In addition to South Africa, the country allocation framework followed by the major index providers is most susceptible to second-guessing in countries such as Russia and Israel. For example, many Russian companies are excluded from MSCI’s indexes due to its rule that a company can be excluded if its operations are in an emerging market but its listing is in a developed market. Similarly, many Israeli companies have been left out of global, regional and country indexes because of what we view to be the overly strict country allocation procedures followed by the major index providers.
The exclusion of companies that by any clear-headed, intuitive analysis would be allocated to a specific country not only suggests that some major indexes fail the “completeness” test, but also has a detrimental impact on specific markets and the companies themselves given the trillions of dollars that are invested globally according to index benchmarks.
Innovation In Single-Country Benchmark Development
As in any industry, perceived limitations in existing products often spur innovation and the development of superior solutions. The financial services industry in general and especially the index/ETF industry have proven this maxim repeatedly and impressively over the past three decades, and if anything, the pace of innovation is accelerating.
We believe one good example of this innovation was highlighted by our 2011 launch of the BlueStar Israel Global Index (BIGI). The index was designed to resolve the difficult country allocation issues described above, while still adhering to the seven key criteria for index construction outlined in the first section of this paper.
Until the development of BIGI, and the June 2013 launch of the Market Vectors Israel ETF (ISRA | C-32) that tracks it, portfolio managers wanting to make the proper allocation to Israeli equities in the context of an all-country, international or developed-market portfolio had limited choices on how to execute this strategy. The benchmarks existing at the time, whether those offered by MSCI, FTSE or even the Tel Aviv Stock Exchange (TASE), all failed to represent the complete universe of Israeli stocks, and, in the process, shortchanged investors seeking to capture the full-opportunity equity returns from Israel’s fast-growing, dynamic economy.
Indeed, some of the most successful Israeli companies were then and are still excluded from the most prominent global Israeli benchmarks because of the country allocation process followed by the major global index providers. These include Checkpoint Software, SodaStream, Amdocs and Verint Systems, to name just a few. Based on our proprietary research, the amount of market capitalization that is excluded from the most used benchmarks was close to $70 billion as of Dec. 31, 2013, and passive investors in these benchmarks would have to have allocated an additional 32 to 44 bps to Israeli stocks to achieve what we consider is the appropriate weight of Israeli equities in global benchmarks. (See Figures 1a-1c for a comparison of Israel’s weight in some major global benchmarks using the BIGI methodology and that of the major index providers.)