Whenever and wherever investment patterns look likely to change, index providers are there, waiting in the wings to offer new benchmarks to suit new times.
With the arrival of the single currency in the euro-zone, whole families of new indices sprang up to cater for a new era of borderless investment. And now all the major providers are vying for first place with the index to end all indices – the global equity benchmark.
So, why is there a need for global indices? “We are seeing a trend towards global sector investment, and some sectors, such as oil, pharmaceuticals and some technologies, are global by their nature,” says Graham Colbourne, a director of FTSE International.
And it is no passing fad. This worldwide trend towards a global sectoral approach to investing is here to stay, says Rabbe Ekholm, of Morgan Stanley Capital International.
FTSE International is launching its FTSE All-World Index, which extends the FTSE World Index into emerging markets by using information provided by the ING Barings Emerging Markets Index. Dow Jones offers its Global Index and Standard & Poor’s has now completed its S&P Global 1200, which is a composite of seven regional indices.
MSCI has created its All Country World Index, which is a combination of the MSCI World Index and the MSCI Emerging Markets Free Index. Salomon Smith Barney’s Global Equity Index System (GEIS) has been running for 10 years, but the firm has only recently decided to back it with a strong marketing push.
There is plenty of opportunity for new index providers to win business, providers say. Once a pension fund has selected a benchmark, it still needs to monitor the suitability of that marker continually. “In the same way they reassess their manager, pension_funds should reassess their benchmark,” says Ian Toner of SSB.
While pension funds tend to spend a lot of time worrying about whether their portfolio manager is matching the target, they are less concerned about whether their target matches the target out there in the market, he says.
And the decision on which benchmark to choose is not easy, with each of these heavyweight providers making strong claims for their own set of indices.
FTSE claims its new worldwide index will give fund managers a more comprehensive global benchmark than ever before. SSB says its index is the most comprehensive and exactly replicates the investible market with its fully free-float weighting system.
S&P says its Global 1200 offers the best of two worlds. It is broad enough to be used as a longer-term benchmark, but also has good liquidity in the underlying constituents, which is essential for use with index funds and as the basis for derivative products.
What exactly is the market for global indices? “The primary opportunities we see are in index-based product licensing and in continued brisk growth in the basic benchmarking business,” says Ekholm. Licensing in particular has shown a great deal of vibrancy, he says, reflecting the growing appreciation of the benefits of indexing.
And the growth of exchange-traded funds has provided further opportunities for providers of index products. MSCI recently licensed Barclays Global Investors in its major launch of a range of exchange-traded funds aimed at the retail sector, says Ekholm. “Europe will also see a developing ETF market over the coming years,” he predicts.
However enthusiastic the providers, it is hard to get away from the fact that usable indices already exist in each of the world’s financial markets. While the idea of a using one unified family of regional indices, all run according to the same rules, sounds neat and tidy, is there really a need for global investors to have a single benchmark for their regional portfolios?
The providers believe so. FTSE says that, increasingly, investors are looking to manage both their developed and emerging markets portfolios within a single benchmark structure. Where managers have been forced to use separate emerging markets indices with a benchmark which covers the rest of the world, there has inevitably been an element of double counting, they say. And problems have occurred when a country changes status from an emerging market to a developed one.
In most cases, investors using the global index product do not use the whole of it, says Colbourne. But they do want a series of regional mandates to be consistent, and a global index can offer this.
And, in any case, one of the major uses of global indices is for benchmarking international sectoral portfolios. In this type of investment, existing local indices are no help at all.
One major issue for global index providers is how to reflect investibility. With a simple market capitalisation approach to weighting stocks within the index, the marker can become impossible for passive managers to track. Large stocks, such as Deutsche Telekom, would carry a heavy weighting in the index, even though less than half of its share capital is freely available to investors.
The FTSE All-World index series addresses investor concerns about the weighting within indices given to stocks with restricted free float, but some say the index's four-level banding system to account for free float is too crude. SSB claims to have a more accurate approach, saying its GEIS is fully free-float weighted, with the precise free float of each stock reflected in the index.
However, FTSE counters that its banding system is aimed at reflecting only those changes to free float that really matter. Otherwise changes would have to be made far too often to be practical.
S&P tackles the problem by taking account of ownership and large holdings by individual investors, by means of an investible weight factor. This is the proportion of capital effectively open to international investors.
Dow Jones, meanwhile, is still busy addressing the whole problem of how best to reflect free float in its global benchmark. “There is no standard as to what is considered free float,” says Scott Stark, regional director of Dow Jones Indexes in London. And coming by the information necessary is also a stumbling block. “Dow Jones is looking at how to get accurate information on this,” he says.
Currently, the Dow Jones Global Index excludes companies if there is a lack of broad-based ownership that impairs the marketability of their shares. If there are foreign restrictions on a particular shares, only the proportion of shares which is available to foreigners is included.
MSCI, through its selection criteria, excludes those stocks with a low free float. But once a stock is judged suitable for inclusion in the index, it is included at 100% of its total market capitalisation.
Although all these indices claim to be global, the weightings their methodologies end up giving the major geographical regions vary quite significantly. According to FTSE data, under weighting given to the US varies from 46.6% of MSCI’s All Country World Index to 58.3% for the S&P Global 1200.
The indices do not even see eye to eye on whether the UK or the Japanese market is the more significant for global investors. In the Dow Jones Global Index, the FTSE All-World Index and the MSCI All Country World Index, the UK is weighted at roughly three quarters of Japan, but the S&P Global 1200 gives the UK the higher weighting.
So how is a fund manager to decide which index to choose? Pensions consultants say the choice is not straightforward. “There is no battle of the indices,” says Andrew Burchill of consultant Watson Wyatt. Pension funds simply have to choose the benchmark by whose methodology they are most convinced.
Nick Sykes, senior consultant at Mercers in the UK, sees the global indices offered by FTSE and MSCI as the front-runners. Broad coverage of the market is the vital requisite for a usable benchmark, he says.
SSB’s Toner believes pension scheme trustees have a duty to make sure they are choosing the best benchmark. They should take the time to find out about the range of indices on offer and decide which is the most suitable.
“If you don’t use an index that perfectly matches the risk/return pattern of the equity market, then all you’re doing is adding in another uncompensated volatility factor,” says Toner. “We’re saying you should do due diligence on this because the differentials are substantial,” he says.
Can the market support so many different global index products, or are some bound to fall by the wayside? Perhaps they will all find their niche. Steven Vale, senior investment consultant at Bacon & Woodrow in London believes the diversity of products on the market serves investors needs which are becoming increasingly individual. “It depends where you’re coming from as to which index is best for you,” he says.