Summary:
- The Singapore Exchange (SGX) introduced the iEdge Singapore Next 50 Index and the iEdge Singapore Next 50 Liquidity Weighted Index to broaden market interest beyond the 30-stock benchmark Straits Times Index (STI), enhancing visibility and liquidity for mid-sized companies.
- The two indices use different weighting approaches – market-cap and liquidity-weighted – allowing investors and fund managers to tailor exposure, potentially enabling ETFs and new investment products focused on the “next 50” stocks.
- Inclusion in these indices can boost attention and trading volume, but it doesn’t guarantee returns. Investors should remain mindful of fundamentals, higher volatility in mid-cap stocks, and whether the indices gain long-term acceptance in the market.
Those of you who follow developments in the local stock market would know that the Singapore Exchange (SGX) launched two new market indices last month – the iEdge Singapore Next 50 Index and the iEdge Singapore Next 50 Liquidity Weighted Index.
The two new indices are part of the overall broad suite of measures to stimulate interest in the local stock market and fall under the Monetary Authority of Singapore’s (MAS’s) Equity Market Development Programme (EQDP).
The announcement was welcomed by the investing community and, as many of you might know, has helped lift sentiment in the market.
The outcome has been a thriving stock market where the main benchmark, the Straits Times Index (STI), rose to several all-time highs in Oct.
So what’s the big deal with the new indices? Why the renewed push on stock prices? First, let’s consider the STI.
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Understanding the benchmark STI
The first thing to note is that that the STI comprises 30 of the largest and most actively traded stocks listed on SGX. Each is weighted according to market capitalisation or value.
The total value of these components amounts to roughly 65-67% of all stocks, which is deemed as an acceptable threshold to be representative of the whole market.
So if the STI rises or falls, we tend to say the entire market has risen or fallen.
Other than as an indicator of how the market is moving, the other use of the STI is as a benchmark for performance by fund managers who are invested in Singapore stocks.
So if a fund manager achieves a return of say 10% over a period during which the STI rose 8%, the excess 2%, known as “alpha” in investment terminology, is the manager’s “outperformance”. Meanwhile, the 8% market return is known as “beta”.
Conversely, if the fund only made 8% while the STI rose 10%, then the manager can be said to have failed to outperform the market.
Now, in order for funds to beat the index or market, most tend to hold the majority of stocks in the index as a core holding, while indulging in stock picking for the rest of the portfolio in the hope that these picks will produce alpha.
For this reason, the 30 STI components are the first port of call for all fund managers as well as retail investors.
Note however, that research has shown that the vast majority of fund managers fail to consistently beat their benchmarks. They might be able to outperform one or two years but not over an extended period.
Which then leads to the logical conclusion that investors who want exposure to any market or sector might be better off simply buying and holding the index that represents the benchmark for that market or sector.
This is the fundamental rationale for exchange-traded funds or ETFs, which are essentially listed funds that track benchmark indices.
So for anyone happy with earning only beta, they would only have to buy and hold ETFs.
Difference between the two new indices
One drawback with having only 30 stocks in the main index is that these components tend to attract most interest and liquidity to the detriment of the rest of the 600-odd listed companies on the SGX.
So in order to spread the interest and liquidity, the two new SGX indices will track the next 50 largest and most liquid stocks outside the STI.
iEdge Singapore Next 50 Index VS iEdge Singapore Next 50 Liquidity Weighted Index
The new indices offer two distinct weighting approaches.
The market-cap weighted iEdge Singapore Next 50 Index follows the traditional approach, giving more weight to larger companies.
Meanwhile, the liquidity-weighted iEdge Singapore Next 50 Liquidity Weighted Index focuses on stocks with higher trading activity, appealing to investors who value liquidity and tradability.
This dual structure lets investors and fund managers better choose exposure that suits their strategies.
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Potential for new investment products
With dedicated benchmarks in place, fund managers and ETF issuers can now build new investment products tracking these indices. This could increase visibility, liquidity, and investor participation for the constituent companies.
It’s a sign of market maturity. Globally, markets have similar tiered structures. For example, the FTSE 250 in the UK and the Russell 2000 in the US. SGX’s move signals a more mature and diversified market, improving the ecosystem for investors, analysts, and issuers alike.
If ETFs are eventually issued to track the two indices, then investors can gain access to mid-sized companies that may have higher growth potential. Note that in time, some of these “next 50” companies could also become future STI constituents.
Another point to note is that index inclusion can boost investor attention and trading volume because membership in an index does have its benefits – it enhances a company’s reputation and attracts more liquidity and research interest.
Points to bear in mind
It’s important to bear in mind that index inclusion doesn’t guarantee returns and that fundamentals still drive performance. If you’re thinking of buying a stock just because it’s in an index, be aware that if it gets dropped from the index possibly because it fails to satisfy the inclusion criteria, this could have an adverse impact on its share price.
Also note that investing in mid-cap or second tier stocks typically carries higher volatility and cyclical exposure.
Last but not least, it remains to be seen if the two new indices gain widespread acceptance by the investment community.
Back in the 1990s, the local banks launched their own market benchmarks – UOB had a Blue Chip Index, OCBC had one with 30 stocks, and DBS had one with 50 stocks.
All these indices quietly faded into obscurity because the market lost interest in them, instead favouring the STI which was more widely recognised.
