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Wednesday May 18th, 2022

Sri Lanka bourse changes ASPI compilation to for less volatility from Jan. 24

ECONOMYNEXT – Sri Lanka’s All Share Price Index (ASPI) will see less volatility from January 24 as the Colombo Stock Exchange (CSE) is set to introduce a new compilation method to eliminate the influence of illiquid shares which have been the reason for high volatility, a senior CSE official said.

The ASPI, the island nation’s main stock index, has been hitting a record high almost on a daily basis since mid last year mainly due to a few market heavyweight stocks which only had a few shares for public floating.

Analysts have told EconomyNext that though the ASPI had given a return of 80.5 percent return last year, some listed firms have given excess returns of 1500 percent mainly because only a few shares created huge demands in the market.

“The market returns are not realistic,” Nishantha Hewavithana, Head of Research and Strategy at Colombo Stock Exchange told EconomyNext in an interview.

The ASPI posted 80.5 percent return last year to make CSE the best performing market in terms of returns calculated in local currency.

“The Stock market cannot give such a large return. At the end of the day the index should represent the performance of companies,” Hewavithana said.

Analysts said companies like LOLC Finance Plc, Commercial Leasing and Finance Company have been on the second board of the CSE due to its lack of free-floating shares since 2019. However, shares in LOLC Finance gained 455 percent last year while Commercial Leasing and Finance Company skyrocketed nearly 700 percent in 2021.

“That happens because of the low public holding,” Hewavithana said.

“The new calculations will capture the real market capitalization of the market as opposed to a current method that calculates the overall shifts in the market.”

Less Volatility
Under the existing system, any small movement in market heavyweights, even if the companies have less than 1 percent free-floating, contribute significantly to the change in index both in gains and losses.

The CSE’s staggering returns last year was one of the best positive news for Sri Lanka which was suffering of forex and food shortage crisis.

As of December 31 last year, the CSE had 296 companies listed and some securities including non-voting shares.

Low public holding in equities is otherwise known as illiquid shares. This results in only a small percent of shares being available for public trading.

Analysts say some companies with low public trading moved up mainly due to some speculations without any fundamental reasons while some of the shares are pumped by some people with a vested interest in the market.

“When demand is high and public holding is low, the demand will shoot up aggressively. This will be again observed by other investors who didn’t join the first rally and when they join it will again create a huge demand with a very small supply. So prices will skyrocket,” Hewavithana explained.

“Ultimately all these individual returns will be summarized into ASPI. That is why I said this is not realistic, when the index is based on the total market capitalization, it doesn’t represent the tradability.”

Under the new calculation of ASPI which will be calculated from January 24, the CSE expects to create more realistic values and stability in the market.

The new method will weigh the indices based on float-adjusted market capitalisation and not the total market capitalisation.

The difference between the two is that the Float Adjusted Market Cap will move based on the publicly held portion of the total market capital.

Only Free Floated Shares
If a company has 100 million shares, but the free-floated or publicly held shares are only 6 million, only the 6 million shares will be considered in the Float Adjusted Market Cap instead of 100 million shares as in the current Total Market Cap compilation.

“So the solution is to weigh the index constituents according to the Float Adjusted Market Cap. Then of course it will not be that volatile,” Hewavithana said.

He said if last year’s index return of 80.5 percent is compiled under the new compilation method, it will be much lower than the 80.5 percent.

“In the current index, the problem is of course it doesn’t represent tradability. That’s what made us bring in this Float Adjusted Market Cap. But it is simply a methodology change,” he said.

Changes in the Float Adjusted Calculation will take place on a quarterly basis, but the market will not see any changes and it will continue as it is but with less volatility.

When companies do not maintain required free float, usually the CSE demote them into a second board from the main board and inform the public.

However, despite this move, many people with less financial literacy have attempted to buy these shares to earn higher profit and some investors in 2011 were caught in a pump and dump deal where the prices of their illiquid shares fell sharply after they bought.

“This will be a solution for the unrealistic returns, this will not solve the other issues,” Hewavithana said.

He said the purpose of the index is to understand the general price trend of the market.

“Still the companies can do whatever manipulations in trading and so on, however they cannot make any unusual change to the index,” he said.

“A company giving 2000 percent return can give those unusual returns this time too, that is completely independent as the index won’t capture that. For the public, they can expect an index that will be more representative of the market and the tradability.”

The CSE also expects some challenges of the new calculation including companies with high free-floating and stand out to dominate.

“As a measure to tackle this, CSE will cap at a predetermined rate of 5 percent,” he said.

There will not be any change in the index when the new calculation comes to effect on Monday, January 24. (Colombo/Jan19/2022)


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