The Believers: Part II

Global sector investing will take a giant step forward with FTSEÆs new suite of indices. A benchmark wonÆt be far behind.

On Monday, 12 February, FTSE, the Financial Times-affiliated index vendor, will launch 11 global sector indices in London. These are the first sector indices to be made available to the public, and mark another step in a steady shift by asset managers away from country allocations to sector allocations.

Earlier this week, fund manager INVESCO was out promoting new sector-based funds. The firm says the main hindrance to institutional investors embracing sector allocations over traditional country allocations is the lack of a benchmark. Everybody knows the MSCI set of global indices, but there’s nothing like that in the sector universe.

FTSE is out to change that. Mark Makepeace, FTSE’s London-based chief executive, explains that until now, the best FTSE could do was create matrices to help clients strategize and determine a portfolio, but these tend to be large and unwieldy, so difficult to trade and impractical as an index. 

In the meantime, brokers such as Merrill Lynch, in the trenches with both retail and institutional clients every day, began creating baskets optimizing clients’ desires to be in a particular sector. Merrills transferred this on-the-ground experience to FTSE, which used it to build this new set of indices. As a result, Merrill Lynch will be the first broker to offer both retail and institutional trading instruments on the back of the FTSE products, also out of London on 12 February.

“We create baskets everyone can use,” Makepeace explains. To ensure fund managers can easily replicate these indices, FTSE is keeping each index small, from 30-50 stocks, representing the biggest players in a sector by market cap, which is adjusted for free floats. The nature of these global sectors, which is marked by consolidation, means these indices can remain small in stock numbers but still cover up to 90% of the full market cap of the sector universe. They have also kept in mind the mandate restraints on many fund managers, who often can’t replicate an index because certain stocks have huge weightings: these indices come with caps on individual stocks at 10%, and the top-five stocks are limited to 40% of the index.

Merrill Lynch, meanwhile, is promoting a number of strategies and products on the back of these indices, says Ken Sue, director of global equity-linked products in Hong Kong. For institutional clients, this means asset equity swaps, hedging, put options and sector-versus-sector trades. In summer of this year, Merrills will also introduce exchange-traded funds (ETFs) in London based on these indices. (FTSE’s Makepeace expects ETFs on these indices to be present “worldwide” in a year’s time.) Retail products include global sectors certificates, which upon maturity provide investors with returns linked to the index.

Marketing is global, but most demand is coming from Europe and the Americas, notes Todd Kennedy, assistant vice president, global equities derivatives strategy at Merrills in Hong Kong. In Asia, Merrills is using its private client network in Singapore, Hong Kong, Japan and Australia. It also has approval from local authorities to publicly market these in Singapore and Japan, and is in talks with local regulators in Hong Kong with a view of doing the same there. It also has a number of third party private client distributors on board. At the same time, the firm is pitching ideas to sector-specialist funds (which are thin on the ground in Asia) and to active managers allowed to take bets outside their region.

Life Blood

In the meantime, the flow of new sector funds only thickens. Firms such as INVESCO, Jardine Fleming and Baring Asset Management are rushing new products to the market. Earlier this week, INVESCO announced a new global multi-sector fund. On April 14, JF Funds will launch the JF Global Life Sciences fund (with the slug line to its classy retail clients: “Your chance to make some serious money out of drugs!”). Barings is launching next week a multi-sector fund covering TMT, healthcare and financial services.

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