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Blog Posts — November 23, 2022

DAX’s two-year methodology overhaul cements German benchmark’s standing with investors, issuers 

This article first appeared on ETF Stream.

The last two years have been among the most eventful in the blue-chip DAX® index’s three-decade life. 

Qontigo, which manages the German benchmark and its entire family of indices, has since 2020 pursued DAX’s biggest overhaul since its inception. The aim has been to bolster the quality of constituent companies, bring selection criteria in line with international standards and improve representativeness.

The methodology upgrade has resulted in widely reported and well-received changes in one of the world’s most-followed equity benchmarks. Among them was the enlargement of DAX to 40 stocks from 30. New rules in the index construction process also require eligible companies to be profitable and submit regular accounts in a timely manner. Insolvent constituents are now removed from DAX Selection Indices within two trading days — a safeguard against potential bankruptcies. 

Elsewhere, the selection criterion of trading turnover was replaced by a minimum liquidity requirement, with market capitalization remaining the key metric as is customary internationally. 

In essence, some of the adjustments have strengthened DAX’s constitution process while others have simplified it. These are important steps for an index that is based on clear rules and minimum discretionary decisions. 

At least one existing rule was reviewed and left unchanged following feedback from investors. A vast majority of respondents in a market consultation this year unequivocally rejected a proposal to lift the weighting cap for constituents of DAX Selection Indices to 15%, from 10% currently. Responses showed that the 10% cap upholds portfolio diversification and, importantly, is aligned with limits on funds’ single-stock components under Europe’s UCITS regulation. 

Eliminating trading risks

The enhancement of the benchmark’s rules has continued since Serkan Batir joined Qontigo as Managing Director for Indices in November last year. Starting in the recent September review, Qontigo now releases information on changes to DAX membership earlier than in previous quarters, helping market participants mitigate trading risks and lower costs for index replication.

The entire overhaul has involved intensive work from different teams at Qontigo. It reflects the recommendations of stakeholders and keeps pace with the needs of investors and product issuers alike.

“Our work in the past two years has cemented the DAX’s standing not only as the undisputed benchmark for the German equity market, but also as one of the world’s most popular underlyings for investment products,” said Batir, who oversaw the latest market consultation around DAX rules. “We will continue to monitor the market environment and liaise with our customers, ensuring DAX’s design remains best-suited for the investment ecosystem and that its transparency, predictability and replicability are always upheld.”

As of the end of August 2022, 18 billion euros were invested in passive ETFs that track the entire DAX family of indices — including DAX, MDAX® and SDAX® — while an additional 27 billion euros were benchmarked to them.

Responsible versions

A growing share of those assets is invested in ‘green’ versions of DAX to benefit a more equitable and sustainable global economy. Qontigo has progressively introduced since March 2020 three alternatives to the benchmark DAX that meet the specific needs of investors with diverse responsible objectives. They are the DAX® 50 ESGDAX® ESG Target and DAX® ESG Screened indices.

While the DAX ESG Screened represents a straightforward negative-screening strategy, the other two indices combine exclusionary screening and best-in-class ESG integration. All three were also specifically designed with distinct characteristics in terms of selection and weighting process, and have become underlyings for respective ETFs. 

Global footprint

The updates to the DAX have coincided with increased demand for the benchmark from investors. In the last year, Nomura Asset Management and Kiwoom Asset Management have respectively listed Japan’s and South Korea’s first DAX ETFs. 

This is testament to increasing interest from overseas, and in particular Asian, investors. In spite of decades of European economic integration and deeper globalization, there is a place for a country index like the DAX in international portfolios. The index is a gauge for Europe’s largest economy, includes world-famous brands, and stands for an innovative, dynamic and highly diversified national corporate landscape.  

The launches also reflect Qontigo’s client-first approach to designing and customizing indices — from sustainable and currency-hedged versions to solutions that employ third-party data.

Looking ahead

And there is more to come in the DAX universe. In the pipeline is a series of enhancements on the treatment of corporate actions such as dividend payments and spin-offs. As part of the new rules, total-return indices such as the flagship DAX will reinvest dividend payments across the entire index instead of in the distributing security. 

Additionally, one more modification will allow for changes in the number of shares of index constituents at any time during the year, rather than only during index rebalancings, as is the case now. 

“In an evolving market landscape, we constantly work to ensure the DAX and its rulebook are fit for purpose,” said Batir.

The next couple of years promise to be as interesting for the German benchmark as the last two.