4. privateMetrics® Index Maintenance & Release Notes
After index construction, changes need to be incorporated to keep the indices current, relevant, and representative on an ongoing basis. The need to make changes can arise from the following sources:
An index constituent suddenly becomes ineligible to be part of the index. For example, companies go public, go bankrupt, or get acquired by another index constituent.
Annual recomputation of country and activity weights can lead to a decrease or increase in the number of companies that can be included in each industrial activity-country.
Valuation may fall and hence make a company ineligible when they are ranked again, and hence they may no longer qualify to be part of the index and be replaced by another company whose valuation has increased recently in that activity-country combination.
Our index methodology does reflect these events, and 1-3 also corresponds to how quickly we reflect these changes in the index.
Monthly Corporate Actions
Companies that list in public equity markets, those that go bankrupt, or get acquired by other index constituents are removed from the index at the end of the month that such information is obtained. The listing (in case of IPO) or acquisition valuation is used as the exit price for those companies. However, for companies that declare bankruptcies, we assume a return of -100% in the month they are removed, thereby introducing no survival bias in the index.
These changes are reflected for both the market indices and PEU/BMU benchmarks. However, the market indices also need replacements whereas the PEU/BMU benchmarks do not require them. Thus, for the market indices, once these companies are excluded, the next eligible company in the industrial activity-country combination is included, i.e., the company with the highest valuation which has just been left out from the index.
Note that these rules can sometimes pull a company from the private3000 (middle-market companies) to the private2000 (large cap). In such a case, we reassign the company to the private2000 and include the next in the queue for the private3000.
Annual Reconstitution For Market Indices
Our methodology for the Market Indices to compute country and sector weights uses annual inputs, thus making it feasible to perform a reconstitution exercise every year. We effect these reconstitutions in June of every year, using the most recent valuation and macroeconomic information. Specifically, we recompute each country-activity’s weights, the number of eligible companies for each group, and the ranking of the valuation of eligible companies.
In these annual reconstitutions, we follow a constrained approach to minimise the turnover in the indices as there are trade-offs between being more representative and not changing the index entirely. To minimise turnover, we impose two constraints as described below.
Annual Reconstitution For Market Indices - Banding
For companies that get excluded from an index due to a fall in valuation rank during the annual sorts, we provide some relief in the form of a lenient threshold for staying in the index as compared to new entrants that scale up in ranks. The threshold applicable for existing constituents is computed as a fixed percentage greater than the applicable threshold for new entrants into the index. This fixed percentage applicable for each country-industrial activity is optimised so that the overall index turnover is restricted to be less than 20% as a result of the annual reconstitution exercise.
An example of banding: there are 5 companies included in the United Kingdom in the retail activity and three of them have been part of private2000 in 2022, with the smallest having a valuation of $ 40 million. When sorting in May 2022 with the valuation of eligible companies, it is estimated that the 5th company has a valuation of $ 45 million – the threshold for inclusion. The three companies that have been part of the index get a valuation boost of, say 20%, then the smallest existing constituent gets a valuation of $ 40 × 1.20 = 48 million, thereby making this company rank higher than the one with a valuation of $ 45 million. Thus, the existing constituents get to maintain their index membership, reducing turnover for the index. But if the smallest existing constituent was to have a valuation that is less than $ 45 million even after the 20% boost, then it would be excluded from the index.
Other than the ranking sorts leading to turnover, two important sources of turnover remain, including:
Lack of financial information on a private company: An index constituent, on which we had previously obtained financial information, may not receive additional updates on its accounts due to a variety of factors, including that the company deregistered, or a vendor we use did not capture its data, etc. In such cases, we tolerate and wait for a reasonable amount of time for the company to declare its results (base expectation of 6 months after fiscal year) and another fixed amount of time for reporting and data acquisition processes to capture the information. If such thresholds are not met, then such companies get dropped out of the index on account of having stale financial data. Our thresholds for staleness are inspired by country-level variations in disclosure and data acquisition processes and are periodically reviewed.
Reallocation in the past and progression towards ideal weights when more data becomes available: Our reallocation algorithm ensures that when certain industrial activities do not receive the number of companies required, the algorithm picks other larger companies in the same country so that the country-level weight requirements are satisfied. However, in subsequent years, when more data becomes available, our methodology prefers to pick the industrial activities that originally were allocated the weights, leading to turnover at the index level.
Both these situations cause turnover in our index, and we carefully manage so that we can update our data through other means, and the progression to ideal weights is performed in a calibrated manner.