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Revamped STI: slimmer, cheaper and better - Jan 09, 2008 (BT)

BackJan 09, 2008

The Straits Times / The Business Times News On SPH

Revamped STI: slimmer, cheaper and better

The new STI actually represents the culmination of almost 40 years of refinements, both in terms of index construction and representation.

By R Sivanithy
Jan 09, 2008
The Business Times

AN appropriate slogan to describe the new-look Straits Times Index when it starts trading on Thursday might well be 'Slimmer, cheaper and better'.

'Slimmer' because instead of 55 components when the index was first constructed in 1998, the new, streamlined benchmark will have only 30.

'Cheaper' because the cost of maintaining a basket of 30 stocks is significantly lower than the present 47, something which fund managers, index trackers and exchange traded fund providers would surely be grateful for.

'Better' on several fronts. First, even with only 30 stocks, the index will still cover around 48 per cent of daily trading activity, marginally less than the existing 47 component-strong index which covers about 51 per cent. Second, it will offer sharper coverage of where the market's interests lie based on activity over the most recent 12 months, irrespective of sectors or countries of origin.

The new STI actually represents the culmination of almost 40 years of refinements, both in terms of index construction and representation.

When it was first launched in 1970, the original Straits Times Industrials Index was a simple price-weighted basket of 30 industrial sector components.

Although adequate for what was then a fledgling stock market, it nonetheless was criticised on two fronts - price-weighting meant it was relatively easy to manipulate the index and confining the focus to industrials meant significant contributors to market activity such as the banks and property were omitted.

The 1998 revamp attempted to address these concerns, with market cap weights introduced to make rigging more difficult.

Broader coverage

Coverage was also broadened to include the banks and new, large-cap entrants such as the Jardine group.

That year also marked the first, significant debate about whether the stock market's main benchmark should adhere to its traditional role of representing the economy, or whether it should focus on market interest instead.

In line with a global trend, the outcome was to shift away from representing the economy and towards representing the market, a shift that was perhaps the most significant of all developments surrounding the index.

This move was accomplished by the imposition of a strict liquidity criterion for index inclusion - if a stock was not sufficiently active over a given period, it meant that investors were probably not interested in it and so that stock was dropped.

Index exclusion

At that time, the most obvious victims were hotel stocks, despite the sector being seen as a traditional bastion of the local economy. As a result, between 1999 and 2003, hotel-based companies such as the illiquid Amara, Shangri-La, Hotel Properties, OUE and Marco Polo were gradually phased out of the STI.

Eagle-eyed observers might have noticed that the electronics sector, long seen as also being a pillar of the local economy, is the latest to suffer index exclusion.

Companies such as Creative Technology, Venture Corp and Chartered Semiconductor have all been removed, either for failing to meet the minimum market cap requirement or because their shares were not sufficiently liquid over the past year.

In their place come two hugely popular China stocks - Yangzijiang Shipbuilding and property firm Yanlord, together with SIA Engineering and commodities/palm oil firm Wilmar International, the latter having the distinction of being the local stock market's best performer in 2007.

Not so long ago it would have been unthinkable for the blue chip electronics triumvirate mentioned earlier to be excluded, especially since all are home- grown, household names.

It is, however, an unfortunate but necessary consequence of the shift towards requiring the index to be first and foremost a market barometer. The message to all firms is, therefore, unequivocally that no one can take index membership for granted - if interest wanes, then companies risk being dropped.

In the quest to ensure the index is always slimmer, cheaper and better, there is no realistic alternative.