Another Country, Similar Problems: Russia
Israel is certainly not the only market where these challenges arise. Russia is another market where index innovation has taken place in order to address the perceived weaknesses in the offerings of the major index providers. It suffers from the index providers’ diktat that some emerging-market-domiciled companies can be excluded from all indexes if they are listed on a developed-market exchange.
Because of this, the MSCI Russia index is less than complete and highly concentrated—the index only has 22 constituents, and the top five companies comprise more than 54 percent of the index. This is in a market where the main index, the Micex, has more than twice as many listed companies. Four of MSCI Russia’s constituents are listed in London and one in the U.S. Leading companies in several industries, most notably retail and technology, are excluded from MSCI Russia, leaving investors who follow the index little or no exposure to those dynamic and fast-growing sectors of the Russian economy, and making the index overly reliant on the energy and natural resources sectors.
In an effort to mitigate these weaknesses, in 2007, Van Eck launched its Market Vectors Russia ETF (RSX | C-63), which originally tracked a custom-calculated DAX Russia index to compete with MSCI Russia by including a much broader slate of companies. The ETF has since switched to an index calculated by Van Eck subsidiary Market Vectors Index Solutions (MVIS). The new benchmark currently comprises 37 companies and is much less top heavy than MSCI Russia. For example, natural gas giant Gazprom is 9.3 percent of the MVIS index compared with 21.0 percent in MSCI Russia.
RSX is but one example of Van Eck’s innovative approach to single-country indexes embodied in its Market Vectors series of funds. According to Van Eck, Market Vectors indexes are built on three key factors that ensure completeness and investability, and more accurately reflect the globalization of today’s investment landscape. These factors are: a focus on pure play and the reflection of target markets through the inclusion of offshore companies; demanding liquidity criteria and diversification to avoid heavy overweighting of particular companies or sectors.
The Case Of Single-Country Sector Indexes
Using a broader and more complete country allocation methodology is even more important when it comes to the design and maintenance of single-country sector indexes. The exclusion of even one key sectorally significant constituent can render such an index less representative and thus less-efficient for sector exposure. We can see this innovation at work in arguably the fastest-growing and most dynamic sector of all—technology—in the two foreign countries that have the most companies listed on Nasdaq, China and Israel.
China presents the most interesting case, as there are three ETFs with underlying indexes that focus solely on technology.11 These indexes range in size from 29 to 61 constituents, with a mix of Hong Kong- and U.S.-listed companies. This compares with MSCI’s flagship China Index, which only has a 20 percent weighting to technology, half of which is in the telecommunications sector, and all of whose constituents are listed in Hong Kong.
Attempts at innovation in Israeli sector indexes are not new. The TASE has had dedicated indexes for the technology, insurance and energy sectors, among others, for quite some time. The local technology indexes, the TA Tech Elite and the TA BlueTech (and previously, the TA Tel Tech), display the same lack of completeness that hampers the broader market indexes; they do not provide investors with the broadest possible exposure to the dynamic Israeli technology sector because they only include domestically or dual-listed companies and exclude Israeli technology companies that are solely listed outside of Tel Aviv. This is not due to any lack of skill or knowledge by the TASE Index department, but due to the historical constraints of focusing solely on Tel Aviv-listed companies.
In contrast, just as with BIGI, the BlueStar Israel Global Technology Index (BIGITech) was developed to overcome these issues and offer investors the broadest possible exposure to Israeli technology companies, no matter where they are listed or domiciled. The index, which went live in November 2013 and has been backtested to 2004, includes the largest and most liquid Israeli and Israeli-linked technology companies, as well as mid- and small-cap companies that meet stringent liquidity requirements. The proprietary BlueStar methodology results in an index with 54 constituents with an aggregate market capitalization of $62 billion compared with 34 constituents and a market capitalization of $45 billion for the TASE Tech-Elite Index. Its relative performance versus Israel Tech, the Nasdaq-100 and two broad Israel indexes is provided in Figure 5.
Conclusion: Innovating With ‘Basic’ Building Blocks Of Single-Country Indexes
Despite the many advances and changes that have taken place in the development of indexes and investment products that track them over the past 10 years, it is clear that there remains plenty of room for innovation. This is true of basic “building block” country indexes, where innovation has shifted to new, “active” formulations and to complex “national” capital markets such as Israel, Russia and China, where a break with conventional classification methodologies can result in a more representative benchmark for a country’s equity market.
The globalization of international stock markets, with exchanges from New York to New Delhi vying for new listings, highlights the importance of continued innovation in the creation of single-country indexes. It is especially vital in the case of Israel, where more than 20 companies have either filed or announced plans to file for initial public offerings in the next several months, only a handful of which actually plan to list on the domestic Israeli market. One of these IPOs, for Mobileye, the maker of automobile collision warning systems—which, as of this writing, is seeking a market valuation of as much as $5 billion—will likely be the largest Israeli company IPO ever. However, because of the methodology developed by BlueStar, the only Israel-focused index in which it will be included is BIGI.
By applying the seven key criteria of index construction in a dynamic manner, it is possible to create better indexes that appropriately balance the inherent trade-offs of index design and therefore develop a more perfect solution to the issue of completeness.