Indexing Developments

May 01, 2006

CalPERS Goes Fundamental

The California Public Employees' Retirement System (CalPERS) will invest $1 billion in an internally managed portfolio based on the "fundamental indexing" strategy of Rob Arnott's Research Affiliates (RAFI). The move will double the amount of money tied to the innovative index family, which weights components by "fundamental" metrics-total cash dividends, free cash flow, total sales and book equity value-instead of market capitalization. RAFI claims that the indexes will outperform standard benchmarks over time by not overweighting companies with inflated market valuations.

In other news, State Street won a five-year extension on its deal to serve as custodian for CalPERS, the biggest pension fund in the world.

S&P 500 Posts Record Earnings In 2005

Standard and Poor's (S&P) says that S&P 500 Index earnings rose 14.4 percent in the fourth quarter of 2005 to a new record, pushing full-year 2005 earnings up 13.5 percent, also a new record. Results in the fourth quarter were led by Energy, which posted a 59 percent profit improvement over year-ago levels.

Q4 marked the 15th consecutive quarter of double-digit earnings growth for the index, an unmatched streak. S&P expects that streak to run one more quarter, calling for an 11.8 percent increase in earnings for Q1 2006, before Q2 earnings growth slows to a pedestrian 7.7 percent.

"After 16 consecutive quarters of double-digit gains, companies are finding it increasingly difficult to post record earnings," says Howard Silverblatt, senior index analyst at Standard & Poor's.

S&P expects the market to be led in 2006 by the Consumer Discretionary and Utilities sectors.

Sector EPS Growth Estimates, 2005 over 2004 EPS Growth Estimates, 2006 over 2005
Consumer Discretionary -5.60% 17.40%
Consumer Staples 3.90% 3.60%
Energy 45.40% 11.20%
Financials 6.10% 8.70%
Health Care 8.60% 10.60%
Industrials 23.80% 12.30%
Information Technology 19.00% 11.80%
Materials 18.60% 5.20%
Telecommunication Services 9.00% 14.00%
Utilities 8.70% 17.70%

Dividend Payout Up In 2005

Cash payouts on the S&P 500 rose 12.5 percent in 2005, while the indicated dividend payout per share jumped from $22.22 to $25.00.

Swiss Family Dividends

Dow Jones expanded its line of Select Dividend indexes with the launch of the Dow Jones SWX Select Dividend 20 Index, covering the 20 highest-yielding stocks in Switzerland. It is the seventh Select Dividend index from Dow Jones, joining U.S., Europe, Eurozone, Canadian, Spanish and Developed Markets ex-U.S. indexes. The Swiss index yields less than 2 percent.

Out Of The Closet

Harry Lange, the new manager of Fidelity's massive Magellan Fund, has wasted no time putting his stamp on one of the world's largest actively managed mutual funds. Since taking over in October, Lange has dumped nine of the fund's ten largest holdings, bumped its overseas exposure from 4 percent to 25 percent and boosted its Technology exposure to 25 percent. I guess we can't call it "the world's largest closet index fund" any more.


What's A Sub-Industry?

Standard and Poor's rolled out the S&P Select Industry Indexes tracking the 139 sub-industry segments of the Global Industry Classification System (GICS). Sub-industry is the smallest classification bucket in the GICS system.

"Industry-based analysis and investing is increasingly popular and important in today's market," says David Blitzer, managing director and chairman of the Index Committee at Standard & Poor's.

S&P intends for these benchmarks to support investable products. They're even willing to sully the purity of their indexes to do it.

Traditionally, one problem with focusing on so narrow a segment is that some sub-industries have very few companies. Most mutual funds, by law, are not allowed to hold more than 5 percent of their assets in a single security. To get around this problem, each one of these new Select Industry indexes has a minimum of 21 stocks (conveniently dipping an equal-weighted portfolio below the 5-percent mark). If the relevant sub-industry has fewer than 21 liquid stocks, "large stocks from relevant, highly correlated supplementary sub-industries are included."

Gunning For The Gulf

Both MSCI and Standard and Poor's recently launched expanded index series covering the six Gulf Cooperation Council (GCC) countries: Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates (UAE).

"This region has become very large. The markets, both economically and from a capital markets view, have exploded," says Khalid Ghayur, managing director and global head of research at MSCI.

"With corporate transparency and disclosure improving substantially in the region … GCC markets (are) attracting growing interest from regional and global investors," S&P says.

Both MSCI and S&P adjust their GCC indexes for government ownership, strategic ownership and cross holdings, which can be substantial in this region. Most oil companies, for instance, are excluded from the indexes because they are state-owned enterprises.

The largest difference between the index families is that the MSCI indexes tweak the float-adjusted holdings so that they remain in-line with the industrial-level breakdown of the domestic stock market; S&P's indexes reflect the investable market, plain and simple.

MSCI actually rolled out two complete suites of GCC indexes: One targeted at the domestic market in each country, and one that adjusts weights to take into account foreign ownership limits in the various countries (Saudi Arabia, for instance, does not allow foreign investment).

From Russia, With Indexes

S&P expanded its indexing coverage of the red-hot Russia market, inking an agreement with the Russia Trading System (RTS) to add the flagship RTS Index to the S&P family of indexes. The RTS is a broad-market index covering the bulk of the Russian market.

"Our clients have expressed a growing interest in products linked to Russian equities," says Robert Shakotko, managing director of Standard & Poor's Index Services.

Short Japan! Short Emerging Markets! Double-Short EAFE!

ProFunds loves to buck the trend. This January, the headline-grabbing mutual fund company launched a series of "short" funds offering investors a way to bet against almost all of the hottest segments of the market, including new funds offering inverse exposure to Japan (100 percent inverse exposure to the Nikkei 225), Emerging Markets (100 percent inverse exposure to the MSCI Emerging Markets Index), and Developed Markets ex-U.S. (200 percent inverse exposure to the MSCI EAFE Index).

Why is the company so bearish, you ask? They're not: For every short fund, ProFunds has a long fund that offers leveraged long exposure (typically 150 percent) to the same area.

No word yet, by the way, on ProFunds' filing with the SEC for the right to launch leveraged ETFs.

FTSE, Singapore Exchange Launch Islamic Index

FTSE, the Singapore Stock Exchange (SGX) and Yassar Research joined forces to launch Asia's first Shariah-compliant market index, the FTSE SGX Asia Shariah 100. The index is made up of 100 Shariah-compliant stocks from Japan, Singapore, Taiwan, Korea and Hong Kong, and is the first index of its kind in Asia.

Squall In A Teapot?

Quick action by FTSE has calmed an apparent squall that erupted in London over FTSE's January 2 implementation of the Industry Classification Benchmark (ICB) system. FTSE launched the new ICB system with only 12 months of historical data, and according to media reports, this lack of historical data greatly upset quantitative analysts, who called the launch "commercial suicide."

Jerry Moskowitz, managing director of FTSE Americas, says that it was a "real problem," and that FTSE was working on fixing it. Moskowitz says that FTSE's sales force does not regularly interact with the quants, which is one reason why they failed to receive numerous notices of the planned change to the ICB system. Also, he says, an extended back-history was not offered because "we thought we'd have a year to get them historical data." Rather than do the back-testing prior to the launch, and perhaps delay the launch as a result, FTSE opted to devote the 12 months post-launch to the labor-intensive task of research and number crunching.

After meeting recently with the disgruntled quants, FTSE accelerated its time frame for back-history delivery, and agreed to have five years of data available in February and ten years available by the end of March. Although some banks threatened to dump FTSE as a data provider, Moskowitz says FTSE has not lost a client in the fallout.

Mi Casa Es Su Casa

The Mexican stock exchange launched a new index (the "Indice Habita") designed to track the red-hot Mexican housing sector. Using back-tested data, the Indice Habita rose 649 percent between 2000 and 2005, compared to 215 percent for the broader Mexican market. The exchange says the index may be used for benchmarking or as the basis for investable products.

XAU Expands Abroad

With gold trading near multi-decade highs, the PHLX expanded its popular Gold and Silver Sector Index (XAU) to include four additional small- and mid-cap companies with exposure to Africa, Russia and Eastern Europe. The new names represent just over 2 percent of the full index, which is dominated by Barrick/Placer (21 percent) and Newmont Mining (21 percent).

Loads Trumps Low Cost

American Funds vaulted to the top of the mutual fund league table in 2005, according to the Investment Company Institute, ending the year with $847 billion in stock and bond assets under management. That's up 22 percent from last year, moving the company from third to first in net assets. Vanguard was second with $795 billion, followed by Fidelity with $794 billion. American Funds scored a double-whammy over Vanguard, as its Growth Fund of America eclipsed the Vanguard 500 Index Fund as the largest mutual fund in the world.

Vanguard's Advisor Ranks Swell

Vanguard has tripled the size of its own financial advisor group in the past two years, according to Financial News, and now employs 220 advisors. Vanguard says that investors are asking for more hand-holding, and that it is simply providing the service. But a few details about the program are making people nervous. For one, Vanguard charges 70 basis points per year for the service: less than most advisors, but still a big chunk for a cost-sensitive investor. Also, Vanguard's advisors will limit themselves to recommending only Vanguard products, which doesn't necessarily seem in the best interests of clients.

Vanguard's New Active Fund

Vanguard filed papers with the SEC for the right to launch a new actively managed small-cap fund. Vanguard's in-house Quantitative Equities Group, or QEG, will run the new Vanguard Strategic Small-Cap Equity Fund, using computer-driven analysis to select the most attractive stocks from the MSCI Small-Cap 1750 Index. QEG will look for companies with reasonable valuations and good growth prospects; in other words, it will follow a computer-driven GARP (Growth At a Reasonable Price) strategy.

The move further aligns Vanguard with the growing cadre of fund managers using quantitative approaches to improve on existing index returns. This is the second fund that QEG will be managing entirely on its own; the group co-manages an additional five Vanguard funds.

Domini 400 Adds Screens

KLD Research and Analytics added new screens to the Domini 400 Index, the dominant socially responsible index, which will test for political accountability, transparency, accounting controversies and tax disputes.

"The behavior of companies such as Enron and Worldcom and lobbyists such as Jack Abramoff have demonstrated the immense power of corporate money and its role in American politics," says Peter D. Kinder, president of KLD Research & Analytics, Inc. "KLD's new corporate governance and community screens will bring greater transparency and accountability to an area that has long been murky for investors and money managers."

Cowboy Up

There are indexes tracking the broad markets, indexes tracking different countries, and indexes tracking different sectors. But an index tracking Dallas?

That's the word from Texas, where the Greater Dallas Chamber has teamed up with Nasdaq to create an index tracking the technology sector of the greater Dallas area.

"We expect the index to bring more visibility to Nasdaq's high technology and life science issuers in the Dallas/Fort Worth area," says Nasdaq executive vice president John Jacobs. "We believe the increased interest created by the index will result in greater liquidity and fairer valuations."

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