What stocks to invest in = tweaking stock market indices « PRACTICAL STOCK INVESTING



What stocks to invest in

When I started my career as a professional investor, the providers of stock market indices were a sleepy group inhabiting a financial industry backwater.

The rise of interest in markets outside the US and the increasing prominence of index funds over the past decade have changed all that, however.  Now index providers are movers and shakers in the financial world.

The two issues of the day:

–whether and in what amount to include mainland China-traded A shares in emerging markets indices.

The argument against has been that the Chinese government controls very strictly not only which foreigners can have access to local stock markets, but also in what amounts and whether/how they can repatriate profits.


The argument for is that the recently instituted Stock Connect mechanism has alleviated part of the problem.  Also, at some point one begins to question the legitimacy of an emerging markets or foreign index that has no representation of the largest emerging market of them all.  Further, the first index to include mainland China names is sure to score points with Beijing.

There’s nothing new about this debate, other than the large size of the A-share market means the decision may have significant consequences.  My guess is that the indices will begin by merely dipping a toe in the water and seeing how things go.

–whether to exclude companies that use multiple classes of shares in a way that allows a small group of insiders to control the corporation despite owning a small fraction of the outstanding equity.  Think:  Alphabet (formerly known as Google), Facebook or Snap.

I find it interesting that index providers are even contemplating excluding multiple-class companies from their indices.  I’m sure they regard this as a service, a natural extension of the legal responsibility of index funds to take part in corporate governance on behalf of the investors who own fund shares.

Maybe that’s right.  But I have three reactions:

—-this type of decision comes awfully close to active management

—-who wants a US index, to say nothing of a US tech index, without Google and Facebook?

—-excluding important names makes an index easier to beat for an active manager, who can gain outperformance by holding non-index names.  I imagine that my former colleagues who are still working are praying that the index providers start down the exclusion path.

– What stocks to invest in

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