MSCI will review its indices. Crypto wallets are at risk. What else should you keep an eye on?

On the evening of November 11, MSCI will announce changes to the composition of its stock indices, and these changes will take effect on November 30. The review is taking place during a challenging period for the market, but it may now create additional uncertainty for small-cap stocks and companies holding cryptocurrency on their balance sheets. For more details, see this article by Capital Lab partner Evgeny Shatov.

MSCI calculates indices that serve as benchmarks for numerous investment funds around the world. If a company is added to an index, funds that passively track that index must purchase its shares in the appropriate proportion; when a company is removed, the opposite occurs.

The upcoming revision covers a fairly wide range of indices:

— MSCI Global Standard — major indices of large and medium-sized companies.

— MSCI Global Small Cap — indices of small-cap companies.

— MSCI Micro Cap — indices of micro-cap companies.

— MSCI Global Value and Growth — indices for value and growth companies.

— MSCI Frontier Markets — markets with frontier status.

— MSCI U.S. Equity Indexes — U.S. stock indices.

— MSCI US REIT Index — U.S. real estate investment trusts.

— Chinese market indices: China A Onshore and China All Shares.

Stocks of companies included in a particular index experience additional demand, which can potentially lead to rising prices. Being removed from an index can lead to the risk of a decline in the value of a company’s securities and increased volatility, including due to excess supply.

According to a study of MSCI index rebalancings across 56 markets from 2006 to 2023, on the last trading day before the changes took effect, trading volume for stocks being removed from the index exceeded the usual volume by more than 12 times on average. At the same time, the final minute of trading accounted for 41% of the daily trading volume for stocks being added to the index and 49.8% for those being removed. Investors who, on the day the changes were announced, bought stocks being added to the indices and opened short positions in the stocks of companies being removed, then closed those positions on the eve of the rebalancing, earned approximately 5.4% in abnormal returns, even after accounting for the costs of borrowing the shares.

However, trying to profit by buying a stock immediately after the announcement of its inclusion may turn out to be less profitable than it seems. As a rule, the market has already priced in a significant portion of the expected demand, and a reversal is possible after the rebalancing.

It is important to note that this index rebalancing is taking place at a time when investors are already facing a challenging period—last week, a wave of massive sell-offs swept through the tech sector. And now, investors’ attention is focused on the situation with non-cloud companies, as well as Nvidia, whose CEO, Jensen Huang, has found himself at the center of a spy scandal.

Buying stocks based solely on news that they have been added to a particular index is a risky strategy. But, of course, investors shouldn't ignore this fact either.

Index rebalancing is likely to have the greatest impact on relatively small and less liquid companies, whereas such news has a lesser effect on large corporations, since even flows amounting to billions may prove insignificant relative to normal trading volumes.

Starting November 30, MSCI will change the rules for including companies in its indices that have virtually no operating activities and primarily hold financial assets. New requirements will be introduced for these companies: they must have tangible operating assets and meet certain financial metrics.

Companies already included in the indices will not be removed immediately; to be removed, they must fail to meet the new criteria for two consecutive reporting periods.

MSCI will eliminate special rules for these companies: from now on, companies with at least half of their assets in digital assets will be evaluated according to general criteria. This does not mean that all companies holding Bitcoin will be automatically excluded from the indices; however, the risk will increase for those whose core business is the accumulation of cryptocurrency. In this case, this could affect Strategy, Metaplanet, SharpLink Gaming, and Yellow Cake.

In addition to changes in index composition, investors should also take into account MSCI’s broader decisions regarding specific countries. Indonesia and Turkey are currently under particular scrutiny.

Back in October, MSCI announced the start of consultations on the possibility of downgrading Indonesia’s status by two levels at once and reclassifying it from the emerging markets category to “Standalone Market” (such markets are classified as neither developed nor emerging). A final decision will be made by the end of June 2027; until then, MSCI may publish interim updates on the matter. The main concerns regarding the local market are the lack of transparency in share capital and alleged coordinated trading. Restrictions on adding Indonesian stocks to indices and increasing their weightings are already in effect.

Indonesian authorities have already warned that a downgrade could trigger a capital outflow of more than $5 billion. Since the beginning of the year, the local stock market has already fallen by 40%, and a potential downgrade could further worsen the already precarious state of Indonesian companies’ securities. Four banks—Bank Central Asia, Bank Rakyat Indonesia, Bank Mandiri, and Bank Negara Indonesia—collectively account for about 71.8% of the index. Therefore, the banking sector is likely to bear the brunt of forced sales.

In Turkey, MSCI has also restricted the inclusion of new stocks in certain indices and the increase in their weightings due to concerns regarding the transparency of the free float and trading activities. As a result, Turkish stocks are unlikely to benefit from the MSCI index reviews in November. MSCI warned that if the situation does not improve by June 2027, it may begin consultations on downgrading Turkey’s status from emerging market to frontier or standalone.

It is worth focusing on Aselsan, Tüpraş, and BİM, which together account for nearly 50% of the Turkish index. Kiler Holding deserves special attention in light of the recent revision of its free float and its potential impact on the company’s weighting in the indices.