KUALA LUMPUR (March 27): Malaysian public-listed companies (PLCs) included in index funds would be appealing as passive funds are growing in the developed and emerging markets across bonds and equities, the Securities Commission (SC) Malaysia said. 

In its inaugural Capital Market Stability Review 2022 released on Monday (March 27), the regulator said that an estimated RM41.85 billion or 40.59% of foreign non-strategic investors in Malaysia were passive investors who tracked index funds in general.

“In this regard, Malaysian PLCs included in an index would be appealing to passive funds. Thus, the shifting trend from active to passive investing intensifies the need for PLCs to be competitive in terms of size and liquidity,” it said. 

SC said that passive investing, together with technological changes and the use of data, have the potential to change the way that securities markets function and market participants interact. 

“Given their tracking of benchmark indices, passive fund weightages could influence the presence of foreign investors in a country. The addition of a PLC to an index would result in an inflow of investment from funds tracking the index, benefiting the domestic capital market,” the statutory body said. 

Globally recognised indices that track Malaysia include the MSCI Emerging Markets Index, FTSE Emerging Index, and the Nasdaq Emerging Markets Index, it said.

“The MSCI Emerging Markets Index comprises large- and mid- cap representation across 24 emerging market countries, covering almost 12% of the world market capitalisation. Malaysia's securities weightage in the MSCI Emerging Markets Index was 1.52% as of Sept 30, 2022,” SC said. 

However, citing the IMF's Global Financial Stability Report issued in April 2019, the SC said that while inclusion in an index provides emerging market countries with access to a larger and more diverse pool of financing, inflows are highly sensitive to global or regional factors common to emerging markets included in the index. 

“Investors are inclined to treat emerging markets as an asset class rather than focus on country-specific developments. Consequently, any adverse news to emerging markets as a group may cause destabilising effects to a country with a larger share of benchmark-driven investments."

It also warned of systemic stability concerns when rebalancing is being carried out by leveraged or inverse exchange-traded funds as it could potentially cause adverse price movements. 

“The increasing use of passive-index and benchmark-hugging-active investment strategies to invest in high-risk, low-liquidity assets might exacerbate first-exit incentives by increasing the likelihood of fire-sales under stress,” SC said. 

Given the concerns, the regulator said the increase in passive funds has prompted comprehensive discussions between index providers, regulators, and investors. It added that enhanced transparency by index providers in terms of eligibility criteria would also improve flow volatility management. 

https://www.theedgemarkets.com/node/660919