One of the most interesting announcements for financial market participants came recently from Germany. The famous DAX index goes under reform, changing the way it tracks the largest companies in Germany.
For an index to change its composition is nothing new. From time to time, companies exit and enter an index, reflecting the changes in the economy. Recent changes to mention are the Salesforce inclusion in the Dow Jones or the upcoming Tesla inclusion in the S&P 500.
However, there is more to the DAX reform than simply adding some companies – it will track more companies and will have different criteria for adding companies in the future.
Changes on the DAX Index
The most notable change is the number of companies in the index – it rises from 30 to 40. This comes at the expense of the MDAX index (i.e., the index tracking middle-sized companies), which will have its number of companies reduced from 60 to 50.
Adding more companies to the DAX index is not something strange. After all, except for Dow Jones in the United States, most indexes in the developed economies track a larger number than 30. For example, the FTSE in the United Kingdom tracks 100 companies; the Spanish index tracks 35, or the Italian one that tracks 40 companies.
Another important change in the DAX index comes from changing the second criterion to be part of it. More precisely, instead of a share turnover volume, a turnover threshold will be used. This would be interesting to watch from a volatility point of view – will volatility increase or decrease as a result?
Besides the two changes, the new DAX index brings a new financial requirement for companies to be considered suitable. Therefore, any suitable company must show at least two consecutive years of profitability. There are some new governance requirements that make the conditions even more difficult to be met by new members.
Why would the DAX go into reform? The answer is simple – for years, it is underperforming on the global stage. For example, Germany is the world’s fourth-largest economy. As such, it has a 4.4% share of the global Gross Domestic Product (GDP). However, it has only 2.6% of the global stock market capitalization. It ranks behind countries like Canada, India, or even Saudi Arabia.
A reform was long due and will come into effect in the second half of 2021. It remains to be seen what the effects will be, but it sure feels like the DAX index is modernized.