Morning Shout released by KASB Securities Limited and Economics Research

Karachi, June 19, 2012 (PPI-OT): KSE-100 to move to free float effective October 1st

According to KASB Securities Limited,

• The KSE has announced that the benchmark KSE-100 index will move to free float from the current market cap method effective Oct 1st 2012, following a parallel 90-day run with current index. The changes in constituents are broadly in line with what KASB Securities Limited highlighted in KASB Securities Limited’s note dated April 27th (details alongside).

• In terms of performance, the beta free float index to date (May 31st to June 12th) depicts a decline of 3.58% vs 3.19% for market cap weighted index but not much can be deduced from this very limited history. However KSE contends that its studies do not indicate any impact on market direction.

• KSE-100 is not the preferred benchmark for domestic fund managers. Plus, there are no meaningful domestic funds tracking KSE-100; hence passive rebalancing is unlikely. However foreign investors who lean towards larger weights as proxies to broader market could reconsider their allocations.

• While the intent is positive, perception management will be key and gathering formal or informal feedback from int’l investors might not be a bad idea.

KSE-100 to move to free float effective October 1st 2012

• As per a notice to members, the Karachi Stock Exchange has announced plans to transition the benchmark KSE-100 index to a free float methodology from the current market cap methodology. The move will be implemented effective Oct 1st 2012, following a parallel 90-day run with current index. The motive behind the move is to align KSE with international best practices and dilute the impact of volatility in stocks with large market caps (but miniscule free floats and thin volumes) on the benchmark KSE-100 index.

• The impact of KSE-100 transitioning to free float Market performance: The beta free float index to date (May 31st to June 12th) depicts a decline of 3.58% vs 3.19% for market cap weighted index but not much can be deduced from this very limited history. However KSE contends that its studies do not indicate any impact on market direction.

• Domestic Asset Managers: As KASB Securities Limited had discussed earlier, there are no meaningful domestic funds tracking KSE-100; hence no passive rebalancing is expected. In addition, KSE-100 is also not the preferred benchmark of domestic fund management industry, which prefers the price return (vs total return for KSE-100) and free float based KSE-30.

• Foreign Asset Managers: While most int’l investors tend to invest in bottom up stories that they like within Pakistan, investors who lean towards the larger weights as proxies to broader market moves could reconsider allocations.

• Index Constituents: Based on the beta free float index, the gainers and losers are broadly in line with what KASB Securities Limited had highlighted ie OGDC, Nestle, HBL, ABL, SCBPL, PPL are the main losers while FFC, Hubco, MCB, POL, Engro, PSO are the main gainers. (Updated table alongside).

• Sector weights: While banks and oil will remain the two heavy weights post the transition, chemicals and power have emerged as the biggest gainers at the expense of food and oil.

Perception needs to be managed

The intent behind the move is positive (ie align the benchmark index to int’l norms and make it reflective of actual value creation) but perception management will be key. The 2008 flooring of the index is still fresh in minds of investors and any move could be viewed with skepticism. KASB Securities Limited believes gathering formal or informal feedback from int’l investors might not be a bad idea. In addition, the KSE could also consider a longer time frame for the parallel run before implementing the change, to allow participants more time to adjust.