Mon, May 27, 2002 - Page 17 News List

Balance of power to shift among stock indexes


Next weekend, without a single share being bought or sold, the value of many stock markets around the world will rise or fall in relation to one another.

Morgan Stanley Capital International is recalibrating the many stock indexes it compiles to reflect the so-called free float: the amount of the component companies' shares that are freely available for trading. It is excluding shares held by government bodies, foundations or others that are not expected to put up their stock for sale.

"What free float does is exclude from market capitalization holdings that are not available to purchase, such as strategic or family holdings," said Baer Pettit, the executive director of MSCI. "Free float represents the real opportunity set -- what is actually available for investors to purchase."

The plan to switch to a free-float system was announced last May and some changes were made in November. The shift will be completed after the markets close on Friday.

The rebalancing will leave the most open markets, including those of the US, Britain, Australia and Ireland, with larger portions of global indexes. Markets with traditions of state control of large enterprises, including Japan, Germany, France and other European countries, will end up with smaller weightings. So will many emerging-market nations.

The composition of stock indexes is important to many investors because fund managers use the indexes to guide them in building their portfolios. Hundreds of billions of dollars are held in funds that track indexes, and many other funds use indexes as benchmarks for judging returns.

When indexes are rebalanced, managers of index funds must adjust their portfolios accordingly. Managers of funds that use the indexes only as benchmarks do not have to make adjustments, but by maintaining a holding when its index weighting has changed, a manager is making an implicit judgment on the value of that company.

"If there's a stock that's 0.8 percent of an index and you have 1.1 percent, then if the index weight goes down to 0.6 percent, your bet's going to increase without you doing anything," said Brian O'Neill, a manager of global growth funds at Gartmore Investment Management, a British subsidiary of Nationwide Mutual Insurance, based in suburban Philadelphia.

"The really important thing about these index changes is they put fund managers on alert that something is happening," he said. "It's a good excuse for them to consider their positions in these stocks."

In certain cases, he said, the rebalancings give investors an excuse to dump stocks that they have held only because of their large index weightings. Conspicuous examples are partially privatized European corporate giants like France Telecom and Deutsche Telekom, which are still largely in state hands.

"Their weightings are going to fall, but they're dud stocks anyway," O'Neill said. "If you don't like a stock in your portfolio, it provides another reason to do something about it."

FTSE International, did its rebalancing in a single move last June. Peter Wall, FTSE's senior vice president for business development, said the changes had produced no significant moves in prices because its indexes were originally designed to include companies with the most freely traded stocks.

"It's a misconception that rebalancings move share prices," he said, "but they can impact marketplaces and long-term demand."

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