When you think of the world’s safest car, what brand comes to mind? For many, the answer is consistent: Volvo.

Volvo has been known for its high safety standards for decades. This reputation, combined with the company’s global popularity, has propelled its stock to all-time highs, boosting its market capitalization to over $60 billion. However, despite this success, Volvo’s Class A shares will soon be removed from MSCI’s global indices, a change set to occur later this month. As a result, funds tracking these indices will be forced to sell a significant portion of the stock. Volvo has two public share classes, A and B, that differ only in voting rights and are highly correlated. Volvo’s A shares are generally preferred by longer-term investors that place a premium on voting rights, while the B shares have watered down voting rights yet are more liquid and traded more frequently.

Based on the assets under management benchmarked to MSCI tracking funds, the amount of Volvo A shares that need to be liquidated is equivalent to more than 60 days’ worth of trading volume. Ironically, it is Volvo’s A shares’ daily trading volume that’s at the heart of this issue. Typically, as a company’s stock price rises, its market capitalization grows, leading to an increased weighting in market-cap-based indices. However, over the past year, Volvo’s A shares have seen a decrease in daily trading and liquidity. This reduction has caused the A shares to fail MSCI’s liquidity threshold, which is crucial for ensuring the investibility of constituents.

MSCI applies its investibility screen to individual securities. To be eligible for inclusion in a Market Investable Equity Universe, a security must meet minimum liquidity requirements, measured by:

• Twelve-month and three-month Annual Traded Value Ratio (ATVR)
• Three-month Frequency of Trading

Volvo’s A shares just fell short of the 12-month ATVR requirement and, as a result, will be removed from MSCI’s global indices. Volvo’s B shares passed both tests and will remain comfortably in the indexes. This removal of the A shares could result in a short-term dislocation and potential for mean reversion.

This decline in trading volume and liquidity has affected a much broader set of European equities in recent years. As the U.S. economy and stock market have motored upward, capital has flowed out of European markets. Over the past 10 years, the value of trading in European listed companies has seen a decline of over 30%, while the U.S. and Asia have seen increases of over 150% and 300%, respectively. Volvo’s A shares are one of the most significant casualties of this trend so far, and even a company known for its safety standards isn’t immune to the specific index rules.

Custom indexing can allow the methodology to be designed to handle multiple voting class shares, liquidity and investibility thresholds and can be tailored to better fit your individual goals and objectives.

Understanding what’s under the hood is key to index selection. Westwood’s MIS team can help put the investor in the driver’s seat.

Sources: MSCI, Intropic and Instinet