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Journal of Indexes
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2007
2007
Hedge Fund Replication
July / August 2007
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Page 1 of 2
 Henry Fernandez is president and chief executive officer of MSCI Barra, by far the largest player in the international equity indexing market. The company is in the process of completing a major revamp of its core (Standard) international index series. As part of the revamp, the company has launched, for the first time, a complete lineup of international small-cap indexes. The move came at a time when more and more investors are looking at small-cap international equities, and more and more index providers are entering the international benchmarking space. Fernandez spoke with Journal of Indexes senior editor Matt Hougan about the index revamp at MSCI Barra and about where the indexing industry is heading next. Journal of Indexes (JoI): Under the new MSCI indexing system, the "Standard" international indexes only include large caps and mid caps; small caps are now captured in a separate index series. Why did you decide to separate the two? Henry Fernandez (Fernandez): Our international equity indexes are predicated on major trends in the investment world. We don't want to be leading the investment world, and we don't want to be lagging it. It is our job to measure the performance of different assets, not to lead investors into this or that section of the market. Today, with the growing synchronization of global markets, global investment managers get less diversification from international large caps than they did in the past. Going into small caps gets you added diversification, but not all investors are ready to do that. The enhanced index series includes large-cap, mid-cap and small-cap indexes, so you can choose any combination you need. It's about responding to client demand, and providing new tools to investors. JoI: So you are saying that most global investors are not looking at international small caps right now? Fernandez: They are starting to. But the majority of investors are not yet going to the full depth of the market. A significant and meaningful minority are, and they are looking all the way to small-cap emerging market stocks. But not all investors... If we had taken the Standard version of our EAFE (Europe, Australasia and Far East) index and said that it had to include large-, mid- and small-caps, we would be forcing people to invest in a tier of the market that they may not be ready to invest in, or that they may not want to invest in today. You also have a lot of investors who approach small cap international and large cap international differently. It's the same thing as dividing the world into developed and emerging markets. The mandates can be separated, and investors can have different asset allocations and measure different types of performance. JoI: It seems like everybody in the index industry is moving into alternative assets. Why do you think that is? Fernandez: For sure, the world is turning more and more multi-asset class. And there are a lot of reasons for that. For one, there is now a significant continuum of instruments that you can buy. In the past, most bond managers around the world would just buy sovereign bonds. And most equity managers would only buy blue chip equities. We now have a continuum of products. In fixed income, we've moved from sovereign bonds to emerging market bonds to high yield bonds to CDS's [credit derivative securities]. In equities, we have a continuum from large-cap equities in developed markets to emerging markets equities to small-caps, small-cap value, etc. In such a world, the traditional silos of bonds and equities no longer work. Today, you have a corporate capital structure that starts from equities and moves to convertible bonds, bonds, notes and more ... all of which are being traded around the world. And there is a relationship of prices along that spectrum. So, the traditional divisions of "I'm an equity investor" or "I'm a fixed-income investor" are no longer relevant. Maybe the best way to gain exposure to a company is by buying the CDS. Or maybe it is by buying the equity. Or the bonds. There are different ways to gain exposure that are more effective than before. Operating in this world, you need new tools to measure performance, and new tools to measure risk. You need multi-asset class tools and innovative indexes. JoI: One big topic in the indexing space has been fundamentally weighted indexes. What do you think about these products? Are they gaining traction in the institutional marketplace? Fernandez: We were probably the first index firm in the world that provided a fundamentally weighted index, back in the 1980s, with our international GDP-weighted indexes. That decision was driven by client demand: Clients were asking if a market-cap approach was the right approach given the bubble that was happening in Japan. I think the question we have asked ourselves about fundamentally weighted indexes is this: How much of the demand for a particular index is the opportunity set of the world, and how much is the beta of a particular investment thesis in a sector of the world? Those are two very different things. |
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