Hi, there are recent news that the Straits Times Index (STI) in Singapore will have constituent stocks reduced in number, so that only blue chip stock will remain in the STI. How will that affect the index besides making the index more volatile?
Will that affect share prices of STI ETF 100?
Thanks!
With all due respect, I disagree with the above person.
The STI should experience higher volatility with only 30 constituents compared to before. While there is a high degree of cross-correlation between the current 50 members of the STI. Furthermore, the 50 STI members tend to have a lower Beta compared to the SGX Composite.
The argument that the Dow has a lower volatility than the Nasdaq is not a fair comparison. The DJIA has a much lower Beta compared to NASDAQ Composite. On the other hand, the DJIA has higher system (diversifiable, company specific risk) compared to the Nasdaq composite. That is, NASDAQ is more sensitive to the "market". In other word, the NASDAQ composite has higher market risk, but lower systemic company risk. The DJIA has lower market risk, but higher systemic risk.
Mathematically, you need about 80 stocks to really remove a lot of the system risk. By reducing the number of stocks from 50 to 30, the index will have a higher degree of volatility. However, the STI components currently have a high degree of cross-correlation – so there should be very little change in beta.