Explained - Why today's MSCI Rebalancing will be different from past instances and key risks

The MSCI rebalancing exercise will take place towards the final minutes of the trading session on Monday, August 31. A total of four stocks - Laurus Labs, Lenskart Solutions, Adani Energy Solutions, and Billionbrains Garage Ventures, the parent company of Groww, will be included in the MSCI Standard Index and will see potential inflows.

On the flip side, Balkrishna Industries, SBI Card & Payment Services and Astral will see potential outflows as they will be excluded from the index.

However, more than the action in specific stocks, today's rebalancing exercise will be different in comparison to the ones that have taken place in the past, as this will be the first one that will be taking place after the introduction of the new Closing Auction Session (CAS) at the start of the month.

Here's how it is likely to be different from the past:

The MSCI rebalancing exercise is a involuntary flow event and could be a test of the CAS mechanism. One of the key intentions behind CAS is to avoid tracking errors from the earlier volume-weighted average price mechanism.

As part of CAS, a single equilibrium price discovered at 3:30 PM becomes the official closing price.

Since trading in the Futures & Options (F&O) market closes at 3:15 PM with order placing resuming between 3:20 PM and 3:30 PM, passive funds will have to buy or sell stocks only in the last eight to 10 minutes of the session.

According to market participants and quant analysts, any potential rebalancing (inflows or outflows) for stocks that are not part of the futures & options market should proceed as usual, without any interruptions, as has been the case in the past.

However, for stocks present in the F&O segment, those may see volatility. Buying could take place from passive funds till 3:15 PM but that could risk a tracking error. A tracking error is a measure of how closely a passive fund mirrors the performance of a benchmark index.

Participants and quant analysts indicate that passive funds can place orders between 3:20 PM and 3:28 PM, as the window closes for the last two minutes. Between 3:30 PM and 3:35 PM, order matching and closing price discovery would take place.

Here are some of the key risks that could emerge during this exercise today:

Currently, concerns have been raised around the lack of liquidity and participation of institutional, retail and proprietary traders in CAS, which may not allow for an effective MSCI rebalancing.

Post 3:15 PM, there could be insufficient liquidity for complete order matching and therefore, passive funds will run the risk of tracking errors as highlighted above.

Passive funds may need to buy or sell stocks in the following trading session and may again risk a tracking error.

As part of the rebalancing exercise, Laurus Labs, Lenskart, Groww and Adani Energy Solutions could see inflows between $280 million to $400 million, while the three exclusions could see outflows between $110 million to $150 million.

Another stock to watch during this exercise will be Eternal, as it will see an increase in its weightage on the MSCI Standard Index, and this would result in potential inflows to the tune of $650 million.