Why Germany’s Share Index Overhaul Is a Big Deal

(Bloomberg) -- For portfolio managers, rejigging holdings to reflect the latest makeup of stock indexes is as humdrum as changing a car tire. Not so this September, when they’ll need to accommodate a major overhaul in German equities. Deutsche Boerse AG, the Frankfurt exchange operator, is scrapping a longstanding rule that keeps shares in its technology index out of other indexes -- and bars the likes of Deutsche Telekom AG from the technology index. It’s also increasing the size of some indexes. The result for portfolio managers: The next quarterly review to determine which stocks go in which index may feel more like switching all four tires, and getting an oil change.

1. Why the changes?

In part, because clients asked for it. Deutsche Boerse also wants the broader indexes to better reflect the German economy and to ensure liquidity, which lags bigger markets such as the London Stock Exchange. The new rules apply to the MDAX for medium-sized companies, the small-cap SDAX and the TecDAX tech index. The regulations also have implications for some constituents of the 30-member benchmark DAX.

2. What exactly is changing?

The MDAX, which includes the biggest companies outside the DAX, will increase to 60 constituents from 50. The SDAX will rise to 70 from 50. The number in the HDAX, which encompasses the 110 most liquid stocks, will vary because of overlap resulting from changes to technology shares. Up to now, Deutsche Boerse classed stocks as either “classical” or “technology,” keeping them strictly separate in indexes. Under the new regulations, TecDAX companies will be allowed in the MDAX and SDAX, while DAX stalwarts such as Deutsche Telekom, Infineon Technologies AG and SAP SE can be included in the TecDAX.

3. When will this happen?

The new lineups will be announced after the Sept. 5 market close and will be based on Aug. 31 prices and market data. The last day of trading under the old rules will be Sept. 21 -- the most likely day for index-tracking funds to make adjustments. The first day of trading under the new regime will be Sept. 24.

4. How widely used are the indexes?

Funds totaling 5.7 billion euros ($6.5 billion) have the MDAX as their primary benchmark, while 1.5 billion euros of investments are managed in small-cap-focused funds, data compiled by Bloomberg show. Index reboots are a chance for traders to make (or lose) money, since a stock’s inclusion typically boosts its demand, and price. Exclusion can have the opposite effect.

5. Is it easy to predict the changes?

Not especially. For index membership, a stock needs to meet criteria based on the market value adjusted for free float (the proportion of shares that are available to trade) and trading volume. Currently, several shares are on the borderline in terms of market valuation, while trading volumes of many small- and mid-cap stocks are volatile. Three weeks ahead of the impending announcement, analyst Uwe Streich from Landesbank Baden-Wuerttemberg estimated 23 new companies will join the SDAX and 15 will enter the MDAX.

Why Germany’s Share Index Overhaul Is a Big Deal

6. Will the shakeup alter the performance of an index?

It looks that way. To examine the question, Deutsche Boerse established so-called shadow indexes to simulate performance had the changes been made using data in May. Under those conditions, the rejigged MDAX and SDAX both would have outperformed the existing indexes.

The Reference Shelf

  • Deutsche Boerse’s guide to the changes.
  • The DAX is back on track.
  • Click here for QuickTakes on Germany and here for all QuickTakes.

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