What should investors look for when going global? Consider these “travel tips” when evaluating international benchmarks.
Completeness: Does the index accurately reflect the overall investment opportunity, in terms of both country and company coverage? If not, it’s more difficult to assess the risk-adjusted performance of managers who wander beyond their target benchmark into other asset classes. Also, the invested portfolio may not accurately reflect the intended asset allocation policy.
Investability: Does the index include only those securities that can be purchased by foreign institutional investors? If not, it can be difficult to distinguish between tracking error caused by poor portfolio management techniques and that caused by simply choosing an uninvestable benchmark.
Clear, published rules and governance structure: How transparent and publicly available are the rules that govern the various indices? Clear rules provide predictability to both the investment manager and the plan sponsor and make it easier to anticipate how changing market conditions will be reflected in the benchmark.
Accurate and complete data: For an index to be useful, return data must be accurate, complete and readily available. Also, because performance analysis is one of the main motivations for using indices as a benchmark, extensive historical data must be available.
Acceptance by investors: An index that is well known and widely used gives an investor comfort in the integrity of the index and the ability to make peer group comparisons.
Availability of crossing opportunities and derivatives/tradable products: Indices that are widely used, especially within pooled investment vehicles, offer potential cost savings because they provide crossing opportunities among large institutional investors. In addition, the availability of listed derivative products and exchange-traded funds can further benefit asset owners and managers.
Turnover and transaction costs: In general, the lower the turnover, the lower the rebalancing costs. A broader benchmark favours lower turnover, while an index that works within a narrowly defined market has greater turnover and transaction-related costs.
These seven key areas of assessment may be the most important factors in determining which international benchmark to use, but they are certainly not the only factors to consider. Other possible factors could include closing price convention, foreign exchange treatment and timing.
To further complicate the decision-making process, no single benchmark can meet all of the above criteria because several of the criteria are mutually exclusive. The most effective strategy is to establish your preferences relative to the different factors, then select the benchmark that best meets those preferences. Consider these four key trade-offs: completeness versus investability; frequency of rebalancing versus costs of turnover; adjustment for float versus transaction costs; and objective and transparent rules versus flexible judgment-based methodology.
Where to travel
While there are an increasing number of high-quality international benchmarks, the Morgan Stanley Capital International(MSCI) benchmarks enjoy a significant “first mover” advantage and continue to be the international indices of choice in North America. In Europe, FTSE Group’s homegrown appeal makes its indices the most popular choice, although MSCI is also very prominent.
The recent trend in Canada has been away from separate U.S. and EAFE(Europe, Australasia and Far East)benchmarks toward global(U.S. plus EAFE)and allcountry indices, including both developed and emerging markets(EMs). Per MSCI, EMs now make up approximately 8% of the global market capitalization, so it’s no surprise that investors are refocusing on this market segment.
South of the border, the MSCI All- Country World Index ex-U.S. benchmark is becoming many investors’ benchmark of choice, particularly for foundations and endowments. This trend has positive implications on the expected international fund inflows to Canada, since contrary to the EAFE benchmarks, our domestic market has representation in all-country indices.
Markets are becoming increasingly global in nature, and staying within your own country’s borders can limit the diversity of your portfolio. Finding the right international benchmark requires careful consideration, but with a little research, travelling abroad to expand your investment portfolio may be well worth the trip.
Sarah Butcher is a client relationship officer with Barclays Global Investors in Toronto. sarah.butcher@barclaysglobal.com
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