MBSL revises Midcap Index composition for 2013

In a pioneering move, MBSL constructed a stock market index: the ‘MBSL Midcap Index,’ which measures the aggregate price level and price movements of medium size companies listed on the Colombo Stock Exchange (CSE). There was no index to measure the price movement of medium sized companies listed on the CSE. The MBSL Midcap Index filled this vacuum.

The index which came into operation in 1999 is revised annually and looks at the middle range market capitalisation, liquidity and the profitability of the firms to be included in the Midcap Index.

The MBSL Midcap Index can be used as the benchmark index by individual and institutional investors who prefer growth but are prepared to with stand only conservative levels of volatility in their equity investments.

The Midcap Index, together with the Milanka Price Index (MPI) generate valuable signals for portfolio managers for switching between larger-cap more sensitive stocks and the midcap less sensitive stocks with more growth potential  in response to changing capital market conditions. The Midcap Index focus in profitability helps to screen stocks with better future prospects that will cross to higher market capitalisation in the next year.

Current position

MBSL has included 13 new firms for the 2013 composition by excluding 13 existing firms from the index. The new inclusions are: Central Finance Company PLC, LB Finance PLC, Lanka Orix Finance PLC, Nations Trust Bank PLC, People’s Leasing Company PLC, Access Engineering PLC, Softlogic Holdings PLC, Vallibel One PLC, Asiri Hospital Holdings PLC, Browns Beach Hotels PLC, John Keels Hotels PLC, Primal Glass Ceylon PLC and Textured Jersey Lanka PLC.

Stocks are diversified over 10 sectors. The MBSL Midcap Index has the base as 1,000 as at 31 December 1998 (which is the same base year for Milanka Index). The range for market capitalisation for 2012 was Rs. 1 b to Rs. 15 b. With the stock market activity, this range is adjusted for the change in the ASPI annually. Accordingly the range of market capitalisation for 2013 is Rs. 1.9 b to Rs. 19.9 b.

MBSL has excluded firms Asian Alliance Insurance PLC, Singer Finance ( Lanka) PLC, Union Bank of Colombo PLC, HVA Foods PLC, Renuka Agri Foods PLC, Hemas Holdings PLC, Browns Investments PLC, Nawaloka Hospital PLC, PC House PLC, Overseas Realty PLC, Royal Ceramic Lanka PLC, Vallibel Power Erathna PLC and Brown & Company PLC from the MidCap index composition of 2012.

Selection criteria

The criteria for selecting the 25 stocks of the index remained unchanged for last 14 years and are: middle range market capitalisation, liquidity and profitability.

The Colombo Stock Exchange (CSE) performed exceptionally well in the two years following the end of the war: the benchmark All Share Price Index (ASPI) surged 96% to become Asia’s best – the Midcap Index also surged 125.4% in 2009 and 70% in 2010, although the indexes declined for 2011 and 2012 by 17.1% and 29.6% respectively.

In absolute terms, market indices have declined year-to-date, reflecting the weak global outlook for equities and rising domestic interest rates. The Sri Lankan economy is not immune to global conditions and faces its own challenges in the near term. Larger than expected trade deficits, depleting foreign reserves, rising interest rates and weaker than expected FDIs are primary concerns.

Strong policy measures were adopted by the Central Bank and the Government in the early part of the year to limit excessive credit growth and contain the high import demand thereby arresting the imbalances that were emerging in the economy since the latter part of 2011.Policy makers have allowed the currency to depreciate and interest rates to rise in order to address structural imbalances in the economy in the short to medium term.

Inflation, as measured by the y-o-y change in the Colombo Consumers’ Price Index (CCPI), increased to 9.5% in November 2012 from 8.9% in the previous month. Inflation has remained near 9% in the second half of the year as a result of the increases to administered prices and recent tariff adjustments while adverse weather conditions towards the third quarter caused prices, particularly of fresh food items, to remain high.

However, as per current projections, inflation is expected to moderate towards the second quarter of 2013 and stabilise thereafter benefiting from the strong demand management policies introduced at the beginning of this year.

At the same time,  in order to induce a downward adjustment in market interest rates, the Monetary Board decided to reduce the policy rates of the Central Bank by 25 basis points each while allowing the ceiling on rupee credit extended by banks to expire at end 2012. The Monetary Board was also of the view that the credit ceiling imposed for 2012 has served its purpose and such a policy measure may not be required in the near future.

On a positive side, we have observed net foreign inflow in to the market over Rs. 36 b; this sluggish market trend is an opportunity to the investors to collect value stocks since most share prices trading below its intrinsic value, and there is an opportunity prevailing in investing Midcap Stocks, when market recovers the chances of Midcap Stock price increase is high.

Conclusion

Mid-caps generally outperform because they are in the prime of growth and seeing both cash flow and earnings per share accelerate, especially compared to large-caps, and Mid-cap companies generally have much greater growth potential than comparable large-caps, with more seasoned management, liquidity, and operating histories than small-caps.

The Milanka Price index (MPI) will be discontinued as of 1 January 2013 following the launch of the S&P SL20 index earlier this year. The S&P SL20 currently represents 54% of the total market in contrast to the MPI’s comparatively lesser representation of 22% as at 12 November 2012.

The S&P SL20 Index includes the largest 20 stocks, by total market capitalisation, listed on the CSE that meet minimum size, liquidity and financial viability thresholds. As a result there will be no longer measure to track the performance of the midcap stocks in the market. Therefore including mid-caps in an overall portfolio allocation is a proven diversifier for increasing returns while enjoying a very favourable risk/reward ratio, the MBSL Midcap index continuously fill the vacuum of measures the aggregate price level and the price movement of medium sized companies listed on the CSE.

In conclusion, it could be noted that MBSL Midcap has a proven track record of 14 years with return positive in almost nine years. The last two years the returns have declined in line with the overall market return, which signals for above average positive return for 2013 with a tried and tested Midcap Index.

(Prepared by Corporate Advisory & Capital Markets Division, Merchant Bank of Sri Lanka PLC)