What is LQ45?

In January 25, the Indonesia Stock Exchange (IDX) released the latest list of stocks that become constituents of LQ45 indices. In the list there are three new stocks, ie Aneka Tambang (ANTM), HM Sampoerna (HMSP), and Hanson International (MYRX), where they replaced XL Axiata (EXCL), Indo Tambangraya Megah (ITMG), and Wijaya Karya Beton (WTON). Soon I received many questions: As of third quarter of 2015, ANTM suffered a loss of Rp1 trillion (about US$ 90 million), or in other words it had poor fundamentals, right? Then how could it became constituent of LQ45?

In this case I became aware that there are still many investors who do not understand about LQ45. Okay, let’s we talk about it.

LQ45 is a special stock indices in Indonesia which its movement is influenced by forty five stocks of its components, and these stocks must meet the following criteria:

1. Included in the top 60 companies/stocks with the highest market cap in the last 1 year.
2. Included in the top 60 companies/stocks with the highest transaction value in a regular market (transactions in cash and negotiation markets are not counted) in the last 1 year (in the end, 45 stocks of the highest market cap and also the most liquid would be taken)
3. Have been listed in the Indonesia Stock Exchange for at least 3 months, and
4. Have good financial conditions, and good prospect of growth.

Every six months, the IDX will evaluate all of forty five stocks that become constituents of the indices, which stocks that are no longer meets the four criteria above will be removed from the list and replaced by other stocks. However, in practice, the criteria that received most attention is only the liquidity of the stock, that 45 stocks included in the LQ45 are the most liquid stocks in the Stock Exchange in term of transaction value (not the volume, nor the frequency of transactions).

While about the company’s fundamentals, it only received a small attention. Several years ago when the Bakrie Group still ‘controls’ the exchanges, where transaction value of the shares of Bumi Resources et al were still in tens or even hundreds million US Dollar per day, the stocks like BUMI, Bakrie & Brothers (BNBR), Bakrie Sumatera Plantations (UNSP), until Bakrieland Development (ELTY), all of them were permanent constituents of LQ45. Even damned stocks like Trada Maritime (TRAM) had also been included in the list of LQ45, simply because of its huge daily transactions value.

However, after all the above stocks continue to fall and their liquidity automatically decreases, they are kicked out from the list. I mean, if currently the trading value of TRAM is still one of the largest in the Stock Exchange, the stock will be included in the list of LQ45, even if the company has been in serious trouble.

Because the list of LQ45 only contains the most liquid stocks in the market, and not ‘the best stocks in term of fundamentals’ or whatsoever, in turn makes LQ45 indices to be less popular than Jakarta Composite Index (JCI), where investors are more interested to see the current position of JCI instead of LQ45 indices. As an investor, you know the position of JCI for some time, right? But you probably do not know the position of LQ45. Well, you can see it in www.finance.yahoo.com, the ticker is ^JKLQ45. When this article was written, the index was in a position of 794.

However, compared to the other stock indices in Indonesia such as Bisnis 27, IDX 30, Perindo 25, ISSI (Indonesia Sharia Stock Index), Kompas 100, to Sri-Kehati, then LQ45 index is the most important indices behind the JCI, because LQ45 more reflects the direction of the market compared to JCI. And it is because of the movement of the LQ45 index is only affected by forty five stocks of the most traded, while JCI is influenced by all of the shares listed on the Stock Exchange, including penny stocks or ‘dead’ stocks with no trading transactions (though the weigh of the influence of each stocks towards JCI is different). Look at the following picture, it is obvious that when the market is down, LQ45 index down deeper than the JCI. While in a rising market, LQ45 rose higher than JCI.

The movement of JCI (blue line) and LQ45 index (red line) between March 11, 2013, until today. Click image to enlarge

In addition, for professional investors/fund managers, stock liquidity is very important where the liquid stocks can be prioritized/purchased more than the illiquid ones, so the list of stocks that became constituents of LQ45 is still need to be considered. Brokers also need to pay attention to the constituents of LQ45, so that they would know what stocks that are traded the most, then recommend the stocks to their customers. Brokers usually only recommend liquid stock of LQ45 to its customers and rarely recommend stocks outside the list, especially if the stock is completely illiquid, because illiquid stocks are not easy to be bought and also difficult to be sold. And if investors then just holding the stocks, the brokers will not generate a trading fee. Perhaps because LQ45 stocks are often recommended to the investors, the there is an impression that the forty-five stocks are the best stock picks in the Stock Exchange, but these are not.

Thus, you already know that if there are certain stocks that enter the LQ45 list, it does not mean that you can immediately buy it, but you still have to analyze it first. However, if there are two stocks that have equally good fundamentals and both valuations were similarly low, but the first stock included in the LQ45 list while the second does not, then I myself would prefer to buy the first stock.

Okay, I think that's enough. If anyone would like to add, please write it in the comment columns.

Any inquiries about investment in Indonesia Stock Market, please send an email to teguh@averepartners.com