Imagine if the Dow Jones just announced it would expand by a third, growing from 30 member stocks to 40. Well, that's what happened overnight in Germany, when the operator of Germany's DAX index announced its most sweeping overhaul since its inception, adding 10 new companies and new quality controls after the implosion of Wirecard rocked investor confidence in the gauge.
According to Bloomberg, the changes will trigger "billions of euros of passive flows for the new members" which are likely to come from the largest stocks in Germany’s MDAX gauge, which include Airbus SE, Siemens Healthineers AG, Sartorius AG and Zalando SE.
Qontigo, which operates the DAX index, said in a statement that it will boost the number of DAX members to 40 from 30 in the third quarter of next year, while reducing MDAX membership to 50 from 60 companies.
“In general, the larger volume, the slightly higher diversification and the slightly increased share of dynamically growing companies is positive for the DAX and should slightly improve the leading German index,” said Ulrich Urbahn, head of multi-asset strategy and research at Berenberg Bank.
Qontigo, which is a unit of Deutsche Boerse AG, will also impose new criteria on both existing and prospective DAX members, including a requirement to publish quarterly statements and audited annual results, with a fast exit for those failing to release them on time (this begs the question why there wasn't such a requirement in the past).
A roadmap of the new DAX rules which will begin taking place in 2021 is shown below:
The earnings reporting requirements will become effective during the first-quarter index review, along with a mandate for companies to include an audit committee on their supervisory board. Existing members that don’t yet have an audit committee will get until August 2022 to adapt to the new rule. The only proposal that was not adopted would have banned companies involved in “controversial weapons.” According to Qontigo, this would have affected one current member of the MDAX.
In addition to facilitating passive flows, the changes were prompted by the implosion of the Wirecard fraud, which was a DAX member for two years despite repeated allegations of irregularities. When it collapsed in June, pressure to overhaul the index mounted as existing rules didn’t allow for the benchmark’s first-ever insolvent member to be ejected right away. After that, the index makers undertook a four-week long consultation with more than 600 market participants before adjusting the rules.
The winners from this reshuffle, of course, as the new entrants: for prospective new members, the potential benefits are big, with about 14 billion euros ($17 billion) in exchange-traded funds tracking the index, according to data compiled by Bloomberg.
Entry will be based on market cap, a general liquidity threshold and the new qualitative criteria, with the index owner dropping its previous methodology of rankings which included the volume of shares traded. New members will also need to have been profitable for the past two years.
While the 10 new members has yet to be determined, possible new members include Airbus, Symrise AG, Zalando, Sartorius, Qiagen NV, Siemens Energy AG, LEG Immobilien AG, Brenntag AG, Siemens Healthineers and Hannover Rueck SE, according to Landesbank Baden-Wuerttemberg index analyst Uwe Streich. HelloFresh SE, Scout24 AG, Knorr-Bremse AG, Puma SE and TeamViewer AG are next in line, he added.
Delivery Hero joined the DAX in August to replace Wirecard, and some investors expressed unease about the fact that the Berlin food-delivery firm had never reported an annual profit (wait until they hear about Tesla). Had the new rules already been in place, it would not have been eligible to join.
One tangential benefit of the overhaul is that the change to 40 members brings Germany in line with France’s benchmark CAC index, and may help to minimize the impact of heavyweights on the gauge.
"Europe’s benchmark indexes are generally too narrow compared to U.S. equity indices,” said Frederik Hildner, Salm-Salm & Partner portfolio manager. “I very much like the fact that these are a better proxy for the economy, whereas narrow large-cap indices are oftentimes heavily impacted by sharp moves of large constituents."
Most investors welcomed the changes and the new quality controls, but some expressed concern about the impact on the midcap gauge. Quoted by Bloomberg, Tarek Saffaf, Greiff Capital Management AG portfolio manager said that "due to the fact that small companies will join the DAX the weights of the bigger ones won’t change much and cluster risks remain. It is even more tragic for the MDAX index as the gauge will lose a lot of liquidity. The quality measures are a good step."