The Aon/ IPE survey of European benchmark preferences
The race to provide the dominant EMU equity and bond indices is being hotly contested, both by the usual field and by new contenders. In 1998 we saw high profile advertising campaigns by index providers and the launch of at least a dozen new indices designed to meet the needs of European investors. Due to the frequent appearance of new entrants in the run up to the launch of the Euro, it has been difficult to draw clear conclusions about the likely winners. As the race enters its final lap the situation is becoming clearer.
IPE and Aon surveyed leading investment management organisations about their preferred European indices and the trends they expect to see developing in practice.
The 50 organisations that res-ponded to the survey were predominantly based in Europe (both inside and outside the Euro zone) and manage assets in excess of Ecu 370 bn in European markets (see page 44).
Structure of investments
The emergence of the EMU area as a potentially separate geographic asset class raises questions about how European investments as a whole will be managed. Investors can now have the following options:
p Invest in EMU bloc assets as a separate portfolio and Europe (ex EMU) assets as a part of a foreign portfolio
p Run investments on a pan-European basis
p Invest in EMU bloc assets and Europe (ex EMU) assets as two separate portfolios.
Managers domiciled outside the EMU bloc believe that the majority of equity portfolios will be managed on a pan-European basis for at least the next year. Those based within the EMU bloc forecast that by January 2000 similar proportions of mandates will be invested in each of the three structures outlined above.
For bond benchmarks the picture is less clear. Pan-European mandates are expected to account for a significant block of European bond investments according to the managers based outside the EMU bloc, but less than half of mandates are expected to be managed along these lines. Managers based inside the EMU bloc forecast that most bond investments will be structured as EMU portfolios with Europe (ex EMU) assets invested as a part of foreign portfolios.
EMU bloc assets can now be regarded as domestic assets by investors domiciled in EMU member countries. This may be the reason behind the greater focus placed on stand alone EMU bloc mandates by EMU based managers than those outside EMU.
Regulatory requirements, which typically require that a proportion of assets is invested in the same currency as liabilities, may also play a role. EMU only mandates are expected to be more prevalent in bond investments than in equity management, possibly due to the emergence of the EMU bond market as a discrete market, a trend that is happening more gradually in equity markets.
Investment managers' preferences for equity indices for both EMU and Europe wide mandates were clearly split along country lines. UK and Irish respondents had a preference for the FT / S&P-A indices, while continental European respondents prefer the MSCI index family.
These choices reflect the pattern of index use before the introduction of the Euro and suggest that providers will face a difficult battle to change this pattern.
For benchmarking EMU bloc assets, there was also some support for the FTSE Eurotop 300 Eurobloc index (predominantly from UK based investment managers) and for the Dow Jones Euro Stoxx index. The FTSE Eurotop 300 will be used to benchmark some Europe-wide portfolios.
The investment managers' res-ponses suggest that broad equity indices (which include over 300 stocks) are more important than narrow indices, which focus on large capitalisation stocks.
The interest in the FTSE Eurotop 300 Eurobloc (which contains around 150 stocks) indicates that there is a demand for smaller indices that still provide reasonable market coverage.
The JP Morgan bond indices are the clear leaders in the race to benchmark both European and EMU bloc government bond portfolios. There is also a significant body of support for the Salomon Smith Barney Government Bond indices.
These conclusions hold for EMU and non EMU based managers. A minority of managers intends to benchmark EMU bloc bond portfolios against their domestic bond index.
Investment Grade Bonds
It is widely expected that non government bonds will play an increasing role in the post EMU environment. This will result in demand for bond indices that cover investment grade bonds in addition to the government sector.
The leading contenders to benchmark this asset class are the Salomon Smith Barney Euro Broad Investment Grade Index and the Lehman Brothers European Government Index for EMU mandates and the Merrill Lynch European Bond Market Index for European mandates.
We can perhaps expect new credit indices to emerge, as investment in non government bonds becomes an important part of mainstream pension investment.
Europe ex EMU assets
By January 2000 managers expect around 20% of European equity mandates and 35% of European bond mandates to be structured as EMU bloc mandates and Europe (ex EMU) mandates. Therefore a benchmark for Europe (ex EMU) assets is required.
Managers plan to follow a consistent approach, typically using Europe (ex EMU) sub indices from the same families as their choices for EMU and European mandates. Some managers will use customised benchmarks for this asset class.
The results of the Aon / IPE survey provide a useful indication of the progress of the European benchmarking race. Investment managers do not currently intend to move away from the index providers they have historically used, so the publishers of other indices face an uphill struggle to gain market share. However, many plans have not yet adjusted the structure of their European portfolios and it is notable that some investment managers felt unable to reply to the survey because they have not yet agreed their approach to the issue. This should provide hope for late entrants as it signals that the race is not over yet.
Claire Lumsdaine is head of European investment research, Aon Consulting in London