2013, Study Session # 12, Reading # 29 INTRODUCTION International benchmarks differ from U.S equity benchmarks as: Float adjustment is more important for international stocks.. Intern
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2013, Study Session # 12, Reading # 29
INTRODUCTION
International benchmarks differ from U.S equity benchmarks as:
Float adjustment is more important for international stocks
International equity markets are divided into developed & emerging categories (category has consequences for the benchmarks & countries)
Local currency & investor currency versions of benchmark
Categorization (b/w emerging & developed category) is a complex matter
1 EARLY DEVELOPMENT OF INDEXES
Early indexes were complied by news papers, were price-only & not cap weighted
MSCI followed the basic principles of good index construction (cap weighted, publication of constituents etc.) but capture only 60% of market cap of the countries & sectors it covered
Investors should invest internationally for many reasons (diversification, different industrial mix etc)
2 NEED FOR FLOAT ADJUSTMENT
Cross holdings (cause double counting) & closely held ownership requires free float adjustment
Now float adjusted indexes are popular & constructed by the entire international index providers
3 INTERNATIONAL EQUITY INDEXES COMPARED
Major providers of international equity indexes include MSCI, FTSE, citigroup, S&P & Dow jones &
company
Trade-Offs in Constructing International Indexes
Breadth V/S Investability Liquidity & crossing Opportunities Versus Index Reconstitution Effects
Breadth ⇒ coverage of the index
Investability ⇒ readily buying & selling of stocks with minimum
price pressure & transaction costs
Take extra measure of choosing an index that errs on the side of
greater liquidity & less breadth
Popular & most widely used indexes have greater index-level liquidity
More liquid indexes have greater crossing opportunities (matching buying & selling orders without using brokers i.e no transaction cost)
Program trades on liquid benchmarks involve low bid-ask spread from broker
Popular indexes may suffer from reconstitution (inclusion &
deletion) effect
() price pressure when stocks choosen for inclusion (deletion)
Detrimental to performance (no negative alpha as reconstitution effects both the benchmark & investor’s portfolio)
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2013, Study Session # 12, Reading # 29
Trade-Offs in Constructing International Indexes
Precise Float Adjustment V/S Transaction Costs from Rebalancing Objectivity and Transparency V/S Judgment
Frequent float adjustments
transaction costs
Float Band Precise Float Adjustments
Free float bands are categories e.g 75-100 percent
Less transaction costs (only when outside the float band)
Benchmark constituents are easy to predict
More effective trading
Easier to understand
Use as proxies for asset classes
in asset allocation
Judgment Based Index Construction Rule Based Index Construction
May be difficult to defend
The advantages of this method (e.g liquidity) may overcome disadvantage of this method
4 CLASSIFICATION OF COUNTRIES AS DEVELOPED OR EMERGING
Leading developed market index providers are also leading providers of EM benchmarks
Boundary between Developed and Emerging Markets
A country’s category (developed or emerging) has consequences for benchmark & county itself
When a country has large market cap in EM index, it is a huge player in a small market
For any country, being in a developed index is highly desirable as more capital
is committed to developed rather to EM & as new source of capital becomes available to that country’s companies
Acceptance of Integrated Indexes
Today, the developed-emerging distinction seems less important because the largest companies in the EM are traded on NYSE (meet transparency &
liquidity standards)
Integrated mandates (a single manager to invest in all non-U.S markets) are growing rapidly as a result of the transparency & liquidity
5 IMPACT OF BENCHMARKING ON INTERNATIONAL MARKETS
Examples
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