Are Equity Indices Becoming More Alike? | Chief Investment Officer

(January 29, 2014) — Performance of MSCI and FTSE global equity indices has converged since 2001, despite each claiming to their investors to have fundamental differences.

Norges Bank Investment Management (NBIM) has undertaken analysis of the MSCI GIMI and the FTSE GEIS indices to see if there were any differences in risk/reward performance, and found that the two indices have been steadily converging since 2001.

From a return and risk perspective, the analysis indicated that over the past 10 years FTSE had a higher cumulative return than MSCI, but most of that outperformance occurred between 1998 and 2001.

After 2001, performance of the two indices has converged. In terms of index composition, the two indices historically overlapped each other with around 93%-94%, of their stock selection, but this increased to 96% after FTSE’s change of free-float methodology, NBIM said.

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There remain differences between the two indices, however. While both follow broadly the same set of classification rules, there are anomalies, such as how they classify South Korea (FTSE: developed, MSCI: emerging).

FTSE includes index orphans— stocks that are not often tracked by analysts due to being not very well known or because it belongs to an industry that is generally performing poorly—which allows FTSE to gain from companies with an ambiguous country-classification, while MSCI’s decision to target 99% of the investable universe, compared to FTSE’s 98%, means they have different medium-sized company definitions.

But these differences amount to almost nothing in terms of performance, NBIM found. It said the trend for benchmarks to be created from concentrated portfolios covering a specific set of markets and the development of “best practice” for constructing market-cap-weighted indices had resulted in returns being almost identical.

The convergence may also be driven by the needs of the fast-growing ETF sector, NBIM’s report said.

“For an index fund or an ETF vehicle, where replicating a benchmark is the goal, availability of liquidity (which the vendors try to ensure through relatively complex liquidity rules and narrow free-float bands) at every point in time is of high importance,” the report continued.

This convergence is leading investors to find other differentiators, such as cost, instead, NBIM concluded. Based on a simple indicator of trading, NBIMA found that less trading was required to follow MSCI historically, cutting costs for investors. But this was unlikely to continue in future, thanks to FTSE’s change in free-float methodology in March 2013.

Leaving cost considerations aside, a potential differentiator in the future might be increased transparency in areas of benchmark construction.

Index transparency is currently difficult and costly for investors to verify. In particular, free-float adjustments can put asset managers in a worse position to understand how the final benchmark is constructed and how the weight of each constituent is assigned, NBIM argued, due to the lack of clarity on the information used for the adjustments.

The full discussion paper can be found here.

(January 29, 2014) – New Jersey is facing a political showdown over its $72 billion public pension deficit.

State Senate President Stephen Sweeney told the Star-Ledger newspaper he was prepared to shut down state government if Republican Governor Chris Christie did not support the payment into the public employee pension fund they had both promised when approving a major overhaul of the programme three years ago.

His outburst was in response to Christie’s suggestion that he was open to conversations on where the next budget’s money should be spent—even if that’s at the expense of the public sector plan.

“If we do not choose to reduce our soaring pension and debt service costs, we will miss the opportunity to improve the lives of every New Jersey citizen, not just a select few,” Christie said in his annual address to the legislature on January 14.

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“I am ready to engage in those conversations and help, with you, to truly create an attitude of choice.”

Sweeney, who is a democrat, reacted angrily to the statement, telling reporters at the time: “He talks about having an honest conversation. That did not happen today. It was a bait and switch. The pension payment is an obligation to hundreds of thousands of people who worked here.”

Speaking to the Star-Ledger on January 28, he reaffirmed: “If we have to shut the government down, we would. I stand by that, and I mean it. I made a commitment, and I’ve got to keep it.”

Governors from both the Democrats and the Republicans failed to contribute to the pension plan for years, contributing to its $86 billion deficit. In 2011, a revision was agreed, which called for the state to phase in added payments to the fund until 2018, when the state’s contribution would reach what is needed to preserve its long-term health.

But the Christie administration is enduring a tough spell economically: the state’s economy remains sluggish, and in November, Moody’s Investors Service lowered its outlook for New Jersey’s debt from stable to negative, citing the state’s huge debt obligations.

The state constitution requires a budget to be approved on or before June 30.

A report, prepared by the nonpartisan Common Sense Institute of New Jersey, claimed that if plans were closed tomorrow, there would be approximately $128 billion in obligations but assets with market value of only about $56 billion, resulting in a $72 billion deficit.

The report’s authors praised Christie for making “large strides’’, adding: “They’ve probably done some of the toughest work in the country, but part of the problem was the hill was so hard to climb. They did what was politically feasible (in 2011). They’ve been far more responsive than any other legislature and governor in the past 15 years. But the hole is so enormous.”