SPECIAL REPORT: SHARE INDICES


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themes, as well as products focused on specific sectors, such as finance. But if the sub-set of stocks in a thematic


index is narrow or fails to provide enough liquidity in comparison with the popularity of the strategy, this can cause problems. In April 2021, two BlackRock ETFs


were forced to sell billions of dollars worth of holdings as the S&P-run index they tracked became too popular. Between them, the US-domiciled


iShares Global Clean Energy ETF and the European-based UCITS (Undertakings for Collective Investment in Transferable Securities) equivalent had amassed nearly US$11bn between them, compared with just US$760m in January 2020, as investors increasingly sought investments they perceived to be climate-friendly. But the S&P Global Clean Energy


index that the pair of ETFs followed only consisted of 30 stocks, a decent proportion of which were small caps. In a bid to take action, S&P expanded


the index to a ‘target constituent count of 100’, but this incident led to some very large, forced sales and very large, forced buys being publicised before they took place. For example, New Zealand-based Meridian Energy previously made up 4.23% of the underlying index, but now only makes up 0.31%.


// INDEX CONSTRUCTION IS OFTEN OPAQUE//


It is highly likely that arbitragers took


advantage of the gap between the announcement of a rebalancing in March 2021 and its execution on 19 April, according to Mark Northway. This means they could have sold their exposure to these stocks before the BlackRock ETFs did – meaning the ETFs are potentially selling them at a lower price – and then the arbitragers could have bought the relevant stocks before the rebalancing took effect – which potentially means the ETFs would be buying the stocks at a higher price.


TOO POWERFUL? Index providers have the ultimate say on index rules, which essentially dictate which companies or countries feature in an index. However, index providers should abide


by full transparency in regard to their existing rules and any (proposed) rule changes, while also consulting broadly with


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internal and external advisers, as well as the wider financial community. As Steve Kowal states, index providers


want their products to be useful for clients. If clients can’t use an index, they will turn to other major providers in a competitive market. There are still differences of opinion,


though, between index providers in regard to the inclusion of some securities. South Korea presents a conundrum for


index providers, many of whom list the economy in emerging market indices, despite it being listed as developed by the United Nations Conference on Trade and Development. A stumbling block to the country’s inclusion in developed market indices, which is out of index providers’ control, has been the absence of an offshore currency market for the South Korean won. Daniel Broby suggests if every index


provider simultaneously upgraded the Asian nation to developed market status, it would be the “biggest portfolio trade the world has ever seen”. This would be because every passive


emerging market fund would need to relinquish exposure to South Korea, and every passive developed market fund would need to buy up exposure to the country. The nation is lobbying the likes of


MSCI to be included in its developed market index. In MSCI’s June 2022 review, the country remains in the emerging market index, but it is included in some developed indices. This means that if investors track


emerging and developed market indices with different tracker funds or ETFs, they may want to check they are not doubly exposed to South Korea. Another notable example of index


providers having an element of control over when investors can access a market is the inclusion of China A shares in emerging market indices. In 2017 MSCI agreed an inclusion ratio of 5% of large-cap China A shares (since upgraded to 20% and including mid-cap shares), while FTSE Russell only completed its first phase of China A shares inclusion in mid-2020, weighting the exposure at 6%. Although the Chinese authorities


arguably had the most dominant role in how quickly A shares were internationally available via its methodical regulations, the index providers could have more quickly enabled access to some A shares in their broad market indices.


THE REVIEW MARCH 2023


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