Macquarie predicts that HDFC Bank could attract $5.2 billion in inflows during the MSCI India Index rebalancing in August.

Leading brokerage Macquarie forecasts that HDFC Bank’s weight in the MSCI India Index might double in the upcoming index rebalancing in August. This change could result in passive buying worth $5.2 billion or 281 million shares of the stock. Macquarie noted in a client sale note that HDFC Bank narrowly missed an MSCI weight increase during the May rebalance. Given the recent selling by foreign institutional investors (FII), HDFC Bank's weight in the MSCI India Index is likely to double in the August rebalance.

Currently, HDFC Bank holds the fourth position in the MSCI India Index with a weight of 3.89%. According to Macquarie's calculations, this could double, resolving the technical overhang caused by the post-merger situation where funds ended up with larger positions than the index weight. Foreign investors' overweight position has decreased from 800 basis points in March 2023 to about 500 basis points now. If HDFC Bank's MSCI weight increases from 3.82% to 7.64%, the 500 basis points overweight position would drop to below 100 basis points, due to the combined effect of the increased index weight and passive buying. "Finally, the technical overhang will be behind us," the note stated.

MSCI index weights are determined based on free-float adjusted market cap available for foreign investors. According to MSCI’s methodology, for a security with foreign ownership limits to be fully included in the investable market index, its foreign room must be at least 25%. If foreign room is between 15% and 25%, an adjustment factor of 0.5 is used. Securities with less than 15% foreign room are excluded from the index.

As of March 2024, HDFC Bank’s foreign portfolio investment headroom was 24.95%, just shy of the 25% needed for a full weight increase in the MSCI index. With foreign holdings at 55.54%, a sell-off of 3 million shares (worth $60 million) is required for the foreign room to exceed 25%, triggering a doubling of the bank's weight in the index.

The key question is whether the foreign room can reach 25% in the June quarter for the August rebalancing. Macquarie highlighted that between April 1 and May 15, foreign investors were net sellers of $2.2 billion in financial stocks, suggesting that HDFC Bank likely experienced net selling exceeding $60 million. Continuing net sales by foreign investors beyond May 15 reinforce this likelihood. “The base case is that the August rebalance should see HDFC weight double in MSCI,” Macquarie stated.

Macquarie also addressed the limited downside of a potential weight reduction if foreign holdings increase rapidly. Once the adjustment factor is increased to 1, it will only revert to 0.5 if the foreign room drops below 15%, preventing frequent fluctuations. “If foreign room exceeds 25%, the MSCI weight doubles, leading to passive fund buying. If it then drops below 25%, the weight would halve, causing selling, and the cycle would continue,” the note explained. To prevent this, the threshold for weight reduction is set lower than the threshold for weight increase, avoiding the risk of the MSCI weight fluctuating with foreign investor activity.

Macquarie concluded, “With technical issues nearly resolved, I recommend buying HDFC Bank. Any FII market sell-off will likely double HDFC Bank's MSCI weight in August. Conversely, FII market buying is also beneficial for the stock.”