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2013, Study Session # 12, Reading # 29

INTERNATIONAL EQUITY BENCHMARKS

INTRODUCTION
International benchmarks differ from U.S equity benchmarks as:
Float adjustment is more important for international stocks.
International equity markets are divided into developed & emerging
categories (category has consequences for the benchmarks & countries).
Local currency & investor currency versions of benchmark.
Categorization (b/w emerging & developed category) is a complex matter.
1. EARLY DEVELOPMENT OF INDEXES
Early indexes were complied by news papers, were price-only & not cap
weighted.
MSCI followed the basic principles of good index construction (cap weighted,
publication of constituents etc.) but capture only 60% of market cap of the
countries & sectors it covered.
Investors should invest internationally for many reasons (diversification,
different industrial mix etc).


2. NEED FOR FLOAT ADJUSTMENT
Cross holdings (cause double counting) & closely held ownership requires free
float adjustment.
Now float adjusted indexes are popular & constructed by the entire
international index providers.


3. INTERNATIONAL EQUITY INDEXES COMPARED
Major providers of international equity indexes
include MSCI, FTSE, citigroup, S&P & Dow jones &
company.
Trade-Offs in Constructing International Indexes
Breadth V/S Investability Liquidity & crossing Opportunities Versus Index Reconstitution Effects
Breadth coverage of the index.
Investability readily buying & selling of stocks with minimum
price pressure & transaction costs.
Take extra measure of choosing an index that errs on the side of
greater liquidity & less breadth.
Popular & most widely used indexes have greater index-level
liquidity.
More liquid indexes have greater crossing opportunities (matching
buying & selling orders without using brokers i.e. no transaction
cost).
Program trades on liquid benchmarks involve low bid-ask spread
from broker.
Popular indexes may suffer from reconstitution (inclusion &
deletion) effect.
() price pressure when stocks choosen for inclusion
(deletion).
Detrimental to performance (no negative alpha as
reconstitution effects both the benchmark & investors
portfolio).
1

Copyright FinQuiz.com. All rights reserved.
2013, Study Session # 12, Reading # 29




Trade-Offs in Constructing International Indexes
Precise Float Adjustment V/S Transaction Costs from Rebalancing Objectivity and Transparency V/S Judgment
Frequent float adjustments.
transaction costs.
Float Band Precise Float Adjustments
Free float bands are categories
e.g. 75-100 percent.
Less transaction costs (only
when outside the float band).
Benchmark constituents are
easy to predict.
More effective trading.
Easier to understand.
Use as proxies for asset classes
in asset allocation.
Judgment Based Index Construction Rule Based Index Construction
May be difficult to defend.
The advantages of this method
(e.g. liquidity) may overcome
disadvantage of this method.

4. CLASSIFICATION OF COUNTRIES AS DEVELOPED OR EMERGING
Leading developed market index providers are also leading
providers of EM benchmarks.
Boundary between Developed and Emerging Markets
A countrys category (developed or emerging) has consequences for
benchmark & county itself.
When a country has large market cap in EM index, it is a huge player in a
small market.
For any country, being in a developed index is highly desirable as more capital
is committed to developed rather to EM & as new source of capital becomes
available to that countrys companies.
Acceptance of Integrated Indexes
Today, the developed-emerging distinction seems less important because the
largest companies in the EM are traded on NYSE (meet transparency &
liquidity standards).
Integrated mandates (a single manager to invest in all non-U.S. markets) are
growing rapidly as a result of the transparency & liquidity.

5. IMPACT OF BENCHMARKING ON INTERNATIONAL MARKETS
Examples
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