MSCI Revamps Indexes

April 04, 2007

MSCI revamps global indexes, rolls out complete series of small-cap bogies, as the international index market heats up.

MSCI unveiled the much anticipated expansion of its global index series this week, moving aggressively into the international small-cap indexing market and rolling out over 20,000 style, sector and regional funds worldwide. As part of the revamp, MSCI will expand global coverage from around 85 percent of total global market cap to over 99 percent. This is the second "capitalization extension" for MSCI this decade, following a jump from 60 percent to 85 percent coverage during the 2001/2002 improvements.

MSCI will now have three main index lines globally:

    • The Standard indexes will cover the large- and mid-cap segments of each market, targeting 85 percent of the free-float adjusted market cap. The size cut-off will float somewhat across countries and regions.
    • The Small Cap indexes will "exhaustively cover" the investable small cap market worldwide. This includes both developed and emerging markets, with a global minimum size requirement.
    • The Investable Market will combine the "Standard" and "Small Cap" indexes.

Previously, MSCI's international indexes included full large- and mid-cap coverage, plus a smattering of small-caps. Now, the Standard series will drop small cap exposure entirely, with the new Small Cap series providing complete coverage of that space.

MSCI will also roll out size, style and industry indexes across the global investable universe; every country and region will have its own growth and value index, along with a complete line-up of sector and industry benchmarks.

There will be no overlaps or gaps between any of the size, style, or industry indexes.  

Small Caps Hot

It is not surprising to see MSCI move into the small cap arena. Companies like Russell, Dow Jones and FTSE have been moving aggressively into the international indexing business recently, largely by tapping into the untouched small cap market. 

Ken O'Keeffe, executive director for MSCI, explained MSCI's decision to enter the market this way, "[T]here are now international small-cap and all-cap managers, whereas ten years ago, most international portfolios were only large-and mid-cap, with an emphasis on large … We are intentionally not leading-edge or lagging-edge. We reflect what the international markets and international investors are doing."

Either way, the small-cap indexes are likely to be popular, spurring (we'd guess) a suite of new products from a variety of firms.

"We're finding that large-caps have an increased correlation across markets," said O'Keeffe, explaining the growing interest in small-caps.  "[T]o get the same diversification benefit [you used to get from large-cap international], investors are now moving down the capitalization spectrum."

O'Keeffe said that MSCI's new small-cap indexes are just as robust as the large-cap indexes, with one exception: for the style indexes, MSCI does not use forward earnings estimates on small-caps, due to a lack of analyst coverage in some markets. Forward-earnings estimates are one of seven criteria in MSCI's style indexing methodology.

What Will Funds Do?

It's not clear yet what funds tracking the MSCI indexes will do. Under the MSCI system, the current indexes will translate into the "Standard" index series; the MSCI EAFE Index, for instance, will drop its small-cap exposure and focus fully on large- and mid-cap names. Most funds will likely follow that switch, while others will embrace the broader "international" indexes. Either way, the transition will take place over the next year in a two-stage process, with half the capitalization moving November 30, 2007, and half moving May 30, 2008. 

MSCI says that its improvements were not driven by a need to compete with the new indexers rushing into the international markets - the Russells, Dow Jones, and other groups, all of which have announced global index launches recently. O'Keefe noted that MSCI has been working with clients for more than two years to organize these improvements, while Russell et al. only rolled out their indexes recently. Ultimately, it doesn't matter: the broader point is that international indexes are getting better, with deeper coverage, increased competition and better data. With more investors moving into the space, that's probably a good thing.

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