a region, an asset class or a particular market measure; or any other of a variety of objectives. In any event, index providers and indices have become indispensable. Index providers have well-defined rules-based methodologies that define their indices. These generally are published. These methodologies outline, among other things, the index selection criteria, the weighting of index constituents, the effect of corporate events on the index (such as the effect on the index of a stock split or a spin-off), and index rebalancings. For large benchmark indices, providers conduct consultations from time to time relating to potential changes to their index methodologies. An index provider may remove an index constituent that no longer meets the criteria for inclusion in the index. Similarly, an index provider may consider the inclusion of a new constituent. From time to time, there are exceptional events.

In this newsletter, we have reported on exceptional events in the life of indices. For example, some index providers considered whether or how to address dual class or multi-share class stocks. Some index providers were compelled to address the exclusion of securities issued by companies that were based in the PRC or in Russia. And so on. Now, we come upon another exceptional event, though likely not the last such exceptional event—whether indices will modify their rules for early inclusion of certain IPO stocks

A lot turns on this given that many funds track indices, including many funds that invest on behalf of retail investors. Similarly, exchange-traded products, like ETFs, track indices. Changes to benchmark indices affect the portfolios and retirement accounts of millions of retail investors who are likely not paying close attention to index providers’ press releases.

While this is an area that has been changing by the day, we report on the current state. Below, for illustration, we use one particular IPO stock as an example.

Originally published in REVERSEinquiries: Volume 7, Issue 3.
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