Salomon Smith Barney (SSB) has called for pension fund trustees to consider their due diligence responsibilities and invite all the major index providers to their next trustees’ meeting to present responses to what it calls the ‘significant market ramifications’ of free-float weighting in global indices.
In its latest document ‘How to catch a falling knife’. SSB points out that the announcement by MSCI in February that it was reviewing its long-held position on market capitalisation weighting could potentially lead to the largest aggregate program trade in history, should MSCI decide to adopt free float weighting for its estimated $2trn in benchmarked assets.
Ian Toner, global head of marketing for the global equity index system at SSB, comments: “Pension funds could discover that they are trying to sell up to 25% of their developed markets portfolio at the same time as everyone else, and then purchase other stocks at the same time with the proceeds. That is likely to have a substantial impact on the value of their pension fund.
“Whatever they choose to do over this period, they should do using a formal due diligence process. At least they should give each of the index providers half an hour of time to explain what they do and why.”
Toner explains that with the average float factor of the developed world indices at around 23% and the EAFE float weighted average sitting at about 0.74, pension funds might have to sell anything above 0.74 of the benchmark and then buy anything below that mark – approximately a 25% sell and 25% repurchase. “We believe the awareness issue is bigger than most people think. The important thing to remember here is that everyone could be doing their transition at the same time. This suggests you should be doing a proper due diligence before the process starts.”
Toner says SSB has also started putting its index figures up three times a day on the web, shifting up a gear from the previous daily valuations. The group is also announcing corporate actions on its site.
FTSE has already announced that it will transfer all existing index constituents to a system of free float bandings by June next year.
All new FTSE entrants have been band weighted since the beginning of this year under five band widths: 20–30%, 30–40%, 40–50%, 50–75% and 75–100%. FTSE claims the band widths will keep down trading costs, which it says would be incurred every time a small change in the free float or cross holding occurred.