Indexing Developments

November 01, 2007

S&P Gets A New Theme

S&P hopped on the emerging “theme index” bandwagon, launching three new indexes in August that target hot areas of the marketplace: the S&P Global Nuclear Energy Index, the S&P Global Alternative Energy Index and the S&P Global Timber & Forestry Index.

The Timber and Forestry index includes 25 stocks ranging from timber real estate investment trusts (REITs) to paper product and packaging companies to agricultural product companies that are involved in the forest and timberland sector. The Nuclear Energy index is a 20-stock index of the largest companies from both emerging and developed markets operating in the nuclear materials, equipment and services or actual nuclear energy generation segments. The Alternative Energy index is a combination of the NuclearEnergy Index and a separate CleanEnergy Index.

The indexes are constructed through a combination of quantitative and qualitative analysis; all are global in scope. Like other thematic indexes, these are clearly designed with product developers in mind. Similar indexes have been picked up and translated into successful ETFs and options contracts.

Measuring Credit Conditions

Ned Davis Research announced a new index in August that would measure the cost and availability of credit. Entering a red-hot market, the NDR Credit Conditions Index (CCI) includes two equal-weighted components that together take into account 25 different factors. The NDR Consumer CCI includes nine economic indicators such as mortgage delinquency rates, the debt/net worth of the household sector and senior loan officer surveys of lending standards for consumer credit cards, “other” consumer loans and residential mortgages. The NDR Business CCI covers 16 different factors including credit swap spreads, the NACM Credit Manager’s Index, LIBOR minus T-Bill yield, the debt/net worth of nonfinancial corporations and senior loan officer surveys of lending standards for small and large businesses.

The index was designed for investment professionals such as fund managers and private investment counselors, according to the NDR spokesperson.

The NDR CCI has been trending mainly downward since peaking in early 2005, although the index remained largely flat through 2006 before dropping sharply in 2007 from a level around 75. The subprime credit meltdown is widely agreed to have hit the markets in late 2006.

Housing Indexes Tumble

The latest figures from the S&P/Case-Shiller Home Price Indexes confirm that the U.S. housing market is getting ugly.

The data, through June, show that the average national home price (resales only) was down 3.2 percent year-over-year and 0.9 percent from last quarter. A separate (and more robust) measure of home prices in 20 metropolitan areas fell 3.5 percent.

“The pullback in the U.S. residential real estate market is showing no signs of slowing down,” says Macro-Markets LLC Chief Economist Robert J. Shiller. “The year-over-year decline reported in the second quarter of 2007 for the National Home Price Index is the lowest point in its reported history, which dates back to January 1987. On a regional level, 17 of the 20 metro areas are showing declines in their annual growth rate from what was reported in May.”

Only Seattle (up 7.9 percent), Portland (up 4.5 percent), Dallas (up 1.6 percent), Charlotte (up 6.8 percent) and Atlanta (up 1.6 percent) showed positive annual returns in June, as they did in May.

The metro areas with the worst annual returns were the same ones that posted the worst results in May: Detroit (down 11.0 percent), Tampa (down 7.7 percent), San Diego (down 7.3 percent), Washington, D.C. (down 7.0 percent) and Phoenix (down 6.6 percent).

Importantly, these numbers do not fully reflect the impact of the subprime mortgage meltdown. Although that process started in late-2006, the credit crunch did not really set in until August. With the indexes already exhibiting dismal performance, it appears likely that the dramatic downward trend will continue.

KLD Relaunches CV400

Social and sustainability investment research firm KLD Research & Analytics has relaunched its KLD Catholic Values 400 Index (CV400), after the only fund tracking the benchmark abandoned it for another strategy.

The CV400 is created by layering screens related to Roman Catholic values on top of the Domini 400 Social Index, which is itself modeled on the S&P 500. The values are drawn from socially responsible investment guidelines laid out by the U.S. Conference of Catholic Bishops (USCCB). As part of their launch, KLD added a new screen that removes companies involved in fetal tissue or embryonic stem cell research. Six companies were excluded from the index at its last rebalance specifically for this reason. Other grounds for exclusion from the index include participation or involvement in abortion, the manufacture of contraceptives, the production of tobacco products, large-scale production of weapons, the sale or distribution of pornography and the manufacture of anti-personnel land mines. Companies involved in nuclear power can also be excluded unless they have significant involvement in the field of alternative energy.

KLD hopes that a product developer picks up the index in the coming months.

S&P Launches New STARS Indexes

In late August, S&P revealed new indexes tied to its popular stock ranking system, known as the STARS (Stock Appreciation Rating System). The S&P U.S. STARS Index and the S&P Europe STARS Index contain the top-ranked stocks in Europe and Japan, as rated by S&P’s team of equity analysts.

The STARS ratings are based on S&P’s fundamental research and predictions about which stocks will outperform their benchmark during the next year. On a long-term basis, these picks have proven very profitable; S&P says the top-ranked 5 STARS picks have outperformed the S&P 500 fifteenfold since it started keeping track in 1987.

The new indexes give priority to 5-STARS-rated companies, including all stocks with that designation, but will include 4 STARS companies if there aren’t enough 5-STARS components to make the grade. Components are equal-weighted, and the indexes are reviewed and rebalanced monthly.

There is no word yet on related product development.

Tracking MLPs

With investors constantly searching out the latest, greatest dividend-yielding securities, it has been only a matter of time until they got to master limited partnerships, or MLPs. MLPs are (for the most part) oil and gas infrastructure companies that are structured so that they pass essentially all of their income down to shareholders in the form of high dividends. S&P’s new index currently includes 40 components, with a minimum market capitalization of at least $300 million. Through July 31, the index was up 17.37 percent year-to-date and had an impressive 21.73 percent five-year annualized return.

Outsourcing Index

Business development analytics firm Zagada Markets and Sweden-based Waagstein Research have launched a family of indexes that track information technology outsourcing (ITO) and business process outsourcing (BPO). The benchmark ZagadaWaagstein Global Outsourcing 100 Index includes 100 components spanning three regions: the Asia-Pacific region represents 44 percent of the index, the Americas represent 41 percent and Europe represents 15 percent. The equal-weighted benchmark has posted annualized returns of more than 33 percent during its five-year backtested period. The pair also launched large-cap, small-cap and regional versions of the index.

IPOX Goes To China

Chicago-based IPOX Schuster LLC launched the IPOX China 30 A-Shares Index in July. The benchmark tracks the 30 largest and most liquid IPOs and spin-offs traded on China’s domestic exchanges and is a subset of the broader IPOX China A-Shares Composite Index. Components enter the indexes at the close of their sixth day of trading after the IPO and remain for the next 1,000 trading days, or approximately four years; the same entry and exit plans used in other IPOX indexes. As with other IPOX indexes, IPOs that see a price increase of more than 51 percent on their first day of trading are excluded from the index.

China A-Shares are companies traded on the mainland Chinese exchanges and are largely available only to domestic Chinese investors. The IPOX China-30 index was up 95 percent year-to-date as of July 20, and up 104 percent last year. Over the past five years, it has outperformed the FTSE/Xinhua All-Share Index by 7.41 percentage points. Financials represent nearly 30 percent of the index. Its largest component is the Industrial and Commercial Bank of China (ICBC), one of China’s largest companies, which just went public in October 2006.

S&P Launches Pure Style Indexes For China A Shares

S&P and CITIC Securities Index Information Service recently launched a family of “exhaustive” style indexes and a family of “pure” style indexes covering the China A-Shares market.

The exhaustive indexes include all the stocks designated as growth or value; stocks that are not 100 percent growth or value see their market caps distributed between the two designations.

The Pure Style indexes are far less inclusive, selecting stocks based on style purity: Only one-third of the broad index’s stocks are included in the Pure Growth index and only one-third are included in the Pure Value index. As a result, there is no overlap between the two style designations. The index is also weighted according to style purity rather than market capitalization, further intensifying the “growth” or “value” qualities of the respective indexes.

The joint venture also launched three new headline indexes that divided the market into large, mid- and small-cap segments. The S&P/CITIC 100 Index holds 100 large-cap stocks; the S&P/CITIC 200 Index holds 200 small-cap stocks; and the S&P/CITIC Small Cap Index holds 300 small-cap stocks.

Measuring The China Bubble

HSI Services Ltd., which maintains and calculates the benchmark Hang Seng indexes, has addressed the issue of China’s dual markets with the launch of its Hang Seng China AH Index series, which tracks only stocks that list both A and H shares. The index family includes four indexes—one that combines A and H shares, one for A shares, one for H shares and one that tracks the spread between A and H shares. The series currently tracks 27 stocks with both A and H listings.

By far the most interesting index in the series is the Hang Seng AH China Premium Index, which tracks the premium/discount between the two share classes. Recently, that premium has been above 60 percent, supported by a flood of domestic investors into the Chinese market. That’s remarkable, considering the shares cover the same companies. A bubble, perhaps?

S&P Adds To Shariah Lineup

S&P recently introduced three new Shariah indexes: two covering the global property market and one covering the Pan-Arab region.

S&P said that customer demand led it to create Shariah versions of its property indexes. The S&P/Citigroup Global Property Shariah Index is derived from the S&P/Citigroup Global Property Index, which covers publicly traded property companies in 53 countries. The S&P/Citigroup World Property Shariah Index is derived from the S&P/Citigroup World Property Index, which covers only developed markets.

Rising wealth in the Middle East is pushing index developers to expand their efforts in the Shariah marketplace, where investments must be screened for a variety of factors to meet the central tenets of the Muslim faith.

The S&P Pan-Arab Shariah Index covers roughly 130 companies from 11 different countries: Bahrain, Egypt, Jordan, Kuwait, Lebanon, Morocco, Oman, Qatar, Saudi Arabia, Tunisia and United Arab Emirates.

Shariah ETF For Daiwa

S&P isn’t the only one moving in the Shariah marketplace. Daiwa Asset Management announced that it will launch an ETF based on the recently introduced FTSE Shariah Japan 100 Index. The index contains the largest 100 stocks in FTSE’s Japan universe that qualify as acceptable investments according to the requirements of Islam; Yassar Research Inc. screened the potential components for compliance.

The new product will trade on the Singapore Stock Exchange (SGX) and should launch within the next few months; it will be one of the only ETFs in the world to be based on a Shariah-compliant index.

FTSE plans to expand its Shariah index footprint to develop a broad family of indexes, including global, regional and developed/emerging markets indexes. This is FTSE’s first independent move into the Shariah space.

European Private Equity

STOXX Ltd. has launched a new index designed to track the recently hot private equity market. The new Dow Jones STOXX Private Equity 20 Index features 20 of Europe’s largest publicly traded private equity companies.

Companies included in the index must have at least 40 percent of their portfolio invested in private equity, and a minimum market capitalization of €75 million. Components are capped at 20 percent weightings. The largest company in the index is the United Kingdom’s 3I Group, which at €3.1 billion is 16.55 percent of the index. The U.K. represents almost 45 percent of the index.

Publicly traded private equity firms are a rarity in the United States, where Blackstone’s recent IPO represented almost a first among the major private equity players. In Europe, however, the market is more developed, and there should be enough firms to fill the index comfortably. Interest in the private equity index has ebbed recently, but could return with a vengeance if a market downturn creates new opportunities for corporate buyouts.

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