MSCI Barra will soon be introducing changes to the methodology it uses to construct global equity indices for developed and emerging markets.
The MSCI global standard indices are being enhanced to extend their level of coverage to approximately 85 per cent of each market's free float-adjusted market capitalisation. The standard indices will include all large and mid capitalisation securities that meet MSCI's minimum investability and size criteria.
The MSCI global small cap indices will be broadened to cover all companies with a market capitalisation that falls outside the global standard indices.
Together, the MSCI global standard and global small cap indices form the MSCI Global Investable Market Indices, which cover approximately 99 per cent of the market capitalisation in each market. This index is segmented by region, country, size (large, mid and small cap), style and industry.
The Global Investable Market Indices methodology uses a building block approach to allow the creation of composite indices from the broader index.
Market and sector coverage
The indices will now be more clearly defined by their market capitalisation. Vanguard's head of equities, Alla Kolganova said: "Previously it was not clear which were large cap and which were mid cap indices."
"Currently, the index does not separate large and mid cap securities and the small cap index has had a completely different method of construction. This has resulted in an overlap between the standard index and the small cap index of about two per cent. The new methodology removes the current overlap between the indices, making them more complementary."
This clarification in sector composition will give fund managers greater flexibility to construct portfolios from the different market segments.
MSCI's emerging market indices will also be broadened with clear segmentation of large and mid capitalisation securities and the addition of a small cap global emerging markets index.
The new index methodology will be introduced over two stages - 30 November 2007 and 30 May 2008.
Fund managers have until 30 November to decide how they will implement the changes. A provisional index is now available for fund managers wishing to adopt the new structure.
Ms Kolganova said the changes will have minimal impact on Vanguard's funds. "The turnover to move from one index to the other is no different to the normal turnover in a year. It is not significant from a rebalancing point of view - in the standard indices it is only about four per cent and in emerging markets about eight per cent."
"We will see a slight increase in the market capitalisation and a small decrease in the number of names in the standard index as some stocks are moved to the small cap index. In emerging markets the number of names in the total index will increase."
The major impact will be on the small cap index as it moves from a purpose built index to an integrated component of the broader standard benchmark. Implementing the changes to small cap portfolios is estimated to result in turnover of around 70 per cent.
Vanguard is planning to launch an International Small Cap fund later this year, which will be constructed based on the MSCI World Enhanced Small Cap Index. Combined with Vanguard's existing international and emerging market offerings, the Vanguard International Small Companies Index Fund will efficiently provides broad market exposure to all sectors of the global equity market.
