Adding Adani firms in 14 NSE indices raises worry

On February 17, 2023 NSE Indices said that its equity Index Maintenance Sub-Committee has decided to replace stocks in various indices with effect from March 31 as part of a periodic review. File 
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Financial experts have sought an urgent intervention by the National Stock Exchange (NSE) board and market regulator SEBI to review an NSE subsidiary’s move to include five Adani group firms in 14 Nifty indices, which would drive lakhs of investors’ savings into the group’s sinking stocks from March 31. 

On February 17, NSE Indices said that its equity Index Maintenance Sub-Committee has decided to replace stocks in various indices with effect from March 31 as part of a periodic review. The stocks being included in its indices, among others, are Adani Wilmar (added to the Nifty Next 50 and Nifty 100), Adani Total Gas (Nifty Shariah 25) and Adani Power, which has been added to ten different indices.  

NSE Indices’ move has raised concerns amid the continuing meltdown in Adani group stocks since January 24 when the US-based firm Hindenburg Research made several allegations that the Gautam Adani-led group has denied. Global index provider MSCI is reviewing the inclusion of some Adani group stocks and has already reduced their “free float” weightages.

The NSE’s most popular market benchmark, the Nifty 50, already includes Adani Ports and SEZ and Adani Enterprises. Following this review, the number of Adani group stocks in the Nifty Next 50 and the Nifty 100 will rise to six and eight, respectively. Adani Enterprises, which was already part of the Nifty 100, has been added to the Nifty 100 Liquid 15 index. 

Reviewing NSE indices

In response to queries on the rationale behind the move , NSE Indices told  The Hindu that the reconstitution of Nifty Indices’ constituents is done on the basis of “objective stock selection criteria” published on its website.

“As mentioned in the [methodology] document, review of broad market indices is undertaken semi-annually based on data for six months ending January and July each year. As part of semi-annual periodicity, Index Maintenance Sub-Committee conducted a review of broad market and other category of indices based on data for six months ending January 31, 2022 and replacements in various indices in accordance with stock selection criteria…,” the firm said, adding that the changes shall come into effect from March 31 or the close of March 29.

But given the sustained fall in most Adani group stocks since the January 31 cut-off date used by NSE Indices, Jaimini Bhagwati, a financial sector expert who had handled the capital markets division at the Finance Ministry, suggested that a review of the decision would be advisable before the March 31 implementation date for the new indices. 

‘SEBI, NSE must act’

“There is an urgent need for the NSE’s board of directors to take stock of this unusual situation and consider a review of the indices and their associated provisions, and related issues,” Mr. Bhagwati said. 

At a broader level, he said that the Securities Exchange Board of India (SEBI) board, which has recently proposed regulating index providers, should also examine the Nifty indices’ inclusion of Adani group companies’ stocks that have suffered the steepest falls.

“Not just the indices, the SEBI board should also take up the other issues related to the high price volatility of several Adani stocks as urgently as possible,” he suggested. 

Exceptional circumstances

NSE Indices’ indexing methodology does have provisions that allow the Index Maintenance Committee to take a decision to deal with “any exceptional situation that may arise where application of stated methodology may not be practicable”.

There are also clauses that enable the firm to review its methodology based on market feedback. “In case of a market stress or disruption, NSE Indices Limited will review and deal with the situation on consultative basis with the National Stock Exchange of India Ltd. (NSE) as NSE is source for price data for computation of equity indices,” the methodology document states.  

NSE Indices declined comment when asked if these provisions could be invoked for a review. 

Retail investors at risk

Mr. Bhagwati, a distinguished fellow at the Centre for Social and Economic Progress (CSEP), stressed that this was a matter that is correlated to the interests of all investors, particularly retail individual investors.

Nearly 16% of India’s mutual fund industry’s ₹41 lakh crore is parked in index funds and exchange traded funds (ETFs) that mimic indices constructed by the NSE and BSE, some of which will be steered to these stocks from March 31.

Wealth managers have begun advising clients to shift out of any exposures to index funds or ETFs linked to the Nifty indices that retain or will add Adani group stocks.

“While index providers like NSE Indices follow objective criteria like market capitalisation and free float to determine stock selection, they must undertake a critical review of stocks like MSCI is doing. One can’t be blind to the sharp volatility and decline in stock prices seen over the past month,” said Raghavendra Nath, managing director at Ladderup Wealth Management Private Limited.

Index funds vulnerable

Mr. Nath’s firm, which has offices in Mumbai, Bengaluru and Dubai, generally advises clients against passive investing via index funds, as firms with corporate governance concerns or high price to earnings ratios often get included in indices based on their trading data history.

“Very few actively managed mutual funds have holdings in Adani group stocks because their valuations were steep and it would be difficult to justify such bets to their investors,” he pointed out. Investors, he said, must review their exposures to funds linked to indices and move them to mutual fund schemes where managers can exercise discretion and don’t have exposures to these stocks.

“Hopefully, investors will be more careful in the future about following passive index-linked investment strategies in the future,” averred Mr. Bhagwati.