CURRENCY IMPACT ON GLOBAL INDEX PERFORMANCE
Global equity index returns are affected not only by security price changes and dividends in the local currency but also by foreign exchange market fluctuations and the resulting impact on the investor currency.
In 2014, the U.S. Dollar gained strength against most world currencies on signs of an improving U.S. economy and expectations for higher interest rates. This translated into mostly lower global equity returns for U.S. investors.
Two currencies – the Japanese yen and the Russian ruble – saw rather dramatic moves in 2014, both on the downside. The Japanese yen lost 12% versus the U.S. dollar while remaining nearly unchanged, down just 0.44%, against the euro. The currency depreciation significantly affected index returns for international investors. While Japanese equities had a strong year in 2014, returning 9.48% in local terms, a European investor would have experienced a slightly lower but still-solid 9.3% return during the same period. However, U.S. investors did not benefit from strong Japanese equities, as MSCI Japan posted a loss of 4.02% once the exchange rate between the yen and the U.S. dollar is taken into account.
The Russian ruble was another currency that saw its value plummet in 2014, -44% relative to the U.S. dollar, in response to lower oil prices and fears of capital outflows. To ease the falling ruble, in mid-December Russia’s central bank increased its key interest rate by 6 percentage points to 17%; however that did little to slow the currency’s plunge. The drop in the ruble took already-negative local returns, -4.23% for the MSCI Russia index, deep into negative territory, as this index lost 46.27% when calculated in U.S. dollars.
GLOBAL INDUSTRY CLASSIFICATION STANDARD (GICS®) REVIEW
In November, S&P Dow Jones Indices and MSCI Inc. announced two proposed changes after their annual review of the Global Industry Classification Standard (GICS®). Real estate will become a stand-alone sector, having previously been part of the Financials Sector, and its addition brings the total number of GICS sectors to 11. In addition to the changes in the Financials Sector, a new sub-industry has been created for copper, which will remain in the Metals & Mining Industry. Under the current plan, these changes to the GICS structure will be implemented in late August 2016. S&P Dow Jones Indices and MSCI plan to assess feedback on the proposed changes in early 2015, and the final decision on the implementation date will be announced March 15, 2015.
The existence of significant fundamental differences among real estate companies and other companies in the Financials Sector, such as banks and insurance companies, drove the decision to assign real estate its own sector. Further, real estate is often considered to be a separate asset class when placed in an asset allocation framework. Over the past 10 years, the Real Estate Industry Group weighting of the S&P 500 Index has increased from 0.58% at year-end 2004 to 2.40% as of month-end November 2014. Currently, the Real Estate Sector would rank among the smallest sectors in the S&P 500 Index, with a weighting very close to the current weighting of the Telecommunication Services Sector (2.3% as of December 2014). The Real Estate Sector will consist of one industry group (real estate) that breaks down into two industries – equity Real Estate Investment Trusts (REITs) and real estate management and development. Under the proposed changes, mortgage REITs will remain in the Financials Sector but will become a new industry and sub-industry called Mortgage REITs.
The Copper Sub-Industry will primarily consist of companies engaged in copper ore mining. The main reasoning behind the proposed additional sub-industry consists of rising demand for copper leading to expected growth in copper stocks. Creating a Copper Sub-Industry also maintains consistency, since gold and silver each represent a sub-industry within the Metals and Mining Industry. Copper will remain in the Metals & Mining Industry, the Materials Industry Group and the Materials Sector. Previously, copper was included in the Diversified Metals and Mining Sub-Industry.
S&P DOW JONES DEMOTES MOROCCO TO FRONTIER MARKET STATUS
In early November, S&P Dow Jones demoted Morocco from emerging market to frontier market status as a part of its annual country classification consultation. This change is expected to take effect this fall. Though a number of market reclassifications were considered, no other changes were made for 2015. The main justification for the change was the recent drop in liquidity in the Morocco equity market such that its liquidity profile was significantly worse than other emerging markets, making it more appropriately classified as a frontier market.
S&P had considered, but did not act on, several other changes. Among these was a reclassification of Egypt from emerging market to frontier market status, largely driven by issues related to geopolitical developments in the country. Egypt remains an emerging market, as these issues have abated somewhat. Kuwait was under consideration for reclassification from frontier market to emerging market status, but its foreign ownership restrictions continue to prevent such a move. Three stand-alone markets under consideration for reclassification — Saudi Arabia, Palestine and Zimbabwe — remain stand-alone markets. Saudi Arabia, which recently announced plans to provide foreign investors with direct access to its equity market, remains a stand-alone market due to the still-restricted access for foreigners. Palestine was kept as a stand-alone, as market participants view the level of liquidity, size of the market and geopolitical instability as main concerns. Finally, Zimbabwe remains a stand-alone market due to liquidity, foreign ownership and currency stability issues. The major index providers are generally consistent with respect to the classifications of these markets, with the exception of Russell’s classification of Morocco as an emerging market.
MSCI SEMI-ANNUAL REVIEW – NOVEMBER 2014
The objective of the MSCI semi-annual index review is to reflect changes due to initial public offereings, corporate events, de-listings and overall market performance. Based on the new market size-segment cutoffs, current constituents were re-weighted and newly eligible companies were identified, resulting in additions, deletions, float and share changes to the indices effective on the close of Tuesday, November 25, 2014.
MSCI Developed World Summary
Based on the review, 37 companies were added to the World Index, while 17 were deleted. Two-way turnover was 0.7% versus 0.8% in May 2014. Of the 37 additions, 20 were in North America, eight were in Europe and the Middle East and nine were in Asia Pacific. Of the 17 deletions, six were in the North American region, five were in Europe and the Middle East and six were in Asia Pacific. Twenty-seven of the additions were migrations from the small-cap index, and 12 of the deletions were migrations to the small-cap index. The largest weight increase by country was Germany (+0.03%) and the largest decrease was the United States (-0.06%). On a sector basis, health care had the largest increase while consumer staples had the largest decline. On a net basis, the number of constituents in the MSCI World Index increased by 20 names to 1,637 with a market capitalization of US$31.4 trillion. The MSCI World Small Cap Index saw 251 security additions and 162 deletions, resulting in one-way index turnover of 4.0% versus 3.1% in May 2014. Of the 251 additions, 123 were in North America, 57 in Asia Pacific and 71 in Europe and the Middle East. Of the 162 deletions, 75 were in North America, 35 in Asia Pacific and 52 in Europe and the Middle East. The largest weight increase by country was Japan (+0.20%) and the largest decrease was the United States (-0.70%). On a net basis, the number of constituents in the MSCI World Small Cap Index increased by 89 names to 4,347 with a market capitalization of US$4.8 trillion.
MSCI Emerging Market Summary
In the Emerging Markets Index, 21 securities were added and 21 were deleted, resulting in a 0.82% increase in market capitalization. One-way index turnover of 1.3% versus 3.0% in May 2014. Of the 21 additions, 15 were from the Asia Pacific region, there were zero from Latin America and six from Europe & the Middle East. Of the 21 deletions, 14 were from the Asia-Pacific region, three were from Latin America and four were from Europe and the Middle East. The largest country increase in weight was Qatar (+0.29%) and the largest decrease was in Brazil (-0.15%). On a sector basis, real estate had the largest increase (+0.11%) while materials (-0.15%) had the largest decline.
The number of constituents in the emerging markets index remained constant at 834 securities, with a market capitalization of US$3.9 trillion.
There were 160 security additions and 152 deletions from the Emerging Markets Small Cap Index, resulting in one-way index turnover of 8.5% versus 9.6% in May 2014. Of the 160 additions, 138 were in emerging markets Asia, five in Latin America and 17 in Europe and the Middle East. Of the 152 deletions, 128 were in emerging markets Asia, 11 in Latin America and 13 in Europe and the Middle East. The largest country increase in weight was India (+1.6%) and the largest decrease was Taiwan (-1.2%). On a net basis, the number of constituents in the MSCI Emerging Markets Small Cap Index increased by eight names to 1,813, with a market capitalization of US$594 billion.
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