Following last year’s LIBOR scandal and increased regulatory scrutiny of index-tracking ETFs, the traditionally staid business of benchmarking is suddenly in the limelight. IndexUniverse.eu editor Paul Amery asked Baer Pettit, head of the index unit at MSCI, to respond to allegations that benchmark firms have been insufficiently open about the indices they provide.
IndexUniverse.eu: Baer, Edhec-Risk has recently called for regulators to insist on the full transparency of market indices and benchmarks to allow the users of index-based investment products to assess the risks they incur. What’s your response?
Pettit: Across the whole range of equity indices from a swathe of providers, I’m not conscious of any party in the investment process that is suffering from a purported lack of transparency.
And we live in a competitive world, where different providers have different business models. Compare open-source software with software for which you pay a subscription fee. That gives users more choice, which in my opinion is a good thing
IndexUniverse.eu: Isn’t transparency more important, though, now the index business is moving towards more complicated benchmarks? Most people can understand what an index of the largest 100 UK stocks is, for example, but if you’re talking about an index embedding an investment strategy, isn’t it important to be able to see what’s going on and to be able to “kick the tyres”?
Pettit: We make the methodology behind our indices and the research underlying the methodology freely available to everyone.
Depending upon the regulatory environment, an individual investor in an index-tracking fund is also able to see, with some lag, all the holdings of the fund.
Any tracking difference between the portfolio and the benchmark is also clear to the investor.
And let’s remember that most European funds are still actively managed. An individual investor in one of those funds won’t be able to see its holdings on an up-to-date basis.
By comparison, with an index fund you’ll have access to the methodology, a clear understanding of the reasons for any tracking difference between the index and the fund, and the ability to see that you’re following a rules-based investment strategy.
IndexUniverse.eu: Isn’t it important, though, for an investor to be given to be given access to full historical holdings and weightings of an index? Otherwise they won’t be able to tell if the purported performance of an index, especially one that’s sold on the basis of a back-test, is based on realistic assumptions.
Pettit: It is important that people are scrupulous about the track records they present for the performance of an index. We are very careful to distinguish between the actual, “live” index history and any theoretical history, based on a back-test.
And we do not sell indices on the basis of their performance records. We make it very clear to anyone interested in our strategy indices that certain tilts exist, for example to small-cap or value stocks.
If you’re an investor, you should make sure that the index firm you’re dealing with is highly professional, builds its own risk models and can explain to you the exposures of the index you’re considering.
But putting all index data into the public domain, for example via a website, is self-evidently insufficient for anyone to make proper use of it.
You need all the associated services—the research, the corporate actions information, and so on—to make sense of the data. Edhec, for example, will be charging for access to all this information because it is a not insignificant cost to them.
We welcome a diversity of business models when it comes to index provision. But I’d go back to what I said earlier: as far as I’m aware, no one is currently being damaged by current practice in the equity index business. I can say that unequivocally for the clients of our firm.