In this week’s newsletter, we discuss the index fund attack on JFS, the origin story of a tech giant, yet another Adani scam, and more.
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The Big Story –Â The index fund attack on Jio Financial Services is over. Almost.
Jio Financial Services can finally breathe. The stock is in the green.
You see, for a few days after this newly demerged Reliance entity hit the stock exchange, things werenât good. It kept dropping 5% every day. And thatâs due to a simple factâââforced selling by index funds.
Let us explain.
When JFS was demerged from Reliance Industries, it ended up on stock market indices such as the Sensex 30 and the Nifty 50. It didnât really deserve to be there. It didnât meet any of the typical criteria laid out for inclusion in these prime benchmarks. But, a small change in the rulebook meant that it landed up here anyway. The new rule simply said that in case a stock thatâs part of an index is involved in a demerger, the new stock or the demerged stock will also find a temporary home in the index. And since Reliance Industries was the biggie within the index, its spawn found a place too.
So for a brief period, the Sensex 30 became the Sensex 31.*
Now, for the uninitiated, index funds donât have a fund manager at the helm to pick good stocks and dump bad ones. No oneâs doing the research and pulling the strings. Thereâs no one behind the curtain whoâll dump a stock when a scathing new report alleging misdeeds at a company. Or who’ll buy a stock when a company snags a big deal too. Instead, these funds are âpassively managed.âThey simply buy and hold stocks in the same proportion as an index such as Sensex 30. If a stock drops out of the index, they sell too. They copy, they mimic, and they mirror the index. Thatâs it.
So you know what they wouldâve had to do with JFS, right?
If the index was dumping it, theyâd have to exit too. They didnât care if the stock had a sound business or not. Theyâd break up with it once it leaves the index. Thatâs the forced selling we alluded to at the start.
But what if they chose not to sell for a while? What if they took their own sweet time?
Well, they could. But on the flip side, if they didnât sell, it would introduce something called a tracking error. Which, simply put, is the difference between the returns of the index and the fund mirroring it. And investors donât like a large tracking error in these funds. They want it to be as close to each other as possible. So if an index fund begins to exhibit these deviations, investors will lose trust. Theyâll look for alternatives. And thatâll affect its business prospects too.
But what the JFS incident also goes to show is the power of index funds. Even in a nascent market like India, these funds were able to drive down the price of a stock quite easily. No one else stood a chance against the relentless selling pressure. After all, by some estimates, thereâs over âš5 lakh crores in funds tracking the various Nifty indices. Thatâs quite a bit of âmindlessâ money thatâs buying and selling stocks without a care in the world.
Now some folks might point to this âattackâ on JFS and remark, âLook at the harm caused by the mindless mimicry by index funds. Itâs distorting the market.â
But what if we told you that these events might actually be good for active fund managers? You know, the ones who spend hours poring through annual reports and speaking to management before making a buy or sell decision.
You see, the breed of active management has been going through some tough times. People are questioning whether the fees they pay for these funds are worth it. And thatâs because the performance of these actively managed funds has been quite underwhelming. Take this stat for instanceâââin 2022, 88% of such funds that pick stocks of large companies failed to beat the benchmark. And if you extend the timeline to 3, 5, or even 10 years, youâll see a similar trend. They just canât seem to outperform the index.
But think of these situations. Such as when the stock is being deleted from an index. Passive funds have no option but to sell en masse. It could knock down the share price. And if the fundamentals are strong, it gives a perfect buying opportunity for an active fund. They might be able to snag it for a bargain.
Or it could happen in reverse too when a stock is added to an index. Now this addition doesnât happen out of the blue. Investors know about it a few weeks in advance. And active fund managers can start buying the stock in the lead-up to that event. Because they know that passive funds have to wait on the sidelines. Theyâll take action only once the stock makes its appearance in the index. And once it does, the massive influx of passive fund money can drive up the price. Itâs called the âIndex Inclusion Effect.â And the active fund manager who entered earlier benefits.
Heck, there are actually funds out there globally that bet on such situations. The active fund manager can basically ride the passive wave for their own benefit. Sure, you could argue that these events donât happen every day. And thatâs true. But hey, when it does, itâs exciting times for sure.
So yeah, the next time you hear a fund manager complain about how passive funds are spoiling their party, maybe think about this story, eh?
*As of 1st September, JFS has been dropped from the Sensex 30. But, it still continues to be part of the Nifty 50 and could exit this week.
Todayâs Discussion
: From Dried Fish to Smartphones – The Hidden Story of a Tech Giant
You see, back in 1938, a young entrepreneur named Byung-Chull Lee founded a small trading company in South Korea.
Its specialization?
Exporting dried fish, noodles, groceries & other local goods!
However, in the 1950s & 60s, he started venturing into various industries â like textiles, food processing, insurance & even opened a department store!
But why are we talking about a trading company with such a variety of operations??
Well, because in the late 1960s, the company decided to enter the electronics industry and became one of the biggest brands of all time. We are talking about none other than Samsung!!!
Surprising right?
Well, Samsung initially began manufacturing black and white televisions, an essential consumer electronics product at that time. But what took the business to the next level was their commitment to R&D and innovation!
See, by the 1990s, Samsung had its first breakthrough when it started producing memory and hard drives for use in personal computers. And this is still a big part of Samsung’s business today!
And, in 1995, they finally ventured into the mobile phone market. Though initially, their products didnât work out.
When this was found out by the companyâs then-chairman Kun-Hee Lee, he had the entire inventory burned!
But thankfully, that wasnât the end. Samsung kept innovating. And finally in 2010, they made a significant impact on the tech world with the release of the Galaxy S â a smartphone that rivaled Apple’s iPhone!
This marked the beginning of Samsung’s dominance in the smartphone market! Quite a rollercoaster, right?
But Samsung didn’t stop here, it became a pioneer in producing OLED screens, revolutionising displays in TVs and smartphones.
Fast forward to today, Samsung is a household name worldwide with operations in over 70 countries.
From a humble dried fish exporter to earning a revenue of $234 billion in 2022 â all thanks to the companyâs ability to adapt and innovate!
What do you think? Let us know
Video explainer 
: New Adani Groups Controversy | OCCRP Report Allegations
Adani Groups is in the news AGAINâ for all the wrong reasons.
After the Hindenburg fiasco accusing them of share price manipulation, defrauding the Indian public & corruptionâ leading to a SEBI investigation under the Supreme Court.
Just when Adani started doing damage control, another report came outâ this time from a group called OCCRPâ a global network of investigative journalists who uncover organised crime and corruption.
So, we thought we’d explain the whole saga in a crisp yet insightful YouTube video. Watch it here now!
Infographic of the week!
And that’s all for today folks! If you learned something new, make sure to subscribe to Finshots for more such insights đ