Incoming MSCI index review puts crypto treasury stocks at risk. What else to watch?

MSCI will announce changes to its stock indexes on Wednesday evening in Europe. The changes will take effect at the close on November 30. The review comes at a difficult time for the market and could add to uncertainty for small caps and companies that keep cryptocurrency on their balance sheets. Capital Lab partner Evgeny Shatov explains what to watch.

MSCI calculates indexes that serve as benchmarks for investment funds around the world. When a company joins an index, passive funds that track it have to buy shares in proportion to its index weight. When the company is removed, those funds have to sell.

The review covers a wide range of indexes.

Index additions generate extra demand that can lift share prices. Removals can push prices lower and increase volatility, in part because of the extra shares coming onto the market.

A study of MSCI index changes across 56 markets from 2006 to 2023 found that turnover in stocks slated for removal averaged more than 12 times its usual level on the last trading day before the changes took effect. The final minute of that session accounted for 41% of the day’s volume in stocks being added and 49.8% in stocks being removed. Investors who bought the additions and shorted the deletions at the close on announcement day, then closed both positions at the close of the last trading day before the changes took effect, earned an abnormal return of about 5.4% after stock-borrowing costs.

Buying a stock as soon as its addition is announced can be less profitable than it sounds. The market typically has already priced in much of the expected demand, and the stock can reverse course after the rebalancing.

The review comes at an already difficult time for markets. A broad selloff swept through the tech sector last week. Now, attention is focused on neocloud providers and on Nvidia, whose CEO, Jensen Huang, is at the center of a spy scandal.

Buying a stock solely because it is joining an index is risky. Still, index membership is worth factoring into investment decisions.

Index changes can have the biggest impact on smaller, less liquid companies. Large companies tend to feel less of an effect, since even billions of dollars in flows can be small relative to their usual trading volumes.

At the close on November 30, MSCI will change its index eligibility rules for companies that have little operating activity and primarily hold financial assets. MSCI will first screen for substantial operating assets. Companies that fail that screen will be assessed against a set of financial ratios.

MSCI will remove existing constituents only if they fail the new eligibility test in both of their two most recent annual filing periods.

MSCI will lift its interim restrictions and apply the broader eligibility criteria to companies that hold at least half of their assets in digital assets. Holding bitcoin alone will not trigger removal, though companies whose main business is accumulating cryptocurrency face a higher risk. The new rules could affect Strategy, Metaplanet, and Sharplink, as well as Yellow Cake, which holds physical uranium.

Beyond changes to individual indexes, investors will be watching for MSCI decisions on how it classifies entire markets. Indonesia and Turkey are both under scrutiny.

In October, MSCI announced a consultation on whether to downgrade Indonesia by two tiers, from emerging to standalone market status. Standalone markets sit outside the developed and emerging market categories. MSCI will announce its final decision by the end of June 2027 and may issue an interim update. The main concerns are opaque shareholding structures and suspected coordinated trading. Restrictions on adding Indonesian stocks to MSCI indexes or raising their weights are already in place.

Goldman Sachs estimates that a downgrade could trigger more than $5 billion in outflows, the Financial Times reported. Indonesia’s stock market has already fallen 40% year to date, and a downgrade could put further pressure on local shares. Four banks, Bank Central Asia, Bank Rakyat Indonesia, Bank Mandiri, and Bank Negara Indonesia, account for about 71.8% of the MSCI Indonesia Index. The banking sector could thus bear the brunt of forced selling.

In Turkey, MSCI has also restricted additions to certain indexes and increases in stock weights, citing concerns about the reliability of free-float estimates and possible coordinated trading. As a result, Turkish stocks are unlikely to get a lift from the November review. MSCI warned that if it sees insufficient progress by June 2027, it could start a consultation on downgrading Turkey from emerging to frontier or standalone market status.

The stocks to watch are Aselsan, Tüpraş, and BİM, which together account for about half of the MSCI Turkey Index. Kiler Holding also bears watching after a revision to its free float that could affect its index weight.