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HOCK LOCK SIEW

Are there risks to having too many Jardine units in the STI?

The companies' diversified businesses mitigate any systemic risk or share-price contagion

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This concentration of foreign companies may lead some investors here to wonder if the STI truly represents the Singapore stock market.

WHEN Dairy Farm International joins the Straits Times Index (STI) on Sept 24 at the expense of StarHub, it will be the second index reshuffle this year, following Venture Corp's replacement of Global Logistic Properties in January.

While StarHub's removal was not unexpected in the face of the fiercely contested telco sector, the inclusion of Dairy Farm was somewhat surprising.

At the previous quarterly review in June, Dairy Farm was not even on the STI's reserve list, which is made up of the five highest non-index constituents by market capitalisation.

The inclusion of Dairy Farm also raises the proverbial case of too many eggs in one basket - given that it will be the fifth firm in the Jardine stable included in the STI.

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The other four are Hongkong Land, Jardine Cycle & Carriage (Jardine C&C), Jardine Matheson and Jardine Strategic, which bumped SIA Engineering off the STI last year.

With the exception of Jardine C&C, all the other Jardine companies - including non-STI constituent hotel group Mandarin Oriental - have secondary listings on the Singapore Exchange (SGX). Still, the Singapore bourse operator has noted that the majority of day-to-day trading volume for the Jardine units is generally transacted on SGX.

This concentration of foreign companies may lead some investors here to wonder if the STI truly represents the Singapore stock market.

Yet, a closer look suggests that such fears may be misplaced.

Even with the inclusion of Dairy Farm, the Jardine stable would collectively have an indicative index weight of 15.4 per cent based on June 29 figures. In terms of systemic exposure, this is negligible compared with the financial sector's outsized 58.1 per cent weighting.

And Jardine is not the only octopus in town with tentacles everywhere. Other STI constituents - such as Temasek-linked DBS Group Holdings, Singtel, Keppel Corp, Sembcorp Industries and CapitaLand, as well as Thai Beverage - derive a significant portion of their revenue from foreign markets.

In other words, the STI isn't a bellwether for the Singapore economy. It is a market barometer.

But what about the risk posed by the incestuous cross-holdings among companies nestled under the Jardine umbrella?

Jardine Matheson holds an 84 per cent interest in Jardine Strategic, which in turn holds 58 per cent of its parent. Jardine Strategic is also the holding company for most of the group's major assets - it owns 78 per cent of Dairy Farm, 75 per cent of Jardine C&C, and 50 per cent of Hongkong Land. "All for one and one for all" might have been a great rallying cry for the Three Musketeers - or in this case for the controlling shareholders - but it also requires investors to have faith in Jardine's ability to shrug off the domino effect.

By way of illustration, Hongkong Land, Dairy Farm and Jardine C&C together made up nearly half of Jardine Matheson's underlying net profit for the six months to June 30. Weakness in one or more of these companies' earnings could hurt their parents and amplify their impact on the index.

All that said, the risk of share-price contagion among the companies is low. Hongkong Land, Dairy Farm and Jardine C&C operate vastly different businesses and their exposure to the business cycle is also unrelated. Hence, their share prices do not generally move in lockstep.

As the My Gateway report noted, their stock price performance in the first seven months of 2018, in Singdollar terms, ranged from a 11.7 per cent decline for Jardine C&C to a gain of 17.4 per cent for Mandarin Oriental.

Membership is a privilege

Worries of having too many eggs in one basket may be overblown.

Given the depth - or lack thereof - of the Singapore market, there is no easy fix to the reduce the risk of over-reliance on any particular sector.

For instance, all five stocks on the STI reserve list are Reits. Is this an over-representation, or is it representative of the broader market's make-up?

After all, the STI is biased towards success. A free float-adjusted, market value-weighted index, the STI tracks Singapore's top 30 listed companies. Membership isn't permanent, it's a privilege. Once a constituent starts to flounder, it becomes vulnerable to be ejected when the quarterly review comes around, as Sembcorp Marine, StarHub and Noble Group can testify.

This makes sense, as constituents need to be sizeable in value and highly liquid, for the STI to be easily replicated by index funds.

Institutional favourites

My Gateway noted that the six Singapore-traded Jardine counters saw a combined net in-flow of S$13.4 million from institutional investors in the first seven months.

There's no denying that indexing is big business, which is why STI constituents also tend to be stocks that are favoured by institutional investors.

New York-listed MSCI raked in second-quarter revenue of US$363 million for the period to June 30 - up by 14.9 per cent year on year.

And indices beget more business in the form of index-linked funds, with some - like the Nikko AM Singapore STI ETF - billed as a solid choice for passive-minded retail investors.

Jardine Matheson, Jardine Strategic and Jardine C&C were among the STI's five best performers in July and their price gains outperformed the index.

Regardless of its pedigree, Dairy Farm's inclusion in the STI is to help the benchmark stay relevant, both as a measure of the market and as an investment option for institutions.