With the bull market still raging, the American craze for indexation/tracker funds has really taken hold in Europe. The impending introduction of the euro, bringing with it a shift from a country-by-country to a more sectoral approach, has lent a particular pan-European flavor to the index revolution.
In 1997, the Amsterdam Exchanges and FTSE International launched the Eurotop indices to replace the former Eurotrack benchmarks. Then, in January this year, the Euro.NM network unveiled an official all-share index, covering the Paris, Frankfurt, Amsterdam and Brussels markets as well as a sub-index for each individual market. To top that, FTSE International, Goldman Sachs and Standard & Poor’s recently launched an index for the European region, calculated in make-believe euros until the currency is introduced next January, with associated indices covering countries outside the euro-block.
Stoxx is another recent contender in the battle to control the pan-European stock-index scene. A collaboration between the German, Swiss and French exchanges, and media giant Dow Jones, it introduced its 42 Europe-wide and euro-zone indices in February. According to Peter Reitz, chairman of Stoxx’s supervisory board, the indices’ evolution has been organic.
‘At the Frankfurt bourse, we were beginning to feel that the existing country indices did not fulfil the needs of the market. The pending introduction of the euro meant that the financial community was increasingly considering Europe as one market and so needed pan-European indices,’ explains Reitz, whose other role is head of product development at the Frankfurt bourse. ‘Very similar discussions were going on in Paris so, rather than develop two separate families of European indices at each exchange, we thought it was better to pool resources. We were already working with the Swiss over derivatives trading so then all we needed was to negotiate with Dow Jones,’ Reitz adds.
Lean operation
Despite all the grand talk and pan-European gesturing, Stoxx remains a small operation. Currently, it only has one permanent staff member – Michael Schanz – who as managing director deals exclusively with marketing the indices. All the rest of the work is divided up between the four partners’ operations.
‘We’re a very lean company,’ Reitz says. The supervisory board, which is made up of a representative from each Stoxx partner, meets quarterly and, for the moment at least, has teleconferences about every two weeks. On top of that there are working groups dealing with specific issues like legal questions and marketing. ‘It’s like doing two full-time jobs,’ says Reitz.
The Stoxx partners’ original idea was to model the indices on existing products but in the development stage they discovered that different kinds of investors were looking for completely different things. While a portfolio manager with a broad international view might want a broad-based index, a derivatives trader would more likely be looking for a small, select listing of the largest, most liquid stocks. The solution? To offer something for everyone. ‘When we started we never thought we’d end up with 42 indices,’ Reitz chuckles.
Of those 42, 40 are general pan-European indices – Dow Jones Stoxx and Dow Jones Euro Stoxx – both covering about 80 percent of the market capitalization of the countries involved. The former covers Europe as a whole and includes 664 companies, while the latter covers the Euro-zone, including 326 companies. The remaining two indices – Dow Jones Stoxx 50 and Dow Jones Euro Stoxx 50 – are each composed of 50 blue chip stocks, selected on the basis of market capitalization, liquidity and sector, covering the whole of Europe and countries in the euro-zone respectively.
According to Reitz, reaction so far has been positive. ‘We’ve had a huge response from the media as well as from the banks and institutions. A lot of fund managers have already changed to our benchmarking system or are in the process of doing so,’ he claims.
Stoxx has a list of 22 licensees so far and Reitz says he expects many more investors to switch over to the new indices in the coming months. ‘Our methodology makes sense to the investment community. They like the fact we diversify, taking into account industry stratification,’ says Reitz. He adds that the combination of the Dow Jones Stoxx and the Dow Jones Stoxx 50 offers unique benefits to investors. ‘We designed it in such a way as to make sure there is a high correlation between the broad and blue chip indices – there’s a 98 percent correlation – which has ended any doubts about the type of market coverage that can be provided by an index with just 50 stocks in it,’ argues Reitz.
Difficult questions
Still, despite Reitz’s positive spin, a number of difficult questions have been raised about Stoxx’s methodology. Serious doubts linger over the the viability of such a small index as the Stoxx 50, and many – in the corporate community, at least – have criticized the Stoxx methodology. Is this just sour grapes at being left out of the Stoxx family or are there real concerns?
The main problems have centered around the Stoxx selection process. Stoxx only takes the largest and most liquid stocks, accounting for 40 percent of the market capitalization of 19 individual sectors in all 16 countries. The companies are then ranked by market value and the top 50 are included in the indices. That means that a company like Swiss pharmaceuticals giant Roche is excluded from the list, by virtue of being the second-largest stock in its sector (Swiss pharmaceuticals rival Novartis is larger). Yet Roche is continental Europe’s third largest company.
Understandably, Roche and other companies in similar positions are furious, accusing Stoxx of taking a political approach by treating each country equally when economically they’re obviously not the same. Reitz brushes off the criticism, stressing that there is nothing remotely political about the approach. ‘We have a methodology and we follow it precisely,’ he says.
Alternate audience
Of course, at the end of the day it is the investors, rather than the corporates, whose views really count – despite Stoxx’s protestations to the contrary. After all, it is the investing institutions who will have to be persuaded to switch their benchmarks. And with the substantial portfolio turnover and expense involved in changing systems, that may prove to be a tall order. Reitz appears confident, though, identifying three main advantages that Stoxx has to offer: transparency, reputation and compatibility.
‘In terms of transparency, we provide all sorts of data for investors free. We also publish a rule book so everyone will be able to predict what is going to happen, when composition is going to change and so on,’ explains Reitz. ‘Stoxx has the advantage of having the three leading continental European exchanges behind the concept, as well as Dow Jones. That gives it a lot of weight,’ he adds.
In terms of compatability, Reitz argues that the Stoxx indices have a very close correlation with other pan-European indices like MSCI’s and with the Dow Jones worldwide indices. ‘Investors like the fact that the indices fit in with the Dow Jones global indices so they’re part of a worldwide family as well as a pan-European one,’ he says.
Working well
Reitz dismisses any technical hurdles the company has come up against as insignificant. ‘Overall things have gone pretty well. The calculation of the indices is done in the US by Dow Jones and the datafeed is then distributed to the three exchanges. The system works fine,’ he says. ‘We designed the whole thing and set it up under extreme time pressure. We wanted to be out in the market as early as possible and we’ve managed that.’
In terms of the future, Reitz believes that Stoxx has plenty to look forward to. On June 22, it will launch the first of its trading products: four futures and options to be traded on the Dow Jones Stoxx Euro 50 and on Stoxx 50. Reitz says these are the first of many yet to come. ‘When those derivatives have proved their success there will be more launched. Discussions have already begun,’ he says.
The introduction of the euro should also give a boost to the indices, with the expected increase in trading that will accompany it. Reitz is not convinced, however, that there will be any dramatic changes immediately. ‘With everything denominated in a single currency, we may see a bit more transparency, but the market has already started shifting toward a pan-European approach. That’s a gradual process. It’s certainly not something that happens dramatically overnight.’
