Europe

MSCI Discusses GICS Shift, Expanding ETF Market

Europe

Morgan Stanley Capital International (MSCI) and Standard and Poor's (S&P) recently launched a new index classification system called the Global Industry Classification Standard (GICS). The new system is designed to make investment research and management easier for financial professions. (For more details, click here to read the article.)

Associate Editor John Spence spoke with Richard Quigley, Principal and Global Head of Business Development for MSCI, to discuss the rationale for the shift to GICS, collaboration between major index providers, and the future of exchange-traded funds (ETFs) based on MSCI international indexes.

IndexFunds: What was the motivation for switching to the Global Industry Classification Standard (GICS)?

Richard Quigley: We needed to update our industry classification system to reflect the global economy. The agreement with S&P is 18 months old. We did a couple years of research that preceded that agreement because we were witnessing the shift of a lot of our clients to sector-based investing.

MSCI is a global organization. In Europe, we started to see the economic integration that was going on there, and I think the EMU [Economic and Monetary Union] accelerated that. Generally speaking, the idea of having a meaningful, relevant, and flexible way of looking at the universe became more and more important with the changes in Europe. With the new four-tiered structure [as opposed to the old two-tier system], there's more inherent flexibility in the system - there's a lot of different ways you can look at the universe.

IF: What was the logic for linking up with S&P to design GICS?

RQ: The objective was very simple: a global standard for classifying industries. We felt the best way to do that would be to link ourselves with S&P, which has a very strong presence in North America, and we feel that MSCI is very strong globally. Between MSCI ACWI [All County World Indexes] and the S&P 500, you have a lot of of money managed to those indices. The S&P series and the ACWI series covers a highly relevant universe. So we thought that partnering with S&P to develop GICS would create a very powerful standard because people around the world could make similar comparisons.

IF: Can you go through the process of working with S&P? Was this type of collaboration between index providers unprecedented?

RQ: I think it was unprecedented. The world of index providers is relatively small - there are not many, so I guess we all know each other pretty well. We don't necessarily compete with each other head on, although that may be changing in the future. As I said before, the collaboration was all about giving investors a common view of the world.

We want to keep GICS lively and relevant, so MSCI and S&P have agreed to meet on an annual basis. We each have respective groups of research analysts that cover the securities that are classified under GICS. We want to assess the structure of the system once a year. This system won't make sense if new industries emerge, industries are consolidated, or if certain sectors are not relevant anymore - we want to keep track of changes in the economy that may warrant changes in the structure.

We had our first meeting with S&P last August on the anniversary of the signing of the original agreement. The meeting culminates a year of consultation with our clients, so in our mind we're doing nothing more than institutionalizing a lot of the feedback from our clients. More or less, the way that it works is S&P classifies its universe and we classify ours, and we compare the two products and agree to agree or disagree. In that way, we have a common database of classifications. So we work together on an intellectual level, and to some degree on an operational level.

IF: Will these types of classification collaborations between index providers become more common in the future?

RQ: It's hard to say - it depends. I don't know if it will be more common, but we'll always have our eyes open because we view ourselves as an entrepreneurial operation. But the S&P collaboration demonstrates that we're willing to take risks and work with anyone if it is in the best interest of our clients.

IF: Were there certain kinds of companies that were becoming more difficult to categorize under the old system, and how has GICS cleared things up as far as classification of those companies? In other words, was there a specific type of company that gave you fits when you tried to classify it under the old system?

RQ: It was less a matter of specific companies than overhauling the general structure of our system. But take a hardware company like Dell or Compaq for instance - they were classified under capital goods under the old system. Most of the companies that were growing increasingly difficult to classify were in the Internet economy area. For example, are they services firms or are they consumer goods firms? Now we've created a fairly robust information technology classification and structure. I think GICS, when compared to the old system, more effectively covers the new economy - telecommunications, healthcare, and information technology companies in particular. Another area that comes to mind is diversified financial corporations like Citigroup, which were easier to pigeonhole ten or fifteen years ago.

But we feel implementing GICS was a big win for us, and many of our clients are adopting and organizing around the new system. We're hoping that as more organizations adopt the system, GICS will be an effective architecture to launch products from.

IF: Speaking of new products, talk a little about the agreement with State Street Global Advisors (SSgA) to launch exchange-traded funds (ETFs) in Europe based on MSCI indices. Does the license agreement cover European sector indices or total market indices for European companies? This brings up the whole issue of country vs. sector investing in Europe.

RQ: The focus of the State Street launch is regional and sector indices. We're working hard with SSgA to get these products to the market, because in a lot of ways Europe is still in an embryonic stage at this point in terms of ETFs. The initial series will be targeted to institutional investors because, like in the U.S., the initial interest will be institutional, and establishing reliability and liquidity in ETFs will be important. We are hoping to use the agreement as a platform for reaching retail investors, whether that's through new share classes or different distribution agreements.

IF: What about the future of ETFs in Asia?

RQ: I can't talk too much about the specifics, but I think you've seen the close of chapter one in the U.S. last year with big players getting into ETFs. My view is that chapter one is just beginning in Europe and in Asia. Everyone is gearing up for launches in Asia, and we feel that we're well-positioned in that area and look forward to a good year there.

IF: What do you make of all this noise about ETFs replacing mutual funds?

RQ: I think that ETFs initially will cut more into individual securities than mutual funds, at least on the retail side. In the U.S., traditional mutual fund investors tend to be conservative buy-and-hold investors who don't have brokerage accounts. I think it will take a little time for them to get involved in the ETF world, whereas it's more natural for investors who are active in individual securities to buy ETFs. Everyone talks about them cutting into Vanguard's market share because that's the obvious reaction, because ETFs reflect a Vanguard index fund the most. But the interesting angle to me is that ETFs will bring passive investing to active securities investors.