Tuesday, March 27, 2007
SHORT VIEW- INDEX
By John Authers
Tuesday, March 27, 2007, FT
The basic building block of stock market investment is no longer the common stock. It is the index. There now appear to be more indices than common stocks, and it is indices that form the basis of investment decisions.
Fund managers work on the assumption that returns can be divided into two: “beta” – the returns of the market; and “alpha” – returns uncorrelated to the market. That means more focus on exactly what goes into beta. And as they are judged almost exclusively by reference to a benchmark, they need an index relevant to them. They might need a benchmark for their particular investment style, for example. That means that indices become more important, and they proliferate. And, try though they will to avoid it, indices no longer track markets – they move them.
Many fund managers cannot invest beyond the stocks in their benchmark. Exchange-traded funds, which track indices, make index providers even more powerful. Moves in US small-cap stocks, for example, are dominated by the ETF tracking the Russell 2000 index, which is usually the third most heavily traded ETF. Hedge funds use it as a vehicle to play the entire sector. Google – strong as it was – leapt 7 per cent on the day it joined the S&P 500, which has more money tied to it than any other.
We are about to see another test of the power of indices. By the end of this month, Morgan Stanley Capital International, the dominant index provider for international investors and emerging markets, will unveil an overhaul of its indices to include small-cap stocks on a global basis. This will bring the total number of stocks used in MSCI's indices to 8,000 – and create, incredibly, more than 20,000 new indices, sliced by style, sector, geography, market cap, currency and so on. This will open small emerging market stocks to a range of investors currently barred from buying them.
MSCI will do its best not to move the market, and has avoided doing so when it has moved countries in and out of indices in the past. But it is likely to be an event. Just look at how Merrill Lynch is previewing it: “Coming soon: a new stock universe.” ¶ 3:15 AM
Tuesday, March 27, 2007, FT
The basic building block of stock market investment is no longer the common stock. It is the index. There now appear to be more indices than common stocks, and it is indices that form the basis of investment decisions.
Fund managers work on the assumption that returns can be divided into two: “beta” – the returns of the market; and “alpha” – returns uncorrelated to the market. That means more focus on exactly what goes into beta. And as they are judged almost exclusively by reference to a benchmark, they need an index relevant to them. They might need a benchmark for their particular investment style, for example. That means that indices become more important, and they proliferate. And, try though they will to avoid it, indices no longer track markets – they move them.
Many fund managers cannot invest beyond the stocks in their benchmark. Exchange-traded funds, which track indices, make index providers even more powerful. Moves in US small-cap stocks, for example, are dominated by the ETF tracking the Russell 2000 index, which is usually the third most heavily traded ETF. Hedge funds use it as a vehicle to play the entire sector. Google – strong as it was – leapt 7 per cent on the day it joined the S&P 500, which has more money tied to it than any other.
We are about to see another test of the power of indices. By the end of this month, Morgan Stanley Capital International, the dominant index provider for international investors and emerging markets, will unveil an overhaul of its indices to include small-cap stocks on a global basis. This will bring the total number of stocks used in MSCI's indices to 8,000 – and create, incredibly, more than 20,000 new indices, sliced by style, sector, geography, market cap, currency and so on. This will open small emerging market stocks to a range of investors currently barred from buying them.
MSCI will do its best not to move the market, and has avoided doing so when it has moved countries in and out of indices in the past. But it is likely to be an event. Just look at how Merrill Lynch is previewing it: “Coming soon: a new stock universe.” ¶ 3:15 AM
