Inside Business
September 15, 2013 2:53 pm
When market movers are the index makers
Investors have outsourced much power to the index providers
Who has the power to move markets? Often some unlikely candidates.
As everyone learnt during the global financial crisis, rating agencies had been given too much power. This was the side-effect of regulations that placed limits on the bonds that banks or fund managers could hold, based on their ratings. The result was to outsource due diligence to the agencies. This put far more weight on the opinion of one or two analysts than they were ever designed to bear.
Another division of Standard & Poor’s also has far more power than was intended. Those who draw up stock indexes, in a world ever more driven by passive investment, have immense power. The world’s most powerful stockpicker, in effect, is the governing body of the S&P500 index, as some $2.14tn is tied to it.
As with the reforms that overwhelmed the rating agencies, the moves that gave the indexers such power made sense individually. But judging by the way markets moved last week when several of the world’s best-known indices made slight changes, traders do not understand how the indices work.
The most widely covered move last week involved the Dow Jones Industrial Average, still easily the world’s best-known stock index. On Tuesday, its governing committee announced it would remove Hewlett-Packard, Bank of America and Alcoa in favour of Visa, Goldman Sachs, and Nike, prompting a flurry of commentary about the changing face of corporate America, as well as a move to buy the new entrants. Goldman far outperformed BofA that morning, while both Visa and Nike enjoyed gains well ahead of the market.
Rather, the decision was made because the Dow is weighted by share price, rather than market value, and the three exiting stocks had low share prices, giving them minimal impact on the overall index. The same problem affected the entrants. Apple, the obvious replacement for H-P, would have distorted the index, as its $500 share price would have swamped all others.
Thus this was an exercise in remedying the Dow’s technical inadequacies. Anyone serious about tracking markets would recognise those technical inadequacies as insuperable and ignore the Dow.
On Wednesday, it was the turn of the FTSE 100, covering the hundred biggest London-quoted stocks.
Unlike the Dow, the FTSE announces its quarterly timetable in advance. It was plain to anyone paying attention that ENRC, Serco and Wood Group would leave, while Sports Direct, Mondi and Hellenic Coca-Cola would join.
And like the Dow, the FTSE 100 must be treated with care. As shown by the replacement of a Kazakh miner with a Greek Coca-Cola bottler, the index is a strange amalgam, bearing little relation to the UK economy. Its weighting in technology companies is just under 1 per cent (Arm Holdings and Sage), while more than a quarter is devoted to energy and resources plays. Few should want to base any investment decision on it – unless they are determined only ever to invest in sterling, avoiding any foreign exchange risk, and only to buy very large stocks.
AMD’s share price currently languishes where it did in 1981. It was the smallest stock in the S&P. Meanwhile, Vertex and Ametek were the largest stocks in the S&P MidCap 400, so their inclusion was logical. They still gained 2.7 and 5.7 per cent respectively at Thursday’s opening.
S&P’s methodology is clearer than that of most peers, and it retains discretion over its exact membership, making it harder for traders to “front-run” changes. Its members are not the 500 biggest US stocks, but are adjusted to mirror the sectoral balance of the market as a whole.
But this discretion creates controversy. Google joined years after many thought it should. And Facebook, a far larger company than Vertex or Ametek, is still excluded because it has yet to make a profit for four quarters in a row.
Copyright The Financial Times Limited 2013.
0 comments:
Publicar un comentario