U.S. investors can be excused if they missed what is arguably the most important news in international investing the last couple of weeks. After all, it happened on the evening of Monday, July 3, a time when most were contemplating nothing more than the upcoming Independence Day barbecue. And, to be frank, at first glance the news is a bit of a yawner.
I speak of the announcement by
that it is changing the methodology by which the firm calculates the weighting of European companies in its
indices, used by European mutual-fund managers as performance benchmarks. While that may sound arcane, it promises to affect investors who own mutual funds with holdings in European companies, create some intriguing plays over the next couple of months in specific stocks and mark a major step in changing how indices are calculated.
Dow Jones announced that it would begin using free-float weightings in its STOXX indices. Free-float weightings simply mean that the firm calculates the percentage of its index a company comprises using the number of shares that are actually available for investors to buy, not the total number of shares outstanding. Those companies that have a significant percentage of outstanding shares owned by governments or cross-held by other companies will see their importance decrease in the index.
Dow Jones is the latest indexer to throw its weight, so to speak, behind the free-float methodology, following the
Financial Times Stock Exchange Index
, more commonly known as the
. The system makes more sense. "The goal of creating a benchmark index is to reflect the investable universe," says Steven Schoenfeld, head of international equity strategies at
Barclays Global Investors
, the world's largest index-fund manager, with over $800 billion in assets. "If a major amount of the stock is tied up in a cross holding, then it is not part of the investable universe."
Soundness of concept aside, the reweighting, which is set to occur on Sept. 18, will certainly move the stock prices of the companies most affected by it. It will change the makeup of index funds in Europe that track the STOXX indices, especially the
(which is pan-European) and
(just the countries that use the euro). On Sept. 18, these funds will be forced either to decrease or increase their holdings in companies to follow the weighting in the indices.
The reweighting, by itself, means little for U.S. investors since index funds here typically track the
Morgan Stanley Capital International
indices. But leading up to Sept. 18 expect a lot of buying of the stocks that will be increased and selling of the stocks that will be decreased. International Editor
wrote about the effects of reconstituting Japan's benchmark
Already, the race is on to pick the expected winners and losers in the shuffle, and it is hardly a mystery.
, with significant holdings by their respective governments, will see their positions decrease, by 3.37% and 2.75% respectively, according to an estimate by Anna Mackman, European strategist for
Credit Suisse First Boston
. Indeed, France Telecom's shares fell 5.5% the first day of trading after the announcement (they have since rebounded), while Deutsche Telekom is down 2.1% since the announcement.
The companies that will see their weightings boosted will include France's
, Since the announcement, share prices of those companies have risen 12% and 6% respectively.
All else being equal, playing the winners and losers of the reweighting should be easy over the next couple of months, even for Americans, because many of these big companies have ADRs. The effects could be exacerbated since it looks increasingly likely that the compilers of the benchmark German index
will soon adopt the free-float methodology as well.
Of course, all else is not equal. "You never know what might happen," says Schoenfeld. "
could buy Deutsche Telekom tomorrow and send the stock to the moon, or into the cellar."
So the greater importance is longer term, since the possibility has now increased that MSCI, against whose indices an estimated $2 trillion is benchmarked, will follow suit and use the free-floating methodology. That would have a much more significant impact on U.S. investors.
"There is an 80% probability that MSCI will announce a change, probably before the end of the year," writes Mark Howdle, European strategist for
Schroder Salomon Smith Barney
in a report.
Schoenfeld of Barclays is more cautious, saying it's unlikely the indexing giant will adopt the methodology this year. But the STOXX embrace of free float "makes it more inevitable that it will happen," he says.
(MSCI didn't return a request seeking comment on this topic in time for publication, but the organization is reportedly researching it.)
Even if you don't invest in index funds, you will still feel an effect, since actively managed funds will undoubtedly hold the stocks affected by the reweighting. "That is why benchmarks matter," says Schoenfeld.
David Kurapka's Global Portfolio column appears Mondays, Wednesdays and Fridays on TSC. In keeping with TSC's editorial policy, he does not own shares in any companies or mutual funds mentioned in this column. He also doesn't invest in hedge funds or other private investment partnerships. He welcomes your feedback at