All the News in Indexes From the 4th Quarter of 2001

January 01, 2002

The Vanguard 500 Index Fund celebrated its 25th anniversary on August 31. In March 2000, it claimed the title of World's Largest Mutual Fund, and as of the end of August 2001, it had assets totaling $90.6 billion. That's not bad, considering the fund only raised $11.4 million during its initial underwriting and, as recently as year-end 1995, was worth just $17.4 billion. There are now very few people who would argue with the fund's success, which was built on low fees and a successful index. In the wake of that success, an entire industry has sprung up.

With the Vanguard 500's benchmark index down more than 20% for the year at the end of the third quarter and with uncertain prospects for the future, however, there is a definite sense that the Vanguard 500's 25-year milestone also could double as a turning point for the indexfund industry.

Index funds had remained largely off the radar screens of most investors until the last few years. For the most part, John Bogle was dismissed by the fund industry as a maverick when he started the Vanguard 500 in 1976, and interest in indexing first developed among institutional investors. The first institutional index fund, in fact, entered the scene before the Vanguard fund. The ponderous Samsonite equal-weighted index fund developed by Wells Fargo also celebrated a birthday this year, its 30th. By the 1980s, many plan sponsors began moving some or all of their assets into index strategies, when it became clear that active managers were not beating the indexes. But even well into the 1990s, both institutional and retail investors were still treating index funds as something of a novelty.

If you go back longer term, there just was very little interest at all. I think the big catalyst that really generated significant interest in indexing was the massive bull market of the late '90s, during which time large caps significantly outperformed and propelled the S&P 500, says Gus Sauter, who has headed the management team of the Vanguard 500 for the past 14 years.
Index funds had a virtually meteoric rise to popularity in the late '90s, with 1999 indisputably being their best year as far as inflows are concerned. Nearly 70% of that money was invested in the first two quarters of the year, based on data provided by Lipper.

In 2000, the rise of index-fund inflows faltered with the markets, but then an interesting trend devel-oped. According to Lipper, S&P 500 index funds had their worst quarter at the beginning of 2001 with out-flows of $80 million, while actively managed large-cap funds took in $3.7 billion. But in the second quarter, the S&P 500 funds for the first time saw more money come in than the actively managed, large-cap funds. And while actively managed large-cap funds lost a whopping $19.8 billion in the third quarter, the S&P 500 funds took in about $60 million.

Chris Brown, director of research for Financial Research Corp., a Boston-based research and consulting firm, believes the recent falling off inflows for index funds is a temporary setback.

People have been putting more in money markets and more in bond funds and just kind of staying away from equity funds in general, he says. Stock funds across the board have been seeing less money coming in. By comparison, index funds are thriving.

If nothing else, indexing has had a profound effect on the entire mutual fund industry by drawing attention to the weak points in active management, primarily in the areas of fees and returns.

I think managers are very aware of the indexes, and the big reason is that people realize that there's an index-fund alternative,says Scott Cooley, a Morningstar senior analyst and the editor of Morningstar Mutual Funds. I think it's fair to say that if you're going to charge an active fee, you have to add some value above and beyond what people could get with a passive strategy.

Mr. Cooley also believes that it is the presence this index-fund alternative that leads many fund companies to offer their own index funds simply to attract investors. Many of these funds, he says, don't even make money because they want to be able to compete with Vanguard's ultra-low expense ratios. Vanguard's structure as a mutual fund owned by the fund's shareholders and the sheer size of the Vanguard 500 give it a very strong com-petitive edge as far as expenses go.

Mr. Brown agrees and believes that in the current bear market, investors will pay even more attention to costs. During the bull market, he says, people were less focused on costs and paid more attention to the returns generated by growth and technology funds.

No one close to the index-fund industry seems to think the bear market will be its death knell. Mr. Sauter seems fairly cheerful about the whole situation. After all, cash flows into Vanguard funds have remained mostly positive, with its index funds typically pulling in about $1 billion each month.

I actually think it has been a bit of a positive experience. Despite the overhanging shadow of the bear market, index funds have picked up market share, and I think it is a kind of new lesson being taught. During the bull market, everyone was chasing the past performance of the large caps. Now I think people are seeking the broader diversification, and hence, less risk associated with index funds, he says.

Mr. Sauter adds he has noticed that a lot of people have moved to index funds from actively managed sector or focused funds and individual stocks after experiencing some of the drawbacks of such high-risk investments. Moreover, he says that people who argued that active managers could side step the pitfalls of a bear market are now finding that their active funds have declined along with the index funds and their benchmark indexes.

Mr. Cooley is a little more skeptical. He says that active managers, particularly value managers, who decried the overvaluing of Internet and technology stocks, have gained a considerable amount of credibility, and investors may hold to the idea that an active manager can guide them through the bear market with minimum losses. But this amounts to little more than performance chasing, he believes.

In recent months, value has outperformed growth by the largest margins seen since Morningstar was first started, Mr. Cooley says. And just as funds poured into growth as it was outperforming value by record mar-gins in 1999 and early 2000, money is now sloshing back into value from growth.

I guess the unfortunate thing is that the lesson some people took away from what happened to them over the last couple years was not that they should have stayed diversified but that they picked the wrong hot part of the market, he says. He adds that most actively managed funds haven't beaten the indexes coinciding with their style designation.

What the bear market may do, though, is weed out the weaker index funds. With the exception of exchange traded funds, there have been very few new index funds launched lately, and the number of closures has increased conspicuously. Smith Barney, TD Waterhouse, E*Trade and Eagle Investment are among the fund providers who have closed or abandoned plans for index funds recently.

But if the bear market doesn't spell the end for indexing, where to from here? Vanguard's Sauter views the future optimistically.

While the market share of index funds in the mutual fund industry is currently about 10%, Mr. Sauter predicts that will jump to 30% in the next 15 years. But that doesn't mean money will rush into index funds with any sort of consistency. Messrs. Brown and Cooley both believe that, due to human nature, index funds will grow in a cyclical fashion, attracting more investors when actively managed funds are performing poorly or when the markets are declining. There will always be that segment of investors that reverts to type and chases after the new favorite sector or fund.

I see the growth in index funds keeping up with the growth in overall equity mutual funds, perhaps surpassing that in terms of annualized growth, says Mr. Brown.

To a certain extent, that already has happened. From year-end 1997 through the end of the third quarter of 2001, assets in S&P 500 index funds increased by 70%, according to Lipper. At the same time, assets in large-cap actively managed funds increased by about 30%.

However, in concentrating on the S&P 500, one overlooks certain areas that are key to the future growth of the index-fund industry.

A lot of other types of index funds were brought up in the wake of the Vanguard 500, so we now see some cash flow into all segments of the market, including international. Bond indexing is actually pretty hot right now, too, says Mr. Sauter, adding that sector index investment seems mainly to have focused on tech stocks.

However, ETFs and sector investing seem like they may play a key part in the growth of the index-fund industry. The two are inextricably linked because some of the highest-profile sector funds currently are those marketed under the iShares brand from Barclays Global Investors and the SPDRs and streetTRACKS brands of State Street Global Advisors.

We're seeing narrower and narrower index funds, especially in the ETF format. There are a lot of industry, style and sector-specific funds. We didn't see a lot of that in the past because the big shops like Fidelity and Vanguard didn't offer sector funds. Now Barclays has a lot of them,says Mr. Cooley.

From an asset-allocation perspective, sector funds seem like they could be valuable tools for investors looking to balance a portfolio. But Mr. Cooley points out that although sector-investment products provide investors with control over their portfolios, they also tend to invite performance chasing. And while Mr. Brown foresees sector index funds becoming valuable tools to use in conjunction with asset-allocation mod-els, he believes they never will never achieve the same inflow levels as broader index funds.

To a certain extent, the distribution of assets among the top 10 exchange traded funds supports this viewpoint. The only sector indexes represented in the top 10 as of the end of October were the former-ly hot S&P financial and technology sectors. Arguably, the tech-heavy Nasdaq-100 could be included as a sector index as well. The two ETFs tracking the S&P 500 were both in the top five, as was the fund tracking the Dow Jones Industrial Average. The Russell and Wilshire broad-market indexes were also represented among the largest ETFs. Funds tracking the S&P MidCap 400 and the small-cap Russell 2000 rounded out the size segments in the top 10, though with their numbers of components, they could not really be considered narrow indexes.

I would say that the bulk of the money, certainly at the retail level, is going into broader index funds, says Mr. Sauter. He notes that the Vanguard Total Market Index Fund, tracking the Wilshire 5000 Index, had outpaced the Vanguard 500 as Vanguard's top-selling index fund for the last three years.

I think some institutional players, particularly hedge funds and speculators, are playing the sector funds, he adds.

As far as ETFs are concerned, they have achieved spectacular growth in a fairly short time with about $70 billion in assets. However, the top five funds represent 80% of the total assets invested domestically in ETFs. The oldest ETF, the SPDR, represents more than 35% of the total. And the combined assets of the approximately 100 available ETFs are only now beginning to approach the assets of the Vanguard 500.

SEC Issues Concept Release On Active ETFs

Actively managed exchange traded funds may soon be on the horizon. Considered by most ETF providers and many market participants to be the next step in ETFs, they have already appeared on the German stock market and have long been viewed as something of a holy grail in the United States.

On Nov. 7, the Securities and Exchange Commission issued a concept release requesting comments from the public on actively managed ETFs. The release seeks input on such issues as the structure and operation of such funds, related regulatory issues and the potential benefits and uses of the funds.

The SEC also has asked its staff to explore the possibility of creating a pilot program for such products and instructed them to continue working with fund providers with pending applications for ETFs during the consultation period, including those who are seeking to design and launch actively managed ETFs.

The actively managed ETFs currently available on the Deutsche Börse are not feasible products for listing on American exchanges, given the stricter transparency requirements in the United States. The portfolios for the German funds are only revealed monthly and there is a delay before the information reaches investors. Any actively managed ETF launched in the United States is likely to at the least have significantly greater transparency and creation and redemption of shares. Those same features keep trading values close to underlying net asset values and therefore generally satisfy the SEC.

Vanguard Loses Appeal In S&P Suit

The licensing dispute between Vanguard Group and Standard & Poor's seems to have drawn to a close. In early November, a U.S. Court of Appeals upheld a district court judgment issued in April in favor of S&P.

The district court had ruled that Vanguard did not have the right to issue exchange traded shares based on the S&P indexes. Vanguard had argued that its licensing agreement allowed for the creation of additional share classes for existing funds and that the Vanguard Index Participation Equity Receipts, or VIPERs, were simply a different share class. S&P, which filed suit against Vanguard last year, said the VIPERs were new products and were fundamentally different from traditional mutual fund shares.

We are disappointed and respectfully disagree with the court's decision, said Brian Mattes, a Vanguard spokesman. However, he said, Vanguard didn't plan to continue the court fight.

The decision reaffirms our long-held belief that this is bona fide intellectual property, and the court made a clear distinction between these different classes, said Michael Privatera, a spokesman for S&P.

So what does it all mean? Well, for Vanguard, it means it will not be able to launch an exchange traded version of its largest and most important fund, the Vanguard 500, which tracks the S&P 500, or any of its other S&P-based funds. However, it has already launched a VIPERs class for its Vanguard Total Market Fund, which tracks the Wilshire 5000 Index, with nary a peep from Wilshire. It plans eventually to launch VIPER shares for other index funds that do not track S&P indexes. A launch for an extended-market VIPERs based on the Wilshire 4500 already is in the offing.

For S&P, the victory sends a very public message about its intellectual-property rights. It also protects whatever exclusive agreements S&P may have made with Barclays Global Investors regarding the licensing of the S&P 500 for ETFs. But the court battle is sure to have damaged the relationship between S&P and Vanguard, one of its old-est licensees.

Around The Indexing World

Exchange traded funds in the United States closed out the third quarter with about $64 billion in assets. The preceding quarter showed assets of more than $75 billion. Prior to the World Trade Center terrorist attacks on Sept. 11, those assets were at a little more than $69 billion. By mid-October, those assets were back up to almost $70 billion, indicating that investor interest and the markets had recovered somewhat. Certainly, the expanse of products has continued to grow.

This summer, Barclays Global Investors filed with the Securities and Exchange Commission to create 14 new iShares. Ten of the planned funds will track Standard & Poor's global sector indexes, including the Consumer Discretionary, Consumer Staples, Energy, Financials, Healthcare, Industrials, Information Technology, Materials, Telecommunications and Utilities sectors.

Another three funds will be based on the S&P Latin America 40 Index; the S&P/TOPIX 150 Index, which covers the Japanese market, and the S&P International 700 Index, which covers the non-U.S. stocks in the S&P Global 1200 Index. The remaining exchange traded fund will track the MSCI Pacific ex Japan Index, which includes stocks from Australia, Hong Kong, New Zealand and Singapore.

BGI also has launched a number of funds on the AMEX, including funds tracking the MSCI EAFE Provisional Index, the Russell Midcap Index, the Russell Midcap Growth Index, the Russell Midcap Value Index, the Goldman Sachs Networking Index, the Goldman Sachs Semiconductor Index and the Goldman Sachs Software Index.

In Europe, the iShares family has expanded to include two new funds trading on the Euronext Amsterdam exchange. They track the FTSE Euro 100 Index and the FTSE Eurotop 100 Index.

State Street Global Advisors has not done much recently with its ETF family domestically. However, it has been expanding its line-up on the international front. Besides launching two ETFs in Australia in August, it has also launched several on the Euronext Paris exchange in recent months. The funds track the 10 different sectors of the MSCI Europe Index. MSCI and S&P use the Global Industry Classification System, or GICS, so their sector designations are the same.

Bank of New York, manager of the immensely popular QQQ, filed with the Securities and Exchange Commission to offer exchange traded funds based on its American Depositary Receipts, The Financial Times reported in July. Should the funds receive approval, they have the potential to present investors with cheaper options for investing in foreign markets. ADRs do not carry the fees associated with transactions on foreign exchanges.

MSCI

On October 9, Morgan Stanley Capital International announced changes to its indexes that took effect November 30. While some changes are due to the index provider's regular November Quarterly Index Rebalancing, they also reflect the implementation of the first phase of MSCI's enhanced methodology.

The enhanced methodology provides for the adjustment of the MSCI indexes to reflect 85% of the free-float market capitalization in each industry for each country. Currently, the MSCI indexes are mostly market-cap-weighted and represent a smaller percentage of the market. The first phase of the enhanced methodology will complete 50% of the changes using an interim foreign inclusion factor to adjust the weights of each constituent. The second and final phase is scheduled for implementation on May 31.

The current changes can be viewed on MSCI's Web site at www.msci.com.

Standard & Poor'sCommodities Index Launched

On Aug. 9, Standard & Poor's and the New York Board of Trade introduced the S&P Commodity Index (SPCI).

The index is intended as an investment and benchmarking tool and tracks 17 commodity futures contracts from the Grain, Energy, Meat, Fiber, Soft and Metal sectors. It includes only consumable commodities. Gold, for example, is excluded from the index.

While other well-known commodity indexes use arithmetic formulas, the SPCI is a geometrically calculated price index. The weights of the component commodities are based on commercial open interest and are adjusted to reflect double-counting.

The index history has been backcasted to 1988, and a separate total-return index also is calculated. The NYBOT has said that it will launch futures and options contracts based on the index in the fall.

REITs Become S&P 500 Eligible

In early October, it was announced that real estate investment trusts would be eligible for inclusion in the S&P 500, S&P MidCap 400 and S&P SmallCap 600 indexes.

The matter had been under consideration for several months, with members of the real estate industry meeting with the members of S&P's index selection committee in April. After conducting a review of the REITs industry that examined investor perceptions and tax and accounting treatment, among other topics, S&P concluded that in general, REITS behave and are treated similarly to other listed companies. Although they may receive different tax treatment, so do utilities and natural resource companies, S&P noted in a press release.

From the 1970s, REITs were excluded from the S&P U.S. indexes because they were considered passive-investment vehicles, and they had certain tax and structural qualities differentiating them from standard companies. But in June, the Internal Revenue Service reversed a 1973 decision that stated REITs did not actively conduct business. Over the years, more and more REITs have begun to manage and operate properties rather than simply invest in them. By allowing REITs into the S&P U.S. indexes, S&P is differentiating between the two types. REITs engaging in passive investment are still only eligible for inclusion in the S&P REIT Composite Index. REITs with active operations are eligible for inclusion in both the REIT index and the S&P U.S. indexes. A Salomon Smith Barney study published in the summer suggests that REITs would represent 70 basis points in the S&P 500 index. Equity Office Properties was to become the first REIT to be included in the S&P 500 on October 9. It replaced Texaco, which had been acquired by Chevron, another S&P 500 component.

SPDRs In Europe

S&P is bringing the SPDRs to Europe. The index provider has signed an agreement with Credit Lyonnaise Asset Management in which the latter will create and market ETFs trading under the SPDR brand name. The  partnership was announced at the beginning of October. Although regulatory and market approval is still pending, Credit Lyonnaise intends to launch the first products on the Euronext's NextTrack segment before the end of the year. The first two products will track the S&P Europe 350 and the S&P Euro indexes. Subsequent products will be based on sub-indexes of these two broader benchmarks.

Nothing But GICS

Also, in early October, S&P issued a formal reminder that as of January 2, it would cease to use its old classification system in the calculation of its U.S. indexes. Beginning in January 2001, S&P began calculating dual sets of its U.S. indexes using the old system and the Global Industry Classification Standard developed by Morgan Stanley Capital International.

Dow Jones DJ Sustainability Index Undergoes Review, New Indexes Launched

The Dow Jones Sustainability Index, which underwent its annual review this past summer, now has 313 companies from 62 industries in 26 countries. In the review process, 45 companies were deleted and 133 companies were added.

In addition, the Dow Jones STOXX Sustainability Indexes were introduced in Europe.

The large difference between the number of adds and deletes is due mainly to expanding the universe from which com-ponents are selected to the largest 2,500 companies in the Dow Jones World Index from 2,000 previously.

Methodology also was revised this year to introduce a buffer zone that cuts component turnover in the index. The target representation for the DJSI is 10% of the companies in each industry group; components are selected based on their corporate sustainability performance ranking. Based on this ranking, the top 7% of the eligible companies in the universe in each group, whether existing or new components, are automatically selected for inclusion. After that, existing components falling within the top 7% to 13% of the industry group are added in ranking order until the 10% representation is reached. If the desired rep-resentation has not been reached after all the existing components in the buffer zone are added, non-components are added to the index in ranking order until the 10% representation has been achieved.
More than 30 criteria covering economic, environmental and social factors are considered when analyzing eligible companies. Individual companies receive scores in areas such as corporate governance, stakeholder involvement, corporate codes of conduct, environmental policy, social reporting, strategic planning and environmental performance. The DJSI is licensed by more than 30 financial institutions in 12 countries for index-based products. Creation of the Dow Jones STOXX Sustainability Indexes for European investors was a match of the high interest in sustainability in Europe with the popular Dow Jones STOXX indexes. The new indexes track the top 20% of companies in the Dow Jones STOXX 600 Index in terms of sustainability.
The STOXX sustainability family includes broad indexes covering the European and Eurozone regions; the European index had 151 components when it was launched in October. Users also may choose from subset indexes that exclude companies generating revenue from alcohol, tobacco, gambling or weapons, or all four.

Europe In Style

Since the successful launch of its U.S.-style indexes, Dow Jones Indexes has been working to create similar indexes for other countries and regions. This July, DJI launched the Dow Jones STOXX Growth and Value indexes covering Europe and, in early November, the Dow Jones Canada Growth and Value Indexes.

DJI is in negotiations regarding a licensing agreement for the creation of ETFs based on the indexes.

DJI's style methodology includes six determining factors for classification: projected P/E, projected earnings growth, trailing P/E, trailing earnings growth, current book value and current dividend yield. DJI has said it expects to launch style indexes for each of its European countries early next year.

FTSE

FTSE International's Chinese joint venture, FTSE/Xinhua Index Ltd., added to its lineup of China indexes with the launch of five new domestic indexes on July 26. Included among the launched indexes is the FTSE/Xinhua China A 600, a broad benchmark index tracking shares that are only available to domestic investors.

In the second quarter, FTSE celebrated the launch of the FTSE/Xinhua China 25 Index on the New York Stock Exchange. The index was the first of the series to be introduced and is the only member designed strictly for international investors. It includes B, H and Red Chip shares.

FTSE has gone on to introduce the other two parts of the FTSE/Xinhua index family. The A Share series includes an all-share index, the China A 600 of large- and mid-cap shares, a large-cap index, a mid-cap index, a small-cap index and 49 sector and economic group indexes based on FTSE's classification system. China's A shares are available only to domestic investors.

China's B shares are available to international investors and domestic investors with the proper foreign exchange dealing accounts. The FTSE/Xinhua China B Share Index Series includes an all-share index and the FTSE/Xinhua China B 35, which consists of the 35 largest shares by market capitalization. The new China indexes already have gained fairly wide acceptance. The New York Stock Exchange plans to launch an exchange traded fund based on the FTSE/Xinhua China 25 eventu-ally, and in late August, FTSE/Xinhua Index announced that China Index Fund Ltd., based in London, would adopt the FTSE/Xinhua B All-Share Index as its benchmark.

FTSE and the Johannesburg Securities Exchange are continuing to work on the development of a pan-Africa index series to be launched May 2002. An independent advisory committee met August 6 and began a market consultation on the use of free float in the new indexes. On August 14, FTSE announced that it had acquired ING Barings' stake in Global-Pro, the joint venture between the two companies providing cus-tomized index services. As part of the acquisition, FTSE also will take over the emerging-markets indexes calculated by Barings as of December 31. FTSE had incorporated the Barings indexes into its own global-index series in June to provide broader coverage of world markets. Until then, FTSE had not included emerging markets in its indexes. At the end of August, FTSE launched a market consultation regarding the development of a U.K. corporate bond index. The consultation, which ended September 19, addressed such topics as liquidity screens and the types of bonds to be included. While FTSE expects to make the finalized methodology public in early 2002, it has tentatively said the index will cover fixed-rate, zero-coupon and graduated-rate bonds, as well as bonds with serial redemptions.

FTSE also is involved in negotiations between the stock exchanges of Greece, Cyprus and Israel, which are trying to create a loose coalition of Mediterranean stock exchanges. Part of that initiative would be the creation of a common index with shares from the Athens, Nicosia and Tel Aviv stock exchanges.

The first objective is the commercial exploitation of the index in Greece, Cyprus, Israel and abroad for both the equity and derivatives markets,a representative of the Athens exchange said.

Salomon Smith Barney

Salomon Smith Barney's global-index unit has long covered a broad range of countries. And now it will be adding more during its annual Emerging Markets Reconstitution.

In early August, the index provider announced that it would be adding Nigeria and Croatia to its family of emerging markets indexes. Salomon's rules provide for the coverage of any market whose index-eligible stocks have a combined available float of more than $1 billion. Salomon's indexes include stocks with a minimum available float capitalization of $100 million. Later in the quarter, Salomon also announced that it would be removing Pakistan from its emerging markets index family because the available float of the index-eligible stocks on its stock market had fallen below $750 million.

Originally, the changes were to be effective October 1, but the terrorist attacks on the World Trade Center destroyed Salomon's offices, which were located at 7 World Trade Center, near the two towers. As a result, the annual reconstitution was rescheduled for December 3.

Salomon Smith Barney, now a subsidiary of Citigroup, also indicated on November 15 that it had entered into talks with Standard & Poor's about the possibility of providing index products and services through a cooperative agreement with S&P. Salomon indicated while the talks still were in an early stage, the intellectual quality of SSB would make a nice pairing with S&P's strong index infra-structure and an agreement would serve to benefit the clients of both index providers.

Nuveen

In early October, Nuveen Investments launched a Web-based portal covering the U.S. exchange traded fund industry. The site has information on both closed-end ETFs, such as the ones provided by Nuveen, and on index-based ETFs, offered by the likes of State Street Global Advisors and Barclays Global Investors. Nuveen also has filed with the SEC to launch open-ended ETFs as well. Our goal is to help investors and their advisors better manage their portfolios by providing the most balanced and comprehensive source of ETF information anywhere, said Bill Adams, executive vice president of Nuveen Investments, in a press release.

The site covers more than 500 individual funds and features daily pricing and fund-performance data, an education center that includes FAQs and a glossary, a database of fund sponsors, a fund search engine and industry links and news. Pricing information for the site is provided by Thomson Financial/Wiesenberger. The site can be found at http:/www.etfconnect.com.

Indexfunds.com

IndexFunds.com, a Web site devoted to information about index investment, launched new Web sites for France and Germany on August 20. Both sites contain issues, research and news articles in the same format as the U.S. site, but with a focus on European indexing issues. Comprehensive global index data can be found on the sites. Indexfunds.com is also the only Web site covering ETF returns for all funds listed in Germany and France.

Jim Wiandt, the site's publisher, says that while index investing is gaining popularity with U.S. investors, international investors only now are becoming aware of its benefits.

T h e Fre n c h s i t e i s l o c a t e d a t http://fr.IndexFunds.comand the German site is located at http://de.IndexFunds.com. Individual sites have also been proposed for launch in the United Kingdom, Canada, Australia, Spain and Japan. Each IndexFunds.com site contains data, its own discussion board and articles.

AMEX

The American Stock Exchange is entering into a new era of competition. In 1993, the exchange may have saved its business with the introduction of the first exchange traded fund, the Standard & Poors Depositary Receipts, or SPDRs. It proved to be a hugely successful undertaking. ETFs have since come to represent a significant amount of the exchange's volume, accounting for anywhere from one third to nearly one half on any given trading day. But Nate Most, the AMEX executive who designed the first ETFs, has always warned that any exchange could trade such products. And to a certain extent, that did happen. The New York Stock Exchange and the Chicago Board of Trade have both launched their own ETF.

A l s o , s e v e r a l r e g i o n a l exchanges and alternate trading venues, such as Instinet, Island and Archipelago, have offered ETF trading. The AMEX, however, has typically claimed 50% to 70% of the daily market share in ETF trading. In July, Most's dire warning came true in a way the AMEX probably hoped it wouldn't. The NYSE, the world's largest stock market, announced that it had broken with tradition and granted unlisted trading privileges, or UTPs, to three of the AMEX's largest and most venerable ETFs. It is the first time that the Big Board has allowed trading on securities that it does not list. The SPDRs, the QQQs, tracking the Nasdaq 100, and the DIAMONDS, tracking the Dow Jones Industrial Average, can now be traded on the exchange. The fact that the NYSE has decided to trade the product is a compliment to our success, says Sal Sodano, chairman and chief executive of the AMEX. We have to compete, simple as that. We take it as the ultimate compliment. Before the NYSE began trading the funds, both exchanges, first the NYSE and then the AMEX, announced that they had waived their fees for those products for three months. When the dust settled on the first day of trading on July 31, both exchanges could find some vindication in the final tally: The AMEX's trading volume in the three ETFs remained well ahead of the NYSE's, but the AMEX also appeared to lose market share to its new competitor. The NYSE traded about 6.1 million shares of the Nasdaq 100 Index Tracking Stock (QQQ), or about 11% of composite volume, compared with 17.6 million shares for the AMEX, or 32%. In May and June, the AMEX's market share for the QQQs was, respectively, 48% and 45%. The Dow Industrials DIAMONDS (DIA) traded 817,100 shares at the Big Board, or 30% of com-posite volume, and 1.2 million shares at the AMEX, or 44%. The AMEX had a 70% market share in the DIAMONDS in both May and June. The NYSE traded 2.4 million shares of the Standard & Poor's Depositary Receipts (SPY), or 20% of composite volume, compared with 47% at the AMEX, or 5.6 million shares. The AMEX had a 72% market share in these securities in May and 65% in June. The NYSE declared itself pleased with the results. Everything went smoothly, said Catherine Kinney, NYSE group executive vice president. She said that the Big Board saw good, steady (ETF) volume and that it isn't looking to close the gap with the AMEX right away.

We're looking for a long, steady build in this business, Kinney said. She added that the NYSE may seek unlisted trading privileges in other ETFs and that the exchange hopes to begin trading a couple of its own ETFs early next year. Meanwhile, AMEX spokesman Bob Rendine said that the NYSE's first day of trading was likely aided by some congratulatory volume. He stressed that the data represents just one day of trading.

It's ironic that the rampant success of ETFs on the AMEX is what attracted the attention of the NYSE. But the AMEX is not giving up its prominent spot in the ETF industry just yet. It has been busily spreading its influence under the looming threat of competition from the NYSE. In the past 18 months, it has signed memorandums of understanding with the Singapore Exchange, Euronext and the Tokyo Stock Exchange providing for the cross-listing of AMEX-traded ETFs on those exchanges. AMEX-list-ed ETFs began trading on the Singapore Exchange on May 4. AMEX president, Peter Quick, has said that he expects AMEX ETFs to be listed on the Euronext exchanges in the first quarter of 2002 and on the TSE by mid-2002.

More recently, in July, shortly before the NYSE began trading AMEX ETFs on a UTP basis, the AMEX announced the creation of a new business unit devoted to the ETF market. AMEX ETF Services LLC will provide consulting and market data services relating to the ETF industry. (See Tracking Index People, p.17)

In The Rest Of The World....

Pakistan's Karachi Stock Exchange expects to launch an index in the fourth quarter that will track the companies with futures-contracts trading on the exchange. The KSE's brand-new futures-contract system was introduced in the third quarter and currently includes only 11 companies. The exchange calculates two indexes an all-share index and a 100-stock index of the most commonly traded stocks.

As expected, the Deutsche Börse announced August 7 that it was removing Porsche from its index for mid-cap stocks, the MDAX. The Börse remained firm on its stance after the luxury carmaker's continued refusal to comply with the Börse's requirement for quarterly reports, which became effective in the first quarter of 2001.

The move is widely seen as a victory for share-holders, who have been demanding greater transparency in the German capital markets. German wholesaler Spar Handels AG (G.SPH) was also removed from the MDAX for failing to produce quarterly reports.

Yieldbroker.com, an Australian-based, multi-contributor, fixed-income trading platform, has announced that it expects to become the primary source of price data for the UBS Warburg Australian Bond Indexes and the Salomon Smith Barney Australian Broad Investment Grade Index. The indexes are the dominant bond-market indexes in Australia.

Tracking Index Research  
'Why Benchmarks Still Matter,' by Gerry 'Closed-End and Index-Lined ETF Tax
Rocchi, CEO of BGI Canada. Published by Swap Strategies,' published by Morgan
Barclays Global Investors in Global Solutions, Stanley, November 1. The report discusses
October 2001. This brief article addresses cur- possible tax-swap strategies using index-
rent myths regarding benchmarks and also the linked and closed-end exchange traded
continuing relevance of benchmarks for funds. The document summarizes the differ-
investors. It closes with suggestions for ences between the two types of ETFs and
investors from BGI regarding the use of indexes explains swapping strategies using the same
for benchmarking purposes. To read this article, type of ETF (i.e., index-linked ETFs swapped
visit http://www.barclaysglobal.com/. for index-linked ETFs) and using different
'ETF Portfolio Rebalancing Strategies,' types of ETFs (i.e. closed-end ETFs swapped
published October 18 by Morgan Stanley. for index-linked ETFs or vice versa). It also
Morgan Stanley strategists suggest ways to use identifies which ETFs currently trading are
ETFs to create balanced portfolios in this report. good tax-swap candidates and provides addi-
The document identifies ETFs that provide tional data about closed-end ETFs.
broad, regional, sector or style exposure, as  
well as the investment opportunities with ETFs For more information on the Morgan Stanley
in those areas. Tax-management strategies also strategy reports, contact Paul Mazilli at
are discussed, and in-depth data is provided on [email protected] or call (212)
some ETFs. 761-7528.

Tracking Index People

Dow Jones Indexes has hired a representative to handle its business activities in Asia. James Barringer joined DJI as director of business development for the Asia-Pacific region in August and will be based in Tokyo. He has nearly 10 years experience in financial markets, as well as an extensive background in Asia.

Prior to joining DJI, Mr. Barringer was a vice president with FTSE International, based in the United States. Before that, he worked for Dow Jones Telerate until its sale to Bridge. Fluent in the Japanese language, Mr. Barringer received a bachelor's degree in Asian Studies from Cornell University in Ithaca, N.Y., and a Master of International Management, with concentrations in finance and business in Asia, from the American Graduate School of International Management (Thunderbird) in Glendale, Ariz. Mr. Barringer also was a commissioned officer for four years in the United States Navy.

Steven D. Lydenberg has joined Domini Social Investments as a principal in charge of global social-investing analysis. He will be responsible for strategic development and product support at Domini and also will continue to research and write about important social-investment issues.

Domini Social Investments manages the Domini Social Equity Fund, which tracks the Domini 400 Social Index, a socially and  environmentally screened equities index. The index itself is maintained by Kinder,  Lydenberg, Domini & Co. Mr. Lydenberg is a founder and former research director at KLD and was instrumental in the development of the Domini 400. He continues to serve as a member of the KLD board of directors and the Domini Social Index Committee.

Robert S. Tull, vice president of new product development at the American Stock Exchange, has been named to head the AMEX's new exchange-traded fund business, AMEX ETF Services LLC. Prior to joining the AMEX, Mr. Tull was a managing director with Deutsche Bank. He has been involved in the development of ETFs at both Deutsche Bank and Morgan Stanley.

AMEX ETF Services will provide advisory and turnkey services to the ETF industry, as well as market data services.

On August 3, State Street Corp. announced that Vice Chairman Nicholas A. Lopardo had retired. Mr. Lopardo also was chairman and chief executive officer of State Street Global Advisors. SSgA president Timothy B. Harbert has replaced him as chairman and CEO. Mr. Harbert is also a State Street executive vice pres-ident.
Under Mr. Lopardo's leadership, SSgA's assets under management grew from $18 billion to $727 billion. The firm's index-linked investment offerings also expanded to include the Standard & Poor's Depositary Receipts tracking a variety of S&P indexes and, more recently, the streetTRACKS ETFs.

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