FTSE Global Markets by FTSE Global Markets

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FTSE GROUP CELEBRATES ITS 1OTH ANNIVERSARY ISSUE TEN • NOVEMBER/DECEMBER 2005

ABP: The new shareholder activist steps out The rise and rise of collateral management ECNs: The exchange change

SUPERMAN or Lex Luthor? ...the real Icahn

MOLSON COORS IS BREWING UP A STORM

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Outlook EDITORIAL DIRECTOR:

Francesca Carnevale, Tel + 44 [0] 20 7074 0008, email: francesca@berlinguer.com CONTRIBUTING EDITORS:

Karen Jones, Neil O’Hara, David Simons. SPECIAL CORRESPONDENTS:

Andrew Cavenagh, Rekha Menon, Tim Steele, Bill Stoneman, Angela May Ward, Paul Whitfield, Ian Williams, Benedict Mander FTSE EDITORIAL BOARD:

Mark Makepeace [CEO], Carl Beckley, Graham Colbourne, Imogen Dillon-Hatcher, Paul Hoff, Marianne Huvé-Allard, Paul McLean, Jerry Moskowitz, Gareth Parker, Jamie Perrett, Sandra Steel, Rachel Tanner, Nigel Henderson, Alex Barnes PUBLISHING & SALES DIRECTOR:

Paul Spendiff OVERSEAS REPRESENTATION:

Adil Jilla [Middle East and North Africa], Faredoon Kuka, Ronni Mystry Associates Pvt [India], Harold Leddy & Associates [United States] PUBLISHED BY:

Berlinguer Ltd, 4-14 Tabernacle Street, London EC2A 4LU. Tel: + 44 [0] 20 7074 0021; www.berlinguer.com ART DIRECTION AND PRODUCTION:

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Mailcom plc, Snowdon Drive, Winterhill, Milton Keynes MK6 1HQ FTSE Global Markets is published six times a year. No part of this publication may be reproduced or used in any form of advertising without prior permission of FTSE International Limited or Berlinguer Ltd. FTSE Global Markets is published by Berlinguer Ltd on behalf of FTSE International Limited. [Copyright © Berlinguer Ltd 2005. All rights reserved.] FTSE™ is a trade mark of the London Stock Exchange plc and the Financial Times Limited and is used by FTSE International Limited under licence. FTSE International Limited would like to stress that the contents, opinions and sentiments expressed in the articles and features contained in FTSE Global Markets do not represent FTSE International Limited’s ideas and opinions. The articles are commissioned independently from FTSE International Limited and represent only the ideas and opinions of the contributing writers and editors. All information is provided for information purposes only. Every effort is made to ensure that all information given in this publication is accurate, but no responsibility or liability can be accepted by FTSE International Limited for any errors or omissions or for any loss arising from use of this publication. All copyright and database rights in the FTSE Indices belong to FTSE International Limited or its licensors. Redistribution of the data comprising the FTSE Indices is not permitted. You agree to comply with any restrictions or conditions imposed upon the use, access, or storage of the data as may be notified to you by FTSE International Limited or Berlinguer Ltd and you may be required to enter into a separate agreement with FTSE International Limited or Berlinguer Ltd. ISSN: 1742-6650 Journalistic code set by the Munich Declaration. ADVERTISING AND SUBSCRIPTION ENQUIRIES:

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nprecedented global liquidity, a boom in energy and commodity prices, and good economic fundamentals explain why investor enthusiasm for Latin America continues strong, in spite of nagging political worries. Investors are unusually calm in the face of continued political uncertainty in Brazil, increasingly nationalistic rhetoric emanating from Venezuela’s president Chavez and the growing likelihood that a left-wing government will assume power in Mexico’s elections in July next year. Specialist Latin American hedge funds have been important beneficiaries of investor munificence. Are investors testing the political waters? Are there signs of change? Benedict Mander and Neil O’Hara explain why the carnival atmosphere looks set to continue for some time. Some commentators would have us believe that Carl Icahn is an obsessive corporate raider. His recent purchase of a small stake in Time Warner and reports that he has been trying to pressure the media giant into divesting its publishing assets and buy back $20bn in stock. To others, having made his billions, he is an upfront shareholder activist. Just what makes the ex-psychology and medical student (he reportedly gave up medicine because he did not like working with corpses) really tick? Ian Williams went in search of the man behind the image and found out what the man who owns Las Vegas’ tallest casino, the Stratosphere, among a myriad of other billion dollar-plus investments, really thinks. The rise of shareholder advocacy is not limited to high profile investors, or corporate raiders. Big investment deals, shareholder advocacy and (as a result) headlines increasingly these days follow the biggest pension funds—such as CalPERS. On the other side of the Atlantic and armed with almost 2.5m members and with assets under management of some €168bn few pension funds come any bigger than Stichting Pensioenfonds ABP. So when ABP begins to get involved in pioneering investment deals and shareholder advocacy, it’s worthy of note. Paul Whitfield explains why. It is FTSE Group’s 10th Anniversary, reflected in this issue by commentary and analysis by its founding director and these days chief executive, Mark Makepeace, on the current drivers in the investment benchmark and indexing business. FTSE, like its counterparts, has ridden a rising tide of business on the rise and growing complexity and specificity of index-based investment strategies over the decade. It has been a heady mix of innovation, customisation, the leveraging of technology and risk management software solutions and new markets and relationships—the most significantly of which, perhaps, is its joint venture with China’s Xinhua group. Francesca Carnevale, Editorial Director September 2005

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FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2005

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Contents COVER STORY SUPERMAN OR LEX LUTHOR?

..............................................................Page 49 “Look, I’m not saying I’m being Robin Hood, but I think all shareholders benefit from what I do,” says Carl Icahn of himself. He wears a myriad hats—corporate raider, philosopher king, concerned shareholder activist, financial positivist, even genius. Which is the right one? In an exclusive interview Ian Williams talks with the increasingly activist Carl Icahn about his interventions in Mylan, Kerr McGee and the big daddy of them all, Time Warner.

REGULARS MARKET LEADER IN THE MARKETS

FTSE: 10 YEARS AND COUNTING

..................................................Page 6 Mark Makepeace looks to the future after a decade of growth

THE RISE OF SHAREHOLDER ACTIVISM ................................Page 12 RREV’s Peter Thompson on why UK shareholders do it better

REITS ARE WEIGHED IN THE BALANCE

................................Page 14 How long can the good times last? Karen Jones reports from New York

NEW SEC THINKING ON SOFT DOLLARS

............................Page 18 Karen Jones reports on the upcoming interpretive release from the US regulator

GREEK BANKING RAISES ITS GAME

..........................................Page 20 Francesca Carnevale reports on the new confidence of the Greek banking sector

CUSTODY BUILDS UP STEAM IN EASTERN EUROPE ....Page 26

Tim Steele looks at the pace of product development

REGIONAL REVIEW

PRIVATE EQUITY STEPS UP

................................................................Page 32 More than €7bn is now invested in private equity in Eastern Europe. Alex Sehmer reports

INVESTORS STREAM INTO LATIN AMERICA

....................Page 34 Benedict Mander reports on continued investor appetite for LatAm risk

BRAZILIAN HEDGE FUNDS ON THE MARCH

..................Page 39 Neil O’Hara reports on the flow of funds into alternative investments

JOHANNESBURG BUILDS ON ETFS ............................................Page 41

The JSE talks about its new domestic ETFs

MIDDLE EAST INVESTMENT BOOM

..........................................Page 42 Why Dana Gas has set a new benchmark for investor appeal

FUND REPORT

ABP: THE NEW SHAREHOLDER ADVOCATE

....................Page 67 Paul Whitfield explains why ABP is a convert to shareholder activism

WEALTH ALLOCATION INVESTING

....................................................Page 78 David Morris of GWA shows how you can build portfolios without prices

INDEX REVIEW

TIMELESS EFFICIENCY AND UTILITY

..................................................Page 81 Stephen Schoenfeld makes the case for today’s index investor Market Reports by FTSE Research ................................................................................Page 86 Companies in this issue ..................................................................................................Page 85 Calendar ............................................................................................................................Page 96

NOVEMBER/DECEMBER 2005 • FTSE GLOBAL MARKETS

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Contents FEATURES MOLSON COORS: BREWING A STORM

..........................................Page 44 Molson and Labatt have lost ground to sub-premium brands, brewed mainly by independents. It has been a brutal and rough year for the Molson Coors Brewing Company (TAP), formed only last February by combining Canada’s Molson with America’s Coors. Eventually, it almost certainly will need to combine with a competitor in order to thrive. Art Detman explains why.

CUSTODY COHESION IN ASIA’S FRAGMENTED MARKET

....Page 52 Asia continues to be defined by a series of independent exchanges and clearing houses. Each country has a set of rules and market restrictions all its own. In such a fragmented market sub-custodians have so far maintained their competitive edge. With vertical integration gradually changing the market elsewhere how long can Asia’s current custody infrastructure last? Dave Simons reports.

THE HOLY GRAIL OF RISK MANAGEMENT SOFTWARE

......Page 57 Risk management software vendors are on the threshold of a dream. Models developed for one asset class are giving way to standardised systems that offer consistent results across multiple classes. Users are demanding integrated software that can handle portfolio construction, performance attribution and compliance for all asset classes on a single platform. Neil A. O'Hara reports from Boston.

COLLATERAL MANAGEMENT ..................................................................Page 61 Secured transactions already dominate the repo, OTC derivatives and securities lending markets, a trend the Basel II regulatory capital regime will only reinforce. The range of acceptable collateral, once confined to cash and government bonds, now encompasses corporate debt, structured financial instruments and equity. Banks, broker-dealers and money managers are trying to eke out higher returns by pledging their securities inventories. Outsourcing is increasingly the preferred solution.

RMBS: RESISTING THE PROPHETS OF DOOM

..............................Page 71 The second half of the year will see a further €56bn of mortgage-backed bonds issued, according to analysts in London, defying the prophets of doom who signaled a sharp decline in the European residential mortgage-backed securities (RMBS) market. Andrew Cavenagh explains why the bulls are still outflanking the asset-backed bears.

ECNS: THE EXCHANGE CHANGE

............................................................Page 70 While the possibility of a silent, auction-less, completely computer-driven New York Stock Exchange (NYSE) may be a sobering thought to traditionalists, to others, an allelectronic stock exchange is welcome news. Dave Simons talks us through the pros and cons of the new electronic communication networks (ECNs) trading era.

NOVEMBER/DECEMBER 2005 • FTSE GLOBAL MARKETS

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Market Leader FTSE GROUP Photo: FTSE Group. October 2005.

Mark Makepeace, FTSE Group chief executive

BUILDING ON A DECADE OF CHANGE Market dynamics have built FTSE Group. Over the decade, market deregulation and subsequent re-regulation, globalisation and the growing complexity of institutional portfolio allocation have combined to fuel the index business per se. Now offering in excess of 66,000 indices—many specifically customised —the diversity of FTSE’s product offering reflects a diverse and dynamic global investment market. Mark Makepeace, chief executive of FTSE Group, outlines the historical markers that have forged the index provider’s business growth to date and sets a trail into the future. HESE DAYS, OUTSIDE of the United States, more assets are linked to FTSE indices than any other index provider. It reflects the success of the Group’s work on building the FTSE brand as an objective and trustworthy market benchmark across the globe. To be fair, there is still work to do— particularly in the United States—but we have never rested on our laurels. We have made it a cornerstone of our

strategic business approach that we are focused and committed to providing reliable investment benchmarks, market data and indices to our growing and increasingly diverse client base. As a consequence, over the decade, FTSE has rapidly developed from a small, United Kingdom-focused index provider to become a truly global player. Constant product review and enhancements are the daily business

of today’s index providers, to ensure that we each maintain and build on our market positions. That success has been constructed on a number of pillars. The first and most obvious is the creation of accurate, transparent and tradable indices as a key to opening markets to foreign institutional players. As investors adopt ever more sophisticated and (sometimes) complex investment strategies in the search to deliver alpha, the onus has been on index providers to diversify both their global and local investment vehicles and products. Ironically, as the world becomes smaller and the investment outlook becomes ‘global’, specific local and/or regional expertise is an increasingly necessary requirement for sophisticated asset owners that work with a geographically diversified portfolio strategy. Establishing strong and reliable partnerships with local institutions has provided FTSE with an invaluable building block. In particular, expertise in those leading emerging markets – where the World Bank and the IMF are no longer principal market makers – is paramount if we are to service today’s asset owners who are anxious to capitalise on the emerging market growth story. While investors are offered a sometimes bewildering array of avenues to enter regional or country markets, either through the trading of derivatives, index-tracking funds, exchange traded funds (ETFs), as well as through dedicated country investment funds; the role of index providers is brought sharply into focus in two ways. The first is the provision of reliable country classification systems. The second is to provide accurate benchmarks for leading investment firms that enable them, in turn, to create viable investment products. In this latter regard, we find

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Market Leader

October:

July:

Partnership with Russell on the FTSE Global Classification System The launch of the Socially Responsible Investment Index (FTSE4Good). Partnership with Taiwan Stock 2002: May:

December:

July:

June:

April:

Partnership with Euronext (FTSE Eurotop 100 & 300 Indices) Partnership with Johannesburg Stock Exchange (Benchmark /Tradable Indices) All indices move to free float adjusted calculations The launch of the Socially Responsible Investment Index (FTSE4Good). Partnership with EIRIS. FTSE4Good Index Series revenue redirected in entirety & perpetuity to UNICEF Partnership with Hang Seng (FTSE/Hang Seng Index Series) 2001: April:

New index additions, free float adjusted The extension of FTSE’s global universe to 90% of market capitalisation with the inception of the FTSE All-World Index Partnership with Xinhua Financial News & the establishment of Benchmark/Tradable Indices for China December:

December:

October:

August:

June:

Consultation with the market on the creation of free float adjusted indices. Introduction of the Global Classification System Partnership with Cyprus S.E. (FTSE/CySE 20 Index) Partnership with Nordic Exchanges (FTSE/Norex 30 Index) The launch of FTSE Multinationals Index Series Partnership with Athens Stock Exchange (FTSE/ASE20 & 40 Indices) Partnership with Latibex (FTSE Latibex All Share Index) 1999: February:

FTSE APCIMS Index Series launched 1997: February:

2000: January: September:

FTSE GROUP 8

onus on index providers to stay ahead of developments to ensure that our data is up to the minute, our classifications accurate and our indices relevant. The establishment of an accurate classification system that supports our work therefore is paramount. We believe we have been a strategic instigator in the search for an optimal industry classification by providing accurate and transparent sector and country definitions. In turn, it has provided an invaluable tool for the investment community, as classification forms the basis of research and asset management throughout the world. Working together with Dow Jones Indexes we have created a universal classification standard, called the Industry Classification Benchmark, that can be utilised by all specialists – either working in financial or investment institutions or corporations. Developments that will grow in importance over the coming years include the establishment of the FTSE/EPRA/NAREIT Index Series, which anticipate the global rollout of

Ltd, which is one of China’s largest asset management companies, subsequently launched an openended fund based on the index in June this year. Partnering with key local and regional institutions is another important pillar of our business. Partnerships allow us to enhance local market offerings, while simultaneously expanding our own product range and market coverage. Equally, as more countries move up the development ladder and local companies adopt internationally recognised reporting and accounting standards and appropriate corporate governance practices, the universe of sound companies that could feasibly comprise a national or regional index grows – adding value to the specific index. In this way, development is increasingly drawn into the index providers’ business operations. Long gone are the days in which plain vanilla indices—that comprise only the world’s leading corporates, with only a smattering of local companies included—were the mainstay of international investing. That puts the

that expertise in the all-important Chinese market is in particular demand. In 2004/5 alone, clients using the FTSE/Xinhua Index Series launched four new ETFs, with combined assets under management in excess of $1.2bn trading on stock exchanges in London, New York and Hong Kong. As of 2006, this expertise comes into strong focus as the last barriers to a fully free capital market are dismantled and China takes its place in the global capital markets. Our newest index for China provides a marker for things to come. In April we launched the FTSE/Xinhua High Yield 150 Index comprising A shares listed on the Shanghai and Shenzhen stock exchanges, weighted by dividend yield and consisting of the top 150 companies in the existing FTSE/Xinhua 600 Index that have exhibited the highest yield. It is a yardstick for China listed companies, encouraging them to adopt internationally recognised corporate governance practices as well as securing higher returns for investors. China Asset Management Company

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Market Leader

Partnership with Global Wealth Allocation Limited (GWA) FTSE GWA Index Series

September:

July:

Partnership with EPRA NAREIT FTSE EPRA/NAREIT Real Estate Index Series Partnership with NASDAQ FTSE/NASDAQ Index Series Partnership with ASEAN Exchanges (Bursa Malaysia, Jakarta Stock Exchange, The Philippines Stock Exchange, Singapore Exchange and The Stock Exchange of Thailand) FTSE/ASEAN Index Series 2005: February:

December:

November:

FTSE & Dow Jones Indexes announce the merger of their classifications systems to form the Industry Classification Benchmark (ICB) The announcement of country classification rules A memorandum of understanding is signed with the Singapore Exchange Limited to develop Singapore and regional indices. FTSE ISS Corporate Governance Indices launched. March:

November:

September:

September: September:

May:

Together with Euronext, FTSE launches the FTSE Eurofirst 80 & 100 Indices The FTSE Med 100 Index is launched in partnership with the Athens Stock Exchange, the Cyprus Stock Exchange and the Tel Aviv Stock Exchange The global universe is extended to 98% The launch of the Global Equity Index Series (GEIS) Global Small Cap Indices form part of GEIS NASDAQ adopts FTSE’s Global Classification System 2003: April:

Exchange TSEC Taiwan 50 Index The launch of Global Style Index Series, with multi-factor approach. November:

2004: February:

FTSE GROUP 10

portfolio investor. The measure of that commitment is contained within the scale and future vision of our business as well as the current structures that underpin it. While we claim, for example, the well known number of 66,000 headline indices in our product portfolio, what is less understood is that there are a further 260,000 separate and definable calculations underpinning that array of indices. FTSE Group’s ambition is to grow and expand further and those intentions are as strong now as they were when we launched as an independent provider ten years ago. We will continue to pursue new opportunities in the all-important North American and Asian markets, to develop new and innovative products that pre-empt, as well as respond to, the burgeoning requirements of the global investment community and, in the process, we hope to gain greater market share in the global indexing business. Our first ten years as a company have been an exciting time and we promise the next ten years will deliver more of the same.

less well, are less profitable and have higher stock volatility than firms that work with sound corporate governance principles. Providing tools that allow investors to assess corporate governance and other non-financial risks as well as more traditional financial risk measures is a priority for us. For a simple reason: it means that investors will be armed with much more effective analytical tools in future to help secure investment performance. It becomes increasingly important as modern investment thinking encourages shareholders to play an active role in the governance process. Investment firms can now track the financial performance of companies, rated against five leading corporate practices: executive and non-executive compensation schemes, equity structure, board independence and an appropriate measure of integrity in the company auditing process. What do all these initiatives mean for the wider market? Our product developments and enhancements mirror the growing sophistication and diverse requirements of the modern

real estate investment trusts (REITs). They are, for example, fast gaining popularity throughout Asia because of their high dividend payouts. Japan, Korea and Singapore have launched REITs in the past few years and most recently in Hong Kong the local Housing Authority (HA) Supervisory Group on Divestment (SGD) has said that it supports the initial public offering (IPO) of the Link Real Estate Investment Trust as soon as practicable. Market watchers think that the Hong Kong REITs market will become a preferred method of investing in mainland Chinese property. Can China REITs really be far behind? Additionally, the recent launch of new Corporate Governance Indices, which we have developed in tandem with the Institutional Shareholder Service (ISS) illustrates the growing range of investment services providers that are committed to promoting not only corporate governance, but also the related field of socially responsible investment. Research shows that companies with weak corporate governance perform

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In the Markets

The upturn in shareholder voting during the 2005 Annual General Meeting (AGM) season is a positive trend and reinforces the fact that the UK is a model of good practice in Europe. Management and shareholders are trying to do the right things in times of heightened awareness and unprecedented scrutiny and it is welcome news that AGM voting levels have exceeded the 60% mark. By Peter Thompson, chief executive officer of RREV, the joint venture between the National Association of Pension Funds (NAPF) and global research and proxy voting services provider Institutional Shareholder Services (ISS). HAREHOLDERS ARE INCREASINGLY taking their stewardship responsibilities seriously. In RREV’s analysis of 401 AGMs, 85% of all those held between January and July 2005, the highest level of votes cast was at FTSE 250 shareholder meetings, at 63.63%. FTSE 100 and SmallCap companies were marginally below the 60% mark. The UK Government has said that it wants voting levels to increase substantially. In 2003, Patricia Hewitt, then Secretary of State for Trade and Industry, highlighted voting levels at UK AGMs of around 50% of eligible votes, compared to US levels of around 80%. Hewitt subsequently acknowledged that a voluntary system of informed voting over contentious issues should be the UK’s preferred aim, rather than an emulation of the US compulsory approach. In Paul Myners’ 2004 report to the Shareholder Voting Working Group (SVWG), he cited the number of overseas investors in UK companies, stock lending and the inherent

weaknesses of what was then a largely paper-based proxy voting system, as some of the reasons affecting the levels of voting. Myners did however believe that those levels could be sensibly increased if his recommendations were followed. One reason for this year’s increase in voting levels is a greater uptake of electronic voting among shareholders in FTSE 100 and FTSE 250 companies, which was Myners’ key recommendation. The lost ballots and leaky-pipe work of former paper-based systems is now a problem of old. Myners’ 2005 report to the SVWG highlighted that 88% of the FTSE 100 now have electronic voting capabilities, compared with fewer than 50% a year earlier. This has enabled investors to

take their stewardship responsibilities more seriously and to take an active stance when contentious issues surface. During this year’s AGM season, executive remuneration policies and ex-gratia payments caused quite a stir. Lord Hollick eventually yielded on his £250,000 handover bonus from United Business Media in the face of 87.2% of shareholders voting against or abstaining—a record level of dissent for this year and only the sixth time that a remuneration report had been opposed by shareholders. In a statement, he said: “The majority of shareholders have now expressed their disapproval of the bonus and I have accordingly asked the company not to pay it.”

Peter Thompson worked at Mercer Human Resource Consulting (formerly William M Mercer) for nearly 25 years, retiring in 2005. Since leaving Mercer, Peter has become the interim Chief Executive of RREV and also independent trustee of a number of pension schemes. Source: RREV, October 2005

NOVEMBER/DECEMBER 2005 • FTSE GLOBAL MARKETS

Photo: RREV, October 2005

SHAREHOLDER VOTING

UK END OF SEASON VOTING HOTS UP

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Is it time to show and tell? Voting disclosure remains voluntary but is at the centre of much debate ahead of the impending Company Law Reform Bill. In Myners’ report, he highlights that the Government’s White Paper, Modernising Company Law, proposes that quoted companies should be required to disclose on their websites the results of polls at general meetings. Myners supports this proposal and welcomes the fact that the Government has confirmed that it will be introducing provisions for the disclosure of the results of polls in the forthcoming Bill. The Voting Guidelines and Statements of Good Practice for the 2004 NAPF Corporate Governance Policy considers good practice in this regard. It recommends the adoption by companies of procedures so that the voting result of record – whether by a show of hands or a full poll – should be announced immediately after the General Meeting through a regulatory information service and the Company’s web site. The vast majority of companies in the FTSE 100 and an increasing number in the FTSE 250 do already publicly announce the results of their AGMs. However, some companies deliberately adopt a minimally compliant approach when disclosing their voting results, merely announcing whether each resolution proposed at the AGM was passed or not. While this satisfies the letter of the current Combined Code and Company Law, it is highly questionable whether such action reflects the spirit of transparent communication with shareholders that these frameworks were intended to encourage. At some companies where there were potentially contentious issues, the board was able to use this loophole to its advantage. Voting disclosure is achievable in the UK and we welcome the proposed change to Company Law.

Corporate governance is taken very seriously in the UK. RREV’s 2005 Voting Review findings are encouraging. Good corporate governance can mitigate risks and improve value for institutional

investors. There have been many challenges over the years to get to where we are, but there has been a general trend towards transparency and accountability and we are confident that this will continue.

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Regional Review NORTH AMERICA: REITS

REITs: WILL THE TIDE TURN? While Real Estate Investment Trusts (REITs) are not seeing the same year-to-date returns as in 2004, they are still outperforming many US equity benchmarks. The big question is, will 2005 returns end up besting 2004’s year end total of 30%? Do analysts project a bullish outlook for 2006? Or, will the threat of higher interest rates, a possible economic downturn and the predicted burst of the US housing bubble stall their growth? Karen Jones reports from New York. HE NEW YORK based investment firm of Cohen and Steers (CNS) manages approximately $20bn in assets for both institutional and individual investors, the majority of which is in real estate funds. James Corl, executive vice president and chief investment officer (CIO) for real estates securities, says that after the down years of 2001 and 2002, both 2003 and 2004 saw big returns for REITs – marking a turnaround in real estate fundamentals. He says,“We are now entering a multiyear level of accelerated growth with the economy driving higher occupancy levels and higher rate for all property types including office, industrial, hotels, apartments and retail.” Corl says, however if there is an economic downturn or a recession, the results would not be as rosy. “A recession would interrupt the recovery in real estate fundamentals,” and says it would be a “big deal” if earnings growth or job growth turned negative. While he does not think a full blown recession is on the cards, Cohen and Steers’ internal estimates place the US economic growth somewhere

between2.5% to 3.8% in 2006, which is more conservative than most. Dr. Ron Donohue, director of research at Hoyt Advisory Services, a consultant firm specialising in asset management investment analysis, says that last year REITs were looking “fully priced with maybe a little room to lift … they kept going up because properties kept going up.” Additionally, he says: “people are starting to look at them differently. They are becoming more understandable and requiring less of a risk premium.” Today, the threat of rising interest rates looms large over the real estate market, but not necessarily for all REITs, says Donohue – as long as they have properly protected themselves. REITs which have not diversified their debt wisely will take a beating.“REITs are a capital intensive business. A lot of people on the equity side have protected themselves with caps, locks and swaps.” Not everyone agrees. Supply and demand are the key drivers not interest rates, says Corl. “A lot of researchers think this market is interest rate driven.

[But] if you look at why REITs go up, it is that inflationary expectations are accelerating or the economy is strong – both of these are positive for real estate.” He does add that often in the short term, “perception can become reality” and there could be an adjustment, but insists there is no impact over the long term. Michael Grupe, senior vice president for research and investor outreach at NAREIT, the Washington DC-based trade association representing the REIT and publicly traded real estate industry, takes a measured approach. “If you look over the past 30 years of different economic cycles of rising and falling rates, there is no consistent pattern. The reason is that REITs are a true hybrid investment, with characteristics of both fixed income securities and equities. It makes a lot of sense that the bond component will suffer if interest rates go up. What remains uncertain is how the equity component will respond.” Even so, Grupe also feels investors are still bullish about REITs. “Real estate continues to attract a significant amount of capital from both institutional and individual investors. While that tells us there is some chasing of performance in investment markets, fundamentally both institutional and retail investors are in the process of rebalancing their portfolios to allow for higher allocations of commercial real estate, rather than buying properties directly or contributing to co-mingle funds.” Not everyone concurs. Andy Engle, senior research analyst at The Leuthold Group, a Minneapolis-based independent quantitative research firm, says that six to nine months ago he was getting a lot of calls from institutional investors wondering if they should increase their REIT portfolio presence, but has received none in the last six

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NORTH AMERICA: REITS

months. An admitted “contrarian investor” Engle says the Leuthold Group gets uncomfortable when everyone thinks something looks great. “I think REITs are having a relatively good year but I think moving forward you will see weakness. One of the things we look at is the demand for REITs and what you see is a big disparity on a month to month basis.” Engle sees a lot of indecisiveness in the real estate market right now and many people with“itchy trigger fingers”, leading to uncertainty. “Until you can bring prices back down to where it makes sense and have more confidence that real estate is going to be moving from here, we feel this is a negative.” “REITs were great when they were running at lesser values because you could get in and there was daily pricing and a lot more liquidity. Now that valuations have grown, it may make more sense for bigger institutions to go out and start purchasing their own deals. They can do the underlying research and on a one to one basis, get into more attractive real estate,” says Engle. If he were to buy REITs right now, he would look at health care.“You have a long term demographic and I do think they are less sensitive to the economy and interest rates.”After that, he would consider apartments. The steep increase in US residential housing costs over the last five years has prompted many to term it a housing bubble ready to burst. Though what happens in commercial and residential housing is not inextricably linked, if the bottom falls out of the housing market and the economy goes in a tailspin, it is likely to have an indirect affect on REITs. To what degree would remain to be seen. “It is hard to argue that if there was a calamitous collapse of prices in the housing market that would be great for anyone,”says Grupe, adding,“but I am not sure the housing market is subject

to the type of debacle that we saw with technology five years ago. There is far less liquidity in housing. What does it mean for the average home owner, what are you going to do, sell your home?” As a counterpoint, Donohue points to the surge in the international REITs market. “International real estate investing is going back and forth with US firms making major purchases overseas and international Michael Grupe, firms making major senior vice president purchases in the US.” for research and Why? He explains that a investor outreach at lot of the larger US REITs NAREIT want to tell a story about how they can grow Predictably perhaps, the loudest earnings and diversify, but the bigger your portfolio gets in the US, the harder cheering section comes from within it is to stand out. “If you make really the industry. Grupe points to the long good property or investment, for term figures for the big picture on example, it does not make a difference REITs.“Over the last 30 years, the total when you already own 300. However, if returns on REIT stocks have exceeded you can go to another country and all sectors of equity markets, so we are access another kind of capital, then you pretty confident that the performance are diversifying and getting access to of real estate will continue in a what are probably higher growth rates.” manner that provides significant As to 2006, Corl thinks the real performance and diversification estate cycle is going to be positive for benefits to a balanced portfolio.” NAREIT lists 198 publicly traded the next few years with demand outstripping supply. “You will see REITs in its Composite Index with 165 accelerating growth rates for REITs traded on the New York Stock and the stocks will do well in that Exchange (NYSE).The industry’s environment.” Donohue is more equity market cap is $333bn (as of circumspect.“The guys who are saying August 31), up from $275m in 2004 that really believe that REITs have with assets totaling $475bn, compared fundamentally re-priced. Then there is to $400bn in 2004. REITs paid out a set that do not believe this is true. approximately $12bn in dividends in and have paid out There are a lot of people hedging bets. 2004, The reality is REITs are probably approximately $6bn in dividends poised for continued stable through the second quarter of 2005. performance. Are we going to see The question remains however another 30% year? It is hard to say. Is whether REITs can continue on their upward trajectory. it possible? Yes. Is it likely? No.”

NOVEMBER/DECEMBER 2005 • FTSE GLOBAL MARKETS

Photo: NAREIT, September 2005

Regional Review

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After an extensive review of soft dollars commissions, the US Securities and Exchange Commission (SEC) has announced that an “interpretive release” is being readied for industry comment. Soft dollar commissions are used by money managers to pay for brokerage and research services, but abuses surfaced in the wake of recent mutual fund scandals. Though the SEC proposal offers no significant changes, such as abolishing soft dollars or severely restricting them, it does seek more defined guidelines for their usage in today’s marketplace. By Karen Jones in New York “

N MANY WAYS, soft dollars are an anachronism,” said new SEC Chairman Christopher Cox, at the recent open meeting proposing the release. “They are a throwback to the time of fixed rate commission rates on securities transactions… In the old days, under the high price umbrella of fixed commissions, price competition could occur only in the form of extra services, such as provision of research.” When the US Congress abolished fixed rate commissions in 1975, it added a statutory “safe harbor” (SIC) in Section 28(e) of the Securities Exchange Act of 1934. Its purpose was to clarify that money managers could continue using client commissions to pay for research as long as they as they are deemed reasonable in relation to the value of the research services received. Even though the vast majority of soft dollars are used appropriately, in some cases “reasonable usage” has led to aggressive interpretation. “There is a sometimes breathtaking audacity in private determinations of what services qualify as “safe harbor”. For example we have seen soft dollars used to pay for membership dues, professional licensing fees, office rent,

carpeting and even travel and entertainment expenses,“says Cox. He adds that the SEC now has to provide greater clarity as to how a 30-year old law applies today. According to SEC Release 2005-134 the proposed SEC guidance will clarify that the scope of Section 28(e) “safe harbor” is limited to brokerage and research services that satisfy the eligibility criteria in the statute. As well it will provide lawful and appropriate assistance to the money manager in carrying out his decision-making responsibilities. Finally, it will satisfy the requirement that the money manager make a good faith determination that commissions paid are reasonable in relation to the value of the products and New SEC chairman services provided by Christopher Cox. broker-dealers.

NOVEMBER/DECEMBER 2005 • FTSE GLOBAL MARKETS

Photo: Securities and Exchange Commission. August, 2005

NORTH AMERICA: SOFT DOLLARS

SEC RUNS LIGHT ON SOFT DOLLARS

Donald Trone, AIFA, founder and CEO of the Foundation for Fiduciary Studies, a non-profit organisation focusing on investment fiduciary responsibility, says that soft dollars were a “very hot topic on Capital Hill and the SEC” last January in response to the scandals uncovered within the mutual fund industry.“Certain mutual funds were directing trades to certain broker-dealers in order to curry favour with them so the mutual fund could get shelf space. That activity is not in Section 28(e).” Trone adds that he really doesn’t see any monumental policy changes in the new SEC release. “The proposed language would still leave open the possibility of the money manager purchasing research and analysis from a broker dealer and/or investment consultant for the purpose of currying favour with that organisation. Better language would be that soft dollars can only be expended for the exclusive use of the client, not the money manager.”

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While waiting for a definitive ruling by the SEC, US institutional investors have been slowly stepping back from soft dollar usage, according to a 2005 report from Greenwich Associates, a consulting firm for institutional providers of financial services. Soft dollar commissions used to purchase thirdparty research and services fell to an estimated $1.25bn in 2005, down from $1.3bn in 2004. Less then 75% of US institutions reported using soft dollars over the past twelve months, down from 82% in 2004. The report also states that some pension funds and endowments are electing to drop soft dollars completely. The proportion of these

institutions using soft dollars fell from 75% in 2004 to 44% this year. Hedge funds and mutual funds are also moving away. In 2003 nearly 90% of hedge funds and mutual funds used soft dollars. In 2005, only 55% of hedge funds and 75% of mutual funds reported using them. MFS Financial Investment manages a total of $146bn in assets on behalf of 5.2 million individual and institutional investors worldwide as of December 31, 2004. According to John Reilly, an MFS spokesperson, they eliminated the use of soft dollars to purchase market data services and third party research almost two years ago. “We do, however, continue to purchase those things where we

deem them to be of value, using cash as opposed to soft dollars.” As to whether this has negatively impacted fund performance, Reilly replies “the simple answer is no.”The SEC still has to file the release, open it for comment and then determine a course, which according to an SEC spokesperson could easily push it into 2006. As to whether soft dollars will remain viable, Melissa De Vries, associate director, Institutional Research & Marketing at Greenwich, feels that as a payment mechanism, there will be a place for soft dollars providing they are “disclosed and used appropriately for their original purpose, i.e. research to assist the investment decision process.”

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Regional Review EUROPE: GREEK BANKING

THE TEMPTATION OF GREEK BANKING Economy Minister Giorgos Alogoskoufis has tried to discourage mergers among Greece’s leading banks, as their growing market share and reach in Eastern Europe is making them an increasingly attractive proposition. And while most analysts had predicted a downturn in their business, particularly in consumer lending, following Olympic year, the country’s banks have broken with expectations and have delivered yet another good year of growth and results. And that can only mean that Greek banks themselves are looking for more acquisition and growth opportunities outside the country. EW ANALYSTS WOULD dispute that much hinges on the performance of the Greek banking sector in the 2005/6 period. Growing competition for domestic, particularly retail business and opportunities in the natural hinterland of southern and southeastern mainland Europe is highlighting the current structure of the national banking system. If local market-watchers are right, the large Greek banks will continue to offer handsome profits to their shareholders in the next couple of years, likely propelling their shares to new highs. According to Thimios Bouloutas, General Manager of EFG Eurobank, “This year is especially healthy, growing 22% year on year, with net profit above 37%. Growth is coming from expansion in retail

lending, plus investment products and asset management and good returns from the capital markets.” Greek banks enjoy some of the highest spreads in the Eurozone although these spreads will likely converge to the European average over time. Nonetheless, the larger Greek banks offer an attractive growth profile along with a compelling restructuring story, notably that of the National Bank of Greece. Questions remain over the likelihood of a slowdown in domestic consumer loan growth along with a rise in nonperforming consumer and corporate loans next year could highlights a couple of risks to earnings. But even if that growth totters somewhat at home, Greece’s leading banks have the powerful consolation of expanding franchises in

neighbouring South Eastern countries that are witnessing buoyant retail loan growth and hefty lending spreads. National Bank of Greece, EFG Eurobank, Alpha Bank and Piraeus Bank are in this blessed group. The country’s leading banks have reportedly invested around €2bn to date on acquisitions and branch building in the southern and southeastern European countries of Romania, Bulgaria, Serbia, Macedonia and Albania, (please see Table: Greek Bank’s Market Share in South-eastern Europe), “which is emerging as a natural hinterland,” explains Michael Massourakis, Manager of Alpha Bank’s economic research division, “the Aegean is a lake of progress and Romania is the name of the game at the moment,”he adds. Turkey is also increasingly regarded as critical to Greece’s strategic ambitious to build a regional franchise that would enable them to compete on equal terms with Europe’s leading banks. The Greek decision to back Turkey’s candidacy for EU membership has significantly reduced

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Regional Review

containment and reduction programs that have registered effectively on the bottom line. They are also well capitalised. With the exception of Emporiki Bank, which subsequently launched a rights issue to strengthen its capital base, the other banks say they are capitalised enough to absorb all but a major credit meltdown. It is a testament to how rapidly the Greek financial system has evolved in recent years, following the privatisation of public sector banks, the careful segmentation of supervisory bodies in the financial sector (such as the Bank of Greece, the country’s central bank; the Capital Market Commission and the Supervisory Committee of Private Insurance), deregulation, and economic integration with the EU. Commercial banks have benefited most from these developments. Capital markets and insurance companies, by contrast, have not gained proportionately and remain small by European standards and the Greek institutional investment market, which is still dominated by state owned funds, with some notable exceptions, is by and large moribund. This structure has presented foreign banks entering the market with many challenges; particularly in the area of securities services. While recent legislation now allows investment funds to invest up to 23% of their assets in the stock exchange, prohibitions remain on the extent of Photo: EFG Eurobank. October 2005.

EUROPE: GREEK BANKING

perceptions of political risk in the says the bank sees “many attractive Aegean region. And now that Turkish opportunities in both equity and debt accession negotiations started in early markets.” Meanwhile, National Bank October, many market watchers of Greece, the country’s biggest bank, believe that several Greek banks may is considering possible investments try to accelerate entry to the Turkish working out from its representative market through acquisitions or joint office in Istanbul and Alpha Bank, ventures with a local partner. Turkey is which is known to have a close regarded as a critical element in the relationship with Turkey’s IflBank, is efforts of Greek banks to build a also looking for an active strategic regional franchise. It is vital that they partnership in the country. The trend is grist to an already do so, to enable Greek banks to maintain competitiveness in the EU profitably grinding mill. “Confidence market. There are also more pressing is higher than it has been for some concedes Massourakis. reasons, in a Europe keen to secure time,” long term gas supplies. Back in July Moreover, over the last few years the 2000, Greece and Turkey had agreed to Greek banking sector has also develop connections between their supplemented individual growth natural gas networks. Currently, the strategies with simultaneous cost two countries are working with the EUsponsored Interstate Oil Gas Transport to Europe (INOGATE) project, which provides technical assistance to modernise oil and gas transport in central Europe and Asia. In July this year construction began on the Turkey-Greece natural gas pipeline. The 186 mile pipeline will run between Karacabey, near Bursa in Turkey and Komotini in Greece, with a possible future connection to the Greece-Italy pipeline. EFG Eurobank, the private Greek bank controlled by the EFG Group, has taken an early lead by acquiring a majority stake in HC Istanbul Holding, a Turkish brokerage house Platon Monokroussos, for which it reportedly head of financial markets paid €20m. EFG research at EFG Eurobank Eurobank’s Bouloutas

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their freedom to invest overseas. Further moves to open up and spur the local pension fund market are likely, say economists. The first-half results for 2005 of the five large banks shows that consumer and mortgage lending portfolios expanded in double digits year-onyear, says Alpha Bank’s Massourakis. With the economy growing at 3.5% in the first six months of the year, underpinned by a more than 3% real increase in consumer spending, consumer volume loan growth is somewhere between 20% and even 30% on last year. In Greece that still presents opportunity, explains Platon Monokroussos, head of financial markets research at EFG Eurobank as there is a relatively low penetration of

household lending as a percentage of GDP in Greece relative to the Eurozone and the leading 15 economies in the European Union (EU-15). And while the commercial banks are enjoying halcyon days, they also face structural challenges— the most important of which include legal and institutional impediments to strengthening competitiveness. Continuation of this trend is dependent on continuing growth in consumer, mortgage and small business loans and that debt servicing in the retail sector continues at levels that do not require additional provisions for non-performing loans. Even so, the fact remains that Greek banks are an increasingly attractive proposition for foreign institutions

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keen to enter the growing South Eastern European zone. Even disregarding the opportunities presented in the wider hinterland, Greece itself is on something of a roll. According to a recent International Monetary Fund (IMF) report, issued in September this year, the Greek economy has been growing robustly for some time, sustained on the demand side by the sharp decline in interest rates (due to the adoption of the euro), financial market liberalisation and rapid growth in private sector credit. On the supply side strong capital formation continues, says the IMF. Immigration is also on the increase, particularly from South Eastern Europe. GDP growth is slowing

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Regional Review EUROPE: GREEK BANKING 24

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however, a natural consequence of the other public utility companies,” he to see the government not promising fall in domestic investment due to the adds. “It is encouraging to hear the handouts.” At the same time, a broad cessation of expenditures related to reform agenda of the government,” agenda remains: fiscal consolidation the Olympic Games, but, according to concurs Mylonas, “support for the must continue for a number of years, Paul Mylonas, head of the National reforms has gained ground throughout the need to act on pension reform is becoming increasingly pressing, and Bank of Greece’s strategic planning the economy.” Some of the changes are landmark: further structural reforms are required and research department,“Greek GDP growth is expected to grow at a much such as the realisation that lifetime in product and labour markets and in faster pace than that of the Eurozone. employment in the public sector the public sector. If these challenges are The inflation differential with the cannot continue. That and several met, Greece will be well placed to catch Eurozone is pushing real interest rates other bills, calling for a gradual up to the productivity and income to even lower levels.” For the time relaxation of corporation tax rules and levels of Western Europe, and benefit being, household consumption there are even suggestions of the from the economic development of spending is being supported by introduction of a flat-tax regime neighbouring countries. Against this backdrop, the authorities further credit growth and exports have “probably with a tax around 25% been boosted by continued strength in coupled with an increase in the tax have introduced policy initiatives in a the shipping sector and resurgence in threshold the most likely outcome,” number of areas. Most importantly, the tourism. And this is playing strongly adds Monokroussos.“It is encouraging 2005 budget aims for a significant cut in the deficit. In addition, in favour of the local reforms have been banking sector. Enjoying the benefits of structural change - Greek Banks vs. implemented to address Although investment is the FTSE/ASE 20 Index the pension difficulties set to rebound, demand will 140 faced by some banks, be weakened by the full 120 improve product markets impact of oil prices, further 100 and the business climate, erosion of international 80 increase labour market competitiveness, and the 60 flexibility, and promote gradual waning of the 40 infrastructure investment. beneficial effects of euro The top policy priority is entry. According to EFG 20 to reduce the fiscal deficit. Eurobank’s Platon 0 Despite strong economic Monokroussos, the growth and low interest government is trying hard Alpha Bank Bank of Piraeus (Cr) EFG Eurobank Ergasias Bank rates, the general to effect change that will Natl Bank Of Greece FTSE/ATHEX 20 Index government deficit rose keep the economy at full relentlessly during the tilt. Various bills aimed at Price returns. Data as at September 05. Source: FTSE Group / FactSet Limited past few years and, improving Greece’s although final estimates competitive position, such Offering an attractive growth profile - FTSE Greece Banks are still not available, as the extension of working Index vs. FTSE Developed Europe Banks Index significantly exceeded 6% hours in the retail sector, 350 of GDP in 2004. Rapid cheaper overtime pay and 300 growth in real primary more flexible overtime 250 spending (even excluding arrangements, that will 200 Olympics spending) increase efficiency and 150 underlies this flexibility in the local labour 100 deterioration. As a result market and retail of this poor fiscal companies are imminent. 50 performance, little The same thinking is now 0 progress has been made in being applied to public reducing the very high sector companies such as FTSE Greece Banks Index FTSE Developed Europe Banks Index level of public debt in state utility OTE, “that will relation to GDP. be used as a role model for Euro total return values. Data as at September 05. Source: FTSE Group

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Regional Review

Its exchanges and central securities depositories (CSDs) handle small volumes of business compared to the likes of Deutsche Börse, Euroclear or even a mono-market Western European depository such as Italy’s Monte Titoli. An off-the-cuff estimate by another custodian puts the combined market capitalisation of these markets at around a mere 10% of a market such as Spain. The accession of seven of the region’s markets to the European Union (EU) in May 2004 has raised the spectre of acquisitions by predators elsewhere in Europe. Given its track record, OMX – the everexpanding conglomeration of Nordic and Baltic exchanges – must be viewed as a prime candidate, although Deutsche Börse/Clearstream might also be tempted to look east given the

Euronext-Euroclear axis’s grip on large chunks of Western Europe. To head off such an eventuality, exchanges and CSDs in the larger accession states have looked at possibility of mergers of their own, but a combination of complex ownership structures, tax and legal issues and of course political considerations is expected to stymie consolidation in the short to medium term. The merger of the European Central Securities Depositories Association (ECSDA) and the Central and Eastern European Securities and Clearing Houses Association (CEECSDA) in early September to form a new enlarged association of European CSDs will help smooth the process of depository cooperation if nothing else. However, remote access facilities, the reform of securities law and the harmonisation

Photo: istockphotos.com. October 2005.

EASTERN EUROPE: CUSTODY

CUSTODY BUILDS UP STEAM

Following accession to the European Union (EU) custodians acknowledge that the markets of eastern and central Europe have performed exceptionally well. Accordingly there has been a lot of external interest, not just from global and regional custodians but also from tier two and three banks and broker-dealers. The pace of product development has picked up, not only in core custody but also in some of the larger markets to include remote clearing. By Tim Steele.

EASTERN EUROPEAN N OVERVIEW OF the subcustody landscape in Central and Eastern Europe poses a number of challenges. Not least is the fact that this patchwork quilt of markets only qualifies as a region in the loosest sense. Better to say that it comprises three longer-established states – Hungary, Poland and the Czech Republic – and an assortment of less developed emerging, and in some cases even pre-emerging, markets: Bulgaria, Croatia, Romania, Slovakia, Slovenia and the Ukraine. Serbia and Bosnia – “real frontier markets”, in the words of one custodian – might be added to that list. However, for the purposes of this article, Russia will be excluded, lest an already strained attempt to divine common market drivers and dynamics unravel completely.

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of market practice and technology are higher priorities. As for the custody business, broadly speaking there are today four main players across the region: Citigroup; Bayerische Hypo- und Vereinsbank Aktiengesellschaft (HVB), which since 2001 has owned Bank Austria Creditanstalt, for a long time itself one of the dominant providers in the region; ING Bank; and, latterly, Austrian-based RZB. Other smaller players include Intesa-owned Privredna Banka (Croatia); Ceskoslovenska Obchodni Banka, owned by Belgian bank KBC (Czech Republic and Slovakia); Kereskedelmi es Hitelbank, co-owned by ABN

AMRO and KBC (Hungary); Bank Millennium, Bank Pekao and BRE Bank (Poland); and Nova Ljublijanaska Banka and Societe Generale subsidiary SKB Banka (Slovenia). This is a significantly reduced field than was the case just five years ago, when in Poland alone there were no less than 15 banks offering licensed custody services. That process of consolidation moved another step closer to its endgame over the summer with the news that Unicredito Italiano â&#x20AC;&#x201C; the owner of Bank Pekao and Bulgariaâ&#x20AC;&#x2122;s Bulbank â&#x20AC;&#x201C; was to acquire HVB. As Andrew Carter, regional director for domestic custody services in

,UXEMBOURG

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EASTERN EUROPE: CUSTODY

European markets.” Carter. “They are going to move into BNP Paribas many new areas – for instance, they Securities Services will have to offer credit lines to is another provider support clearing and securities to support active in this area. lending/borrowing The Paris-based settlement, as well as a more regional custodian transactional oriented processing has been offering environment,”he says.“ And that will a remote solution require them to spend money, which for all new EU in turn puts more pressure on member states of smaller providers.” Indeed, just as smaller custody that zone for the past two years. players in Western Europe face a bleak The service, an future as a result of clients’ growing and geographic extension of the sophistication bank’s established diversification, so have mono-market M u l t i - D i r e c t providers across Central & Eastern Clearing and Europe found themselves increasingly Custody product, marginalised, explains Harry Devroe, allows clients of its director, securities services, Central & F r a n k f u r t Eastern Europe at ING Wholesale operation to access Banking.“We have seen huge leaps in those markets ‘over assets under custody, in part on the the counter’ via back of rising stock markets and new accounts held in investors coming in, many from Germany, adds countries that were not previously Harry Devroe, director, securities services, Central & Eastern Pierre Willems, interested such as Japan and the Europe at ING Wholesale Banking. BNPSS’s head of Nordics,” he says. However, clients in not just from global and regional local clearing, settlement and custody. general are gravitating towards To accommodate the nascent regional or global providers. custodians but also from Tier II and Tier “They have to devote less time to III banks and broker-dealers,” he adds. demand, custodians are becoming “The pace of product development has General Clearing Members, which in network management that way, plus it picked up substantially over the past turn alters their product profile, adds makes sense given that while the region’s markets are year, not just in terms of the growing, in terms of core custody component but Reaping the benefits of accession - FTSE Czech Republic, assets they are still far also in terms of opening up FTSE Hungary, and FTSE Poland Index vs. FTSE Developed smaller than the major some of the larger markets Europe Index 400 Western European to remote clearing. We have 350 markets,” Devroe ourselves introduced such a 300 continues. “Last but not product in Hungary, and 250 least, following the while interest is currently 200 Russian debt crisis in 1998 coming mainly from 150 many of the foreign global regional broker-dealers, it is 100 custodians and large expected that quite quickly 50 broker-dealers decided the larger broker-dealers, 0 they were better off using including the big UK and a Western [European] US houses, will also be provider rather than an considering remote FTSE Czech Republic Index FTSE Hungary Index indigenous bank.” The membership in the three key FTSE Poland Index FTSE Developed Europe Index events of 1998 continued central and eastern Euro price returns. Data as at September 05. Source: FTSE Group.

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Regional Review EASTERN EUROPE: CUSTODY

Photo: BNP. October 2005.

Photo: RZB. October 2005.

Austria, it holds €110bn invested in to reverberate around the region for 394 funds, most of them its own many years, he adds. ING itself was products. This expansion drive will be forced to look long and hard at its own overseen by Juergen Sattler, the bank’s operations in the aftermath: “Our newly appointed head of sales and assets had fallen significantly, so relationship management, custody questions were asked but we got back department. Sattler certainly knows into profit by 2002 and have remained the territory, having formerly been there ever since.” global head of sales and relationship If the number of providers has management for the region at Bank shrunk, competition nonetheless Austria Creditanstalt. remains fierce, says Devroe. “It is a “Traditionally RZB has operated tough dog fight out there.” along quite decentralised lines, the Like Carter, he sees demand goal was to expand into markets and growing for securities lending put ownership of that business in the services, and also identifies hands of the local operations. derivatives clearing as another up Juergen Sattler, RZB’s newly appointed head However, that model was better and coming area. “Of course the of sales and relationship management, suited for the retail market, so we needs in some markets are noncustody department. have now decided to take a new existent at this time, but in other approach on the institutional side,” markets they are now coming says Sattler. The HVB-Unicredito through: securities lending in the merger has given rise to no little Czech Republic is a good example,” uncertainty and trepidation, he he says. “So it is vital we keep our argues: “Clients are reassessing their eyes and ears open in order to ensure position in respect of various markets we take advantage of the and are looking at the alternatives, so opportunities as they arise, and get in that is something that has come at a on the ground floor rather than good time for us,”Sattler adds.“These becoming a ‘me-too’ player.” clients need to manage their risks Despite its extensive retail banking and this [consolidation] is a risk for business that stretches across Central them because no one knows what is and Eastern Europe and into Russia, going to happen in a strategic sense when it comes to custody RZB is to Bank Austria and the other currently the new kid on the block. affected providers.” The biggest bank in Austria, where it Pierre Willems, BNPSS’s head of local Further consolidation in the region is offers sub-custody and fund clearing, settlement and custody. definitely on the cards, he believes. administration services, RZB started “Local players are definitely life as a centralised out the business – to cover one international treasury, market is not enough,” says brokerage, payments and The merger of the European Central Sattler. “Certainly our clients, custody service for Austria’s Securities Depositories Association the global custodians and Raiffeisen banks. Now it is (ECSDA) and the Central and Eastern broker-dealers, are no longer looking to position itself as a European Securities and Clearing Houses interested in getting together regional and global custody Association (CEECSDA) in early September with local banks – they provider in Eastern and to form a new enlarged association of recognise the benefits a Central Europe. regional provider can offer in Traditionally, its operations European CSDs will help smooth the terms of legal agreements and in Eastern and Central process of depository cooperation if fees, along with the geographic Europe have serviced innothing else. coverage that you get from a house clients. As the largest multi-market package.” fund administrator in

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GROW WITH US IN CENTRAL AND EASTERN EUROPE. www.ri.co.at

Raiffeisen International Bank-Holding AG is a subsidiary of Raiffeisen Zentralbank Ă&#x2013;sterreich AG. It manages the RZB Group's subsidiaries in Central and Eastern Europe.

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Regional Review EASTERN EUROPE: PRIVATE EQUITY

A Buyer’s Market: Investor Confidence in Private Equity Private equity investment in Central and Eastern Europe is now in its fifteenth year. Over that time it has been estimated that more than €7bn has been raised by private equity funds dedicated to the region. Alex Sehmer reports. CCORDING TO THE European Venture Capital Association (EVCA), private equity investment in western Europe averages around 0.3% of GDP, while in eastern Europe—excluding Russia— private equity as a percentage of GDP is only 0.09%. Vindicating the region’s emerging market status, the figures indicate significant potential for growth as well as the holy grail of high returns for investors. An increase in private equity capital inflows is already well underway. EVCA figures show private equity investment in all of Central and Eastern Europe in 2003 was €449m. This represents an increase of 64% on 2002’s total value of €274m. Poland led the way, witnessing €177m of investment, followed by Hungry with €111m. Romania recorded a surprisingly high €82m and the Czech Republic saw €39m of private equity investment. Poland, representing approximately half the region’s population as well as half of its GDP, continues to command the majority of private equity

investment in Eastern Europe. However, while Poland may have the most active market in the region, it is Bulgaria that has seen Eastern Europe’s largest leveraged buyout (LBO) to date: the €1.2bn buyout of Bulgarian GSM mobile operator MobilTel, in May 2004. This deal saw international buyout firms CVC and ABN AMRO Capital come together to buy into the company; with the deal supported by a €650m debt package, arranged by ING Bulgaria, supported by ABN AMRO Bank and Citibank. The sheer size of the financing involved meant this was a deal for the big, international players, but the majority of deals in the region are done by smaller more localised private equity firms. Although international players dip into the region at the very high end of the market, these large investments make up only a small proportion of the buyout market in terms of the volume of deals. Private equity firms are well aware of the importance of local ‘know-how’, and those most active in the Eastern European market are investors with a strong local presence and good understanding of the region. Warsaw-based Enterprise Investors (EI), a large-scale investor by domestic standards, has been active in the region since 1990. The group is currently investing from its €300m Polish Enterprise Fund V, which is

now more than two-thirds invested. Darius Pronczuk, a partner at EI, says “The private equity business is a local business everywhere. It is essential to have local deals done by local people. In Central and Eastern Europe especially, where there are not so many auctions, you need to build local relationships to get the deals.” In July, EI invested €21.5m in the buy-in of Polish furniture fittings manufacturing business Gamet. The deal was comprised of a €5.4m equity investment by EI, which took 100% of the equity of the business, and completed with a senior debt package of €6.1m. More recently, in September, EI allied itself with Intel Capital, the corporate venture arm of microchip manufacturer Intel, to complete the buyout of Czech-based software developer Grisoft, acquired from current owners Benson Oak Capital. The deal was valued at €42m, with the equity groups acquiring a 65% stake in the company. Founded in 1991, Grisoft is a provider of security software solutions. “Grisoft has grown rapidly from a dominant provider of anti-virus software in the Czech Republic to a major player globally,” explained Gabriel Eichler, chairman of Grisoft and a founding partner of Benson Oak at the time of the buyout.“We felt that it was the appropriate time to bring in value-added investors such as

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The post-accession Enterprise Investors and Darius Pronczuk, a partner at EI says countries are inevitably Intel to help capture “The private equity business is a local drawn towards the Grisoft’s future prospects. common currency, but This was not the first business everywhere. It is essential to have adoption of the Euro time EI and Intel Capital local deals done by local people. In Central poses its own risks. A had joined in strategic and Eastern Europe especially, where there major problem “is the partnership. In July the two are not so many auctions, you need to potential conversion rate firms announced a €9.9m build local relationships to get the deals.” and the impact of this on investment in Romanian the competitiveness of the software company Siveco new EU countries,” says Romania. And EI has not ruled out further partnerships with fallen into line with the rest of the Pronczuk. However, he adds,“I think Intel in the future, given the right European community. In comparison the overall perception is that the to other emerging markets, the introduction of the Euro would have a circumstances. Although private equity fundraising advantage of Eastern Europe is that it positive impact on the economy and began as early (or late, depending on is fairly clear where that market is on private equity”. Eastern Europe cannot sustain how one likes to look at it) as 1990, going – it is falling into step with the following hard on the heels of the fall other (western) European economies. current high levels of growth forever, of communism, things really took off All the same systems are in place, they and it would be only prudent to assume after the accession of a number of just currently work more slowly in the that at some point at least one of the post-accession countries will suffer eastern and central European states to eastern half of the continent. Investor confidence has increased some form of economic or political the European Union (EU) in May last year. The date represented something with the region’s accession to the EU upheaval. However, the Eastern of an awakening for investors from the and asked about the risks associated European economies are now safely rest of Europe. ‘Since last May there with investing in Eastern Europe, within the EU, as well as more or less has been more interest from European Pronzcuk is upbeat. “Corporate comfortably within the private sector. players and the size of deals has governance and minority right There also appears to be no shortage of significantly increased,’ says Pronzcuk. protection risks are not much different potential deals. It is a welcome Although the region has seen more than in France or Italy. The foreign development for private equity players activity since the succession date, to exchange risk is still an important as they can avoid the auction process. be fair the groundwork had already consideration; local currencies are It is timely too, as many private equity been laid prior to that date. Neil nonetheless strengthening against the players are beginning to feel that prices are being pushed beyond Milne, a managing partner at Euro,”he says. ‘sensible’ levels. Copernicus Capital This ‘buyers’market’will Partners said in an Are Eastern European prices being pushed beyond ‘sensible’ change given time, of AltAssets round-table levels? FTSE Eastern Europe Index vs. FTSE Developed course, as more investors discussion that he was Europe Index join the fray. This month “…surprised at the extent 250 Belgium-based firm KBC of the reaction we have Private Equity – created seen, because from a legal 200 through the merger earlier and regulatory point of 150 this year of KBC Investco view the reforms associated and Ortelius - announced with accession to the EU 100 it plans to place local were all completed several teams in Poland, Hungary years ago.” 50 and Czech Republic. They Accession has meant 0 are not the first, and you that the risk profiles of the can bet your bottom zloty, Eastern European forint or koruna that they countries that joined the FTSE Eastern Europe Index FTSE Developed Europe Index will not be the last. EU have more-or-less Euro price returns. Data as at September 05. Source: FTSE Group.

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Latin America Focus LATIN AMERICA: INVESTMENT APPROACHES

Photo: EMPICS. October 2005.

In a photo released by the Miraflores Press Office, Venezuelan president Hugo Chavez speaks to business representatives from the United States at a trade meeting in Caracas. Source: EMPICs, September 2005.

Politics? What Politics? Despite a raging political crisis in Brazil, investors calmly look on as the stock market continues to set new record highs. Mexico’s markets have been equally rampant, showing little concern–so far–for the strong possibility that a left-wing government will assume power after the elections due in July 2006. Benedict Mander reports from Mexico City. NALYSTS HIGHLIGHT THREE basic reasons for the impressive performance of Latin America’s capital markets: unprecedented global liquidity propelled by the determined hunt for higher yields; a boom in energy and commodity prices, which drive the region’s economy; and the fact that Latin America’s economic fundamentals are in the best position they have ever been.

Increased liquidity in the global markets has been fundamental to Latin America’s recent strength. “This has been a stunning win for Latin America, which has historically been quite indebted. The world has been in love with debt recently, and bond yields have been falling,”says Michael Hartnett, a global emerging market strategist for Merrill Lynch in New York. Latin America’s bond markets have been deepening to such an

extent that Mexico is now considering issuing a 30-year bond, after it became one of the first emerging markets to offer bonds with a 20-year maturity two years ago. Analysts also emphasise the importance of China in Latin America’s continued appeal. China’s demand for oil and commodities has played right into the hands of energy and commodity-rich countries such as Brazil and Mexico. If anyone has benefited from the fallout of technology stocks, it has been technology-poor Latin America: the “old economy”is back in fashion. “There are new highs in pretty much every market, some of which are now breaking new levels almost by

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WHEN INVESTING, YOU NEED A LITTLE MORE. In emerging markets only the most accurate, up to date and detailed information will do. At FTSE we provide it. FTSE emerging market indices form part of the FTSE Global Equity Index Series. Which means they set unrivalled standards for transparency and rigorous analysis. Our emerging markets expertise is further demonstrated by the series of domestic indices we produce in association with high calibre local partners, combining their local knowledge with the technical superiority and precision you'd expect from FTSE products. We'd like you to try our service for yourself with a free data trial. To apply, or to receive recent research reports, please visit www.ftse.com/emergingmarkets BEIJING +86 10 6515 9265

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Latin America Focus

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management have helped to build up strong current account positions, with a number of countries running surpluses. This eliminates the risk of currencies becoming heavily overvalued and then crashing under the stampede of capital flight, as in the past. Some countries now even enjoy an investment-grade credit rating, with Mexico joining Chile in this category in January 2005. Barrionuevo is even more emphatic than Newman: “There has definitely been a paradigm shift in Latin America,” he says, pointing to sound Fundamentals Jose Barrionuevo, head of Latin American But external conditions by no monetary policy, the introduction of means explain everything – the flexible exchange rates, and increased research at Barclays Capital in New York. region’s policy makers deserve credit domestic saving boosted by pension the day,” says Jose Barrionuevo, too. Although Latin America’s three reform which has significantly increased director of emerging market strategy largest economies have all been struck demand for domestic assets. The for Barclays Capital in New York. He by serious economic crises in the last continent’s young population means questioned how much longer this can decade (Mexico in 1994-1995, Brazil in this trend is only likely to continue. “Latin America has historically go on for: “If they are over extended it 1998-1999 and Argentina in 20012002) there is a general feeling that been a story of inflation and debt, is on the equity side.” “Latin America has been as cheap as the prospects of similar crises in the and those two factors have improved dramatically – now we are seeing chips, and many would argue that Brazil future are now remote. “It is not that the region has fiscal solvency and an ability to repay still is,” says Hartnett. The major companies in the region are performing graduated to a new level, and is never debt,” says Hartnett, adding that this excellently, with Brazil’s oil company to see those levels of vulnerability has been made possible by low rates and inflation Petrobras, South America’s largest again,”says Gray Newman, chief Latin interest company, now having overtaken Nokia America economist for Morgan worldwide. “There has been a in terms of market capitalisation. Stanley in New York.“The difference is tremendous tail wind in Latin “People invest in companies, not how the region is dealing with it,” he America, it couldn’t have been a countries,”says Damien Fraser, the head explains. Floating exchange rate more perfect environment for of Latin American equity strategy for regimes and prudent macroeconomic investing,”added Hartnett. The fact that monetary UBS, who argues that the policy has been steered in a region’s political dramas Investing in Latin America is back in fashion... 300 savvy and conservative way will have little effect on has in particular attracted their performance. 250 investors’ attention, leading And investors believe 200 to such stable conditions there is still plenty of 150 that both Mexico and Brazil value left in many of these 100 have now embarked on a companies. Jaime cycle of interest rate cuts – Aguilera, chief of equity 50 for the first time in three research for HSBC in 0 years in Mexico’s case – Mexico, says that the even though rates continue Mexican stock market is to climb in the US. “This is not overvalued. Worries FTSE Latin America Index FTSE Emerging Asia Pacific Index the first time in Latin that Mexico’s economy is FTSE Eastern Europe Index FTSE Developed Index American history where beginning to cool off will Price returns (US Dollars). Data as at September 05. Source: FTSE Group. De c-9

Photo: Barclays Capital. October 2005.

LATIN AMERICA: INVESTMENT APPROACHES

not hamper growth, he says, as the index is underpinned by a dozen or so multinational companies that do not depend on the economy. These include giants such as America Movil, Cemex and Wal-Mart whose extensive activities in foreign markets insulate them from domestic problems. “They report strong results despite what is happening in Mexico,”he says, adding that for as long as these companies continue to thrive, the stock market as a whole will too.

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there is a counter-Fed monetary policy,”says Barrionuevo. Some argue that the declining interest rate differential between the US and Latin America may have the effect of drawing foreign investment away from the region, as yields become less juicy. “But it depends on the pace of the narrowing,” says Neil Dougall, head of emerging market economic research for Dresdner Kleinwort Wasserstein.“There will not be a major change in investor perceptions in the short term–obviously at some point investors will decide there are better opportunities elsewhere, but it strikes me that there is still quite a way to go–there might be a 75 basis point reduction in Mexican rates by the end of the year to 8.75%, but that is still significantly higher than US rates,” says Dougall.

Local debt issues A positive development to Latin America’s bond markets has been the increasing tendency to issue debt in local currency instead of dollars. This reduces the mismatch between assets in local currency and dollar liabilities by transferring currency risk to investors thus protecting against exchange rate fluctuations which have caused such havoc in the past. After Colombia set the stage by successfully executing a peso-denominated issue last year, Brazil raised $1.5bn of realdenominated debt in September in an offer that was heavily oversubscribed by investors, almost all from the US and Europe, who also benefited from considerable tax advantages. The rewards are “so compelling to investors that it is understandable that they are willing to take on not only country but also currency risk,” says Newman, who describes this as “a very important step forward”. “You can make the argument that

Gray Newman, managing director and senior Latin America economist in charge of all Latin American macro-economic research at Merrill Lynch in New York.

the only reason why inflation is low in Brazil is because the real is strong, as a result of the commodity boom – even if that is true, the end result of low inflation is that authorities can borrow more in local currency,”says Newman. “If authorities can get their house in order, then they are better able to withstand coming shocks,” he added. The recent upgrades of Chile, Peru and Brazil in 2004 and Mexico at the beginning of 2005 were all influenced by the increasing size of localcurrency-denominated debt in relation to their total debt. Argentina returned to the markets in style, after successfully restructuring the $100bn debt which caused it the largest default in history in 2001. “It is quite remarkable. We have a situation where the country defaulted very recently but is able to re-enter the capital markets so quickly,” explains Dougall. Nevertheless, aggressive pricing caused its most recent issue initially to

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2005

Photo: Merrill Lynch. October 2005.

REGIONAL REVIEW 10

be greeted coldly by the markets. “Investors were demanding a higher yield than the government was willing to countenance. There has been a testing process going on as to what rates the government can borrow at,” adds Dougall. Its success in attracting creditors, despite its recent history and the fact that it has not reached an agreement with the IMF, “tells you that Argentina has a market, and that that market thinks it is doing alright,” says Barrionuevo. But others feel that if there is a country that is riding the current bout of liquidity without using this opportunity to make long-term reforms, then it is Argentina. Storming oil prices explain the success of Venezuela’s outperforming markets. It has earned a great deal of attention from investors, despite the unorthodox economic policies of its populist president, Hugo Chavez. The Andean country has been enjoying an impressive cash flow in dollars because of booming oil revenues, enabling the

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LATIN AMERICA: INVESTMENT APPROACHES

this is not the case in Latin America. “With the exception of Venezuela, sound policies have been pursued in an effort to make structural reforms, so investors are not as concerned about regime changes as they used to be,”says Barrionuevo.“Mexico is more of a concern, and there may be more volatility than people think right now – the second quarter next year will be pretty volatile. But whoever wins faces the harsh Michael Hartnett, a reality of a need to global emerging market pursue reforms, or they strategist for Merrill will risk hurting growth Politics are not a worry Lynch in New York. Venezuela may be an extreme and causing social example, but the region in general has pressure,” he says. This shifted towards leftist governments – urgency for reform will also including Argentina, Brazil, Chile, have positive effects as it means “there if its equity markets pick up again. Ecuador, Uruguay and potentially soon is no risk of going back to extreme Considering that Brazil and Mexico enjoy the lion’s share of foreign Mexico. But this no longer seems to populism,”argues Barrionuevo. For investor sentiment to turn sour on investment in equities, Hartnett asked, bother the markets.“People love to talk about politics but they don’t matter Latin America, analysts say there needs “Could there be shocks from elsewhere unless the country is in a dire economic to be a sharp fall in commodity prices in the region? Yes – but look at what position,” says Hartnett, adding that together with an equally sharp rise in happened in Indonesia in August. Who bond yields, would have thought that a 25% dive in while policy the Indonesian equities market would Petrobras vs. Nokia - “As cheap as chips”? complacency is have no contagion on the rest of region? 10000 also an This is testament to the condition of important risk. emerging markets generally.” In a globalised economy, perhaps “Latin America 1000 will remain the biggest risk in Latin America is popular until no longer within, but without – even something else if the risk of contagion has markedly 100 comes along declined. “If the globe slows, then and takes away Latin America slows. That could that popularity,” cause a rethinking and a re-rating of 10 says Hartnett, Latin America risk. The mindset has suggesting that been that in good years it does Petrobras ON Nokia FTSE Global Equity Index Series Japan may better than the rest of the world, provide such an while in bad years it does worse,” Price returns based on logarithmic scale (US Dollars). outlet, or the US, concludes Newman. Source: FTSE Group/FactSet Limited.

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central bank to accumulate vast foreign exchange reserves. They have risen $10bn in the last year to $36bn, way exceeding levels reached during the 1970s oil bonanza. “It’s a very compelling story,” says Barrionuevo, who says that it will continue as long as oil prices remain high. “There’s no question that there is political risk, but there is a premium to it – and I don’t think that the risks of a political crisis are too significant right now. Chavez has always been very focused on honouring external debt payments,” he says, pointing out that as external debt is equal to 75% of its reserves it could buy back its entire external debt if it wanted. Few countries enjoy this luxury: Ecuador’s debt, for example, is seven times the size of its foreign exchange reserves.

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Photo: Merrill Lynch, September 2005

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BRAZIL’S HEDGE FUND PARTY IN FULL SWING When the hedge fund industry in Brazil got started in the mid1990s it grew steadily but did not take the market by storm. That changed about three years ago. Hedge funds based in Brazil became as hot as the girl from Ipanema. In many countries cash inflows to hedge funds have slowed after more than a year of lacklustre performance, yet in Rio de Janeiro and Sao Paolo the money is rolling in as if Carnival never stopped. Neil A. O’Hara reports from Boston. URING THE CHAOTIC months preceding the election of President Luis Inacio “Lula” da Silva, international rating agencies downgraded the country’s credit and the Brazilian Real fell 40% against the US Dollar as capital took flight. That prompted some foreign banks, including Deutsche Bank, Dresdner Bank, Lloyds Bank and JPMorgan, to scale back their asset management operations in Brazil, according to Mauro Bergstein, a managing director of Credit Suisse Asset Management (CSAM) in Brazil. Meanwhile, local commercial banks trying to build their asset management operations went on an acquisition binge that left some talented money managers out of a job. “A lot of very good people at those institutions – not only foreign institutions, but also smaller local banks – decided they didn’t want to work for the largest commercial banks,” Bergstein says, “They thought the same thing that happened in the US and worldwide could happen here. They got together with two or three colleagues and opened small independent hedge funds.” The market was ripe. Changes in regulations governing investment companies had opened the door to

local hedge funds. Paulo Bilezikjian, co-manager of the Alpha Fund at Hedging Griffo, points out that several prominent Brazilian families had sold their businesses in the late 1990s and were flush with cash. “These things came together,” he says, “More people were thinking about their own businesses. They saw the opportunity to create a fund and make money.” Founded in 1997, Hedging Griffo is one of the largest and oldest established Brazilian hedge funds. Market volatility piqued investors’ interest in hedge funds, too. “People decided they had to diversify through a multi-market strategy [hedge funds] that can profit in either bull or bear markets,” Bergstein says. The fund of funds business took off at the same time, sponsored by all the major players in Brazilian finance: Banco Itaú, Unibanco, HSBC Brazil, Bank of Boston Brazil (now Bank of America), Santander, ABN AMRO, Banco Pactual and Hedging Griffo. “They have tremendous power in terms of the flows they control,” he says,“They can kill a manager if they decide to redeem.” The redemption threat looms large in a market where most funds offer daily liquidity. International offshore

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funds typically offer monthly liquidity but lockups may run as long as two years for domestic US hedge funds. Some newer funds launched in Brazil by established players like Hedging Griffo have stretched to monthly liquidity, while Gavea, a global macro fund run by Armenio Fraga, a former president of Brazil’s central bank and erstwhile aide to George Soros, got away with 90 days. But these are exceptions. “It is atrocious,” says Bilezikjian, “It is a structural problem. Daily liquidity doesn’t benefit investors at the end of the day. It works against them.” Hedge funds have to maintain a margin of liquidity to meet potential redemptions and may be subject to erratic cash flows, both of which crimp returns. Even successful hedge fund managers may find it hard to extend the lockup unless they are willing to forgo money from funds of funds, most of which also offer daily liquidity. “Funds of funds will not be able to invest in 30-day funds if they have daily liquidity themselves,” Bergstein explains. That hasn’t deterred CSAM, which closed its daily liquidity long short equity fund to new investors and is working on a new fund that will have 30-day liquidity. Local hedge funds have come to rely heavily on third party distributors, according to Bergstein. CSAM now has contracts with 45-50 different firms, up from five in 2002. “Third party distributors have been a very effective channel for hedge funds and for almost all asset managers in Brazil, including ourselves,” he says. That marketing muscle has contributed to the growth in hedge funds’ assets under management. CSAM created its daily long short equity fund in April 2004 and closed it in March 2005.“In less than one year it went from zero to Rs470m,”Bergstein marvels. Just how much money Brazilian

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Latin America Focus LATIN AMERICA: INVESTMENT APPROACHES

hedge funds manage in total is unclear. Figures compiled by the Associação Nacional de Bancos de Investimentos (ANBID) tally Rs145bn in “multi-market strategies funds,” a category that includes both leveraged and unleveraged funds. CSAM’s hedge fund unit tracks performance and fund flows for about 20% of that segment, explains Bergstein. Most multi-market funds are balanced funds that shift their allocations between fixed income and equities rather than true hedge funds, according to Thyrso Pizzoferrato, who heads Mercer Investment Consulting in Brazil. Exame, a Brazilian business magazine, recently published a list of the 25 largest leveraged funds. Their total assets amounted to Rs12bn, but Pizzoferrato thinks even that figure overstates true hedge fund assets. Institutional investors have shown little interest in local hedge funds so far. High real interest rates act as a deterrent. “Pension funds can make something like a 17% real return in the money market,” says Pizzoferrato, “Why do they need exposure to a hedge fund?” High real interest rates amplify losses, too, because the cost of carry is so steep. Pizzoferrato believes multi-strategy funds are also inappropriate for pension funds because they already have both fixed income and equity portfolios. “They don’t need a multi-portfolio fund,” he scoffs,“That is what they are.” Wealthy private individuals willing to accept more risk have fuelled the growth in hedge fund assets. Jean van de Walle, senior vice president and portfolio manager for emerging markets at Alliance Capital in London, observes that wealthy Brazilians often adopt a barbell investment strategy. “They keep a very significant part of their assets as a cushion in low risk money market instruments,” he says, “At the other extreme they seem to

Photo: istockphoto.com. October 2005.

have a tolerance for much more aggressive investments.” Brazilian hedge funds face liquidity constraints that preclude them from many strategies found in developed markets. Equity long short and global macro funds like Hedging Griffo’s Alpha Fund predominate. “We do not have fixed income long short,” says Bilezikjian,“It is amazing, but the local currency bond market is very illiquid, even though it is huge. The strategies are limited because we don’t have so many asset markets.”Credit derivative and high yield bond markets do exist but cannot yet support hedge funds dedicated to them. Opportunities in niche strategies like merger arbitrage are scarce. The narrow market creates a potential headache for funds of funds, Bergstein says. A fund may be diversified among managers, but if the underlying funds are all doing the same thing the risk is still concentrated. He expects other hedge fund strategies to develop as the local financial markets mature. Recent regulatory changes should help. In spring 2002, some fixed income funds were caught pricing their assets off the yield curve instead of marking them to market, Bergstein says, saddling investors with unexpected losses in a volatile market. The scandal prompted the Comissão de Valores Mobiliários (CVM), Brazil’s financial regulator, to demand greater transparency on pricing, improved

fund governance and enhanced disclosure to investors under Resolution 409, which it adopted in November 2004. The government changed the tax laws relating to investment funds, too. Fixed income funds (a somewhat misleading designation for funds that may have up to 67% exposure to equities) qualify for more favourable tax rates if the average maturity of their portfolios exceeds 365 days. Bergstein says CSAM’s equity long short fund, which holds no more than 49% in equities, migrated to the long term category along with most other hedge funds. They had little choice; the funds of funds threatened to redeem unless they could deliver long term tax treatment. The tax rate declines in six-monthly intervals from 22.5% at the outset to 15% (the rate that applies to equity funds) for a fixed income fund held more than two years, so the new rules may discourage churning. That may help stabilise cash flows. Brazilian investors have proved fickle in the past, says Bilezikjian, who cites “three or four cases of funds going from $300m in assets to $20m in the last 12 months.” Established players such as the Alpha Fund are less vulnerable; it has not suffered despite uninspiring performance this year. “We still have credibility,” Bilezikjian says, “The fund has been closed for a long time so we don’t have that problem – at least not so far.” Looking forward, he believes Brazilian hedge funds will continue to grow, especially if real interest rates drop, as he expects. “That might make this industry grow significantly – hedge funds and everything else,” he says. It might also bring more competition from foreign hedge funds looking for opportunities in a market that looks cheap relative to its peers.

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In early October, the JSE Securities Exchange South Africa (JSE) has launched two new exchange-traded funds (ETFs), the Itrix FTSE 100 and the Itrix Dow Jones EURO STOXX 50, that take advantage of the relaxation of rules governing the amount of money South African private investors can invest in overseas stocks—as long as they are listed on the JSE. HE JSE’S NEW ETFs offer investors exposure to the stock market performance of offshore markets. The ETFs offer two advantages to local investors. The first is their cost efficiency, as local private investors can gain offshore exposure at the same price as buying a listed stock on the JSE. The second advantage is Itrix’s ETFs’ exemption from South Africa’s tough exchange controls andthe fact that no maximum investment is imposed on retail investors. The relaxation of rules governing the amount of money South African investors can put into the ETFs does not apply to institutional investors, explains Leonard Jordaan, manager, specialist securities, JSE. The Itrix FTSE 100 ETF will track the performance of the 100 largest shares on the London Stock Exchange, which includes heavyweight stocks such as BP and HSBC. Investors in the Itrix Euro 50 meanwhile will track the 50 most liquid blue chip stocks from countries within the Euro Zone, such as Deutsche Bank and Deutsche

Telekom. The Itrix prices track the rand value of 1/1000th of the underlying index levels. The Itrix’s first day on the stock exchange saw R1.6m worth of trade in the Itrix FTSE and R1.45m value traded in the Itrix Euro. JSE’s Jordaan explains that virtually all trades bought through Itrix market maker Deutsche Bank. “While it does not appear to signify huge numbers, in terms of who it is designed for, we are immensely pleased with the volume of take-up by private investors.” It is a significant move in a market in which ETFs are in their infancy. As well, ETFs are still largely underutilised by South African institutional investors. “Overseas some 80% of the liquidity in ETFs comes from the institutional sector, while in South African this ratio is still very low indeed,”says Jordaan. The JSE already has a number of domestic ETFs under its belt – five to be exact. The Satrix40 ETF was launched in South Africa in November 2000. It is not only an ETF but also a registered unit trust, and a listed stock to boot. Simply put, it is a passive investment vehicle that holds weighted investments in the 40 biggest JSE stocks. As the weightings change, so Satrix-40 is passively managed, adjusting its portfolio; as such, Satrix-40 can also be described as an “index tracker”fund. In addition, the JSE also offers the Satrix FINI Index ETF, which cover the country’s top 15 financial stocks, while the INDI 25 provides access to the country’s 25 leading industrials. It has offers a specialist New Rand ETF that covers a basket of the top 10 Rand hedge

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AFRICA: SOUTH AFRICAN ETFs

New JSE ETFs build on easier local investment limits

stocks, which is calculated by FTSE and another specialist gold sector ETF, called NewGold. NewGold is also a public company incorporated in South Africa, and represents a joint initiative with the World Gold Council, following several similar initiatives on a number of stock exchanges around the world, including those in the US, UK, Canada and Australia. South Africa posed a special challenge for the listing of an ETF representing an investment in gold bullion as ownership of “unwrought gold” is restricted in the country. Gold bullion is actually considered to be foreign currency. Itrix, the special joint venture vehicle established by the JSE and Deutsche Bank to issue the ETFs, successfully raised R224m in a prelisting initial public offering, the majority of which came from retail investors. Jordaan hopes to attract R1bn in the next six or seven months. According to JSE statistics, the FTSE 100 has experienced growth of 312% in Rand terms over the past ten years, whilst the Dow Jones EURO STOXX 50 has seen growth of 405% during the same period. According to Jordaan, the JSE intends to list two additional Itrix ETFs in the first part of 2006. One is intended to track “a major US index, while the other will probably involve a specialist Japanese index.” The intention continues Jordaan is to “provide South African investors with access to a broad range of international ETFs in the future.” At the same time, Jordaan is keen to promote the JSE to the international institutional investment community. “The domestic ETFs are the lowest cost method of getting access to South Africa, as they have a tracking error of below 10 basis points. They have to be a good deal for the institutional market.”

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Regional Review ISLAMIC FINANCE

INVESTOR INTEREST HOTS UP IN THE MIDDLE EAST If the current mania for emerging market, or at least Middle Eastern risk exposure is exemplified by a single transaction, then Dana Gas’s initial public offering (IPO) in early October is a proper bellwether. Dana Gas spokesmen reported that its Dh2.06bn debut was oversubscribed to the tune of Dh280bn (about $76bn). The company also said individuals and institutions from 87 different countries had applied for shares in the Dh1.27bn wholesale tranche of the IPO—another record for a regional offering. ANA GAS’S OFFERING shattered record after record for Gulf IPOs in 2005. The Sharjah-based issuer is the United Arab Emirates (UAE) first private sector natural gas firm and its debut was oversubscribed 140 times by almost 400,000 subscribers. HSBC Middle East is lead manager and financial advisor for the offering. Around 23,000 shares have been allocated to Saudi investors – institutional and retail, who flocked in large numbers to the Emirate, blocking flights and overrunning local banks. The offering initially had sought to raise $560m for a 34.33% stake, with the remaining 65.67% equity coming from the 300 founding shareholders, including the Sharjah government and Crescent Petroleum. Interestingly the response to the IPO was illustrative of two key facts. The first is that Emirates needs a modern, transparent, and efficient way of launching IPOs – a fact clearly illustrated by the near farcical scenes which greeted the 10 banks selected to process applications in the first

week of October, as they were reported overrun by investors anxious to secure shares. Analysts say that Dana Gas’s IPO will probably be the last of this style of UAE IPO. The establishment of a new Company Law is widely expected to tighten up flotation and share pricing procedures. Even so, the IPO genuinely reflects the substantial stepping up of investment interest, both domestic and international, in the Middle East and in particular Islamic financing issues through 2005, a natural consequence of improving sentiment following a protracted period of high oil prices. Dana Gas is being established as the first regional private sector natural gas resource company in the Gulf, with existing assets in the supply, transportation, processing and marketing of natural gas, and plans to expand in this rapidly growing energy sector throughout the region and the wider Middle East, including into upstream exploration and production, and downstream into gas-related industries. The company is also reportedly investing in a new gas pipeline from Iran, due to

open later this year. In a further innovative move, applications for shares were open to all Gulf citizens, which led to a stampede as historically UAE IPOs have performed well in the aftermarket. Local investors had, however, been chary, given reportedly high levels of institutional interest in what was the largest IPO in UAE history. Applications for the IPO closed on October 3 although the listing itself will not occur until January 2006. UAE banks allowed those who could not travel to the Emirate to open their accounts with them on the basis of attested authorisation letters. The response to Dana Gas brought out local issuers in larger numbers for even miniscule transactions in the region. Even usually anonymous and modest Omani issuers have been able to leverage the trend, as Taageer Finance’s RO4.26m (about $11m) IPO raised RO18.4m and was oversubscribed by more than three times. The company, which specialises in leasing, floated a 3m-share offer, receiving applications from more than 10,000 investors. The IPO, with an offer price of R1.42 per share, was closed on October 9, with local analysts saying the relatively modest take-up in today’s terms was due to the fact that 85% of the issue was earmarked for small investors, giving institutional funds little scope. Even so, it was a benchmark of sorts, for a small Omani company whose 2005 first half profits had risen by only a modest 12%. Investors in the region have benefited not only from competition for shares which have steadily pushed up prices, but also from a growing diversity of choice. And this year, appears to be one of firsts for local issuers. Bahrain-based Gulf International Bank (GIB), for example,

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announced the issue of a $400m 10year subordinated floating rate note (FRN) at the beginning of October— the first subordinated bond issue by a Middle Eastern financial institution. “Following a successful road show in Europe, the order book grew to a total of $1.1bn in only one week after the launch of the bond issue. In view of the exceptionally high demand, the size of the bond issue was increased to $400m,” said Dr Khaled M. Al-Fayez, GIB’s chief executive officer. “At the same time, we were able to reduce the pricing from the initial price guidance of LIBOR plus 75 to 80 basis points down to a coupon of LIBOR plus 70 basis points,”he added. “We were also particularly pleased with the distribution of the transaction,”he continues. Over three quarters of the investors in the bond were from Europe, the United States and Asia, many of which are new to both GIB and the region, reflecting growing interest in the Middle East and GIB’s positive ratings. GIB’s credit ratings have been upgraded by Standard & Poor’s (to A-), Moody’s (to A3) and Capital Intelligence (to A) this year, reflecting GIB’s growing Gulf Cooperation Council (GCC) merchant banking franchise. GIB is one of the largest regional banks in the region, with more than $20bn of its own assets and in excess of $16bn of clients’ assets under management. The subordinated FRN will further enhance the bank’s regulatory capital base, thereby facilitating planned asset growth and will improve the bank’s liquidity profile. GIB has raised $1.2bn of new term financing since the beginning of 2005. In 2002, GIB was the first Middle Eastern financial institution to issue a senior FRN, with a $325m 5year floating rate note. Additionally, the bank finalised an $800m syndicated 5year term deposit facility, the largest syndicated term finance facility raised

by a regional financial institution. The subordinated FRN has a coupon of 70 basis points over threemonth LIBOR and a tenor of 10 years with a call option at the end of 5 years. It has been rated Baa1/BBB+/BBB by Moody’s, Standard & Poor’s and Fitch respectively and is listed on the London Stock Exchange. The subordinated FRN has also been approved for inclusion in Tier II regulatory capital by the bank’s regulator, the Bahrain Monetary Agency. The bond issue was lead managed by Barclays Capital and Citigroup. The size of the bond issue was increased from $300m to $400 following high demand from local and international investors. The issue was almost four times oversubscribed. The Bahrain Monetary Authority (BMA) meantime debuted with an asset-backed 182 days (six months) term tradable Ijara sukuk, or Islamic leasing bonds, denominated in Bahraini Dinar (BD). The issue began in August and matures in February next year. Demand for the issue was high, with the reporting that the bonds were 222% oversubscribed. The bonds will be issued in denominations of BD10m (about $27m) on the last Thursday of each month. Each issue will carry a fixed rental based on the prevailing sixmonth LIBOR rate, with the return paid on maturity. The return on the bonds is reported at 4.6%. The Ijara sukuk is issued by the BMA on behalf of the government of Bahrain and which also acts as guarantor. The BMA in turn benefits from the favourable risk rating of the government, which enjoys a local currency rating of A from both Standard & Poor’s and Fitch. International banks have been active in this market with HSBC, UBS and BNP Paribas all involved in sukuk issues in recent years —an illustration

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of their growing mainstream appeal. For the countries involved the progress of Islamic bonds means a new source of funds for infrastructure projects. Each sukuk issue is available to Islamic and non-Islamic banks which are licensed by the BMA, as well as pension funds in Bahrain. The sukuk can be traded to facilitate short term BD liquidity management, says the Authority. The BMA has made clear that it will allow subscribing institutions to use the short term Ijara sukuk as collateral against short term credit facilities issued by the Authority in the hope of adding further depth to the primary Islamic debt market in Bahrain. The BMA is a regular issuer of Ijara sukuk, having issued more than $1.1bn in sukuk to date, although most of the bonds have been medium to long term. In 2004, the BMA issued the longest tenor sukuk to date, with a BD40m 10 year facility. Growing confidence by local issuers has meant, in turn, more diversification in new investment offerings. In early September National Bank of Dubai (NBD) launched its first European Real Estate Fund. However, the financing story of this year in the Gulf is sukuks with Dubai Islamic Bank (DIB), acting as the mandated lead manager for Emirates on the launch of the world’s first airline Sukuk bond. The issue, which has a seven year maturity, has a semi-annual coupon, was priced at 0.75 above the London Interbank dollar rates. The deal was oversubscribed by almost 50%, was closed at $550m as originally targeted. The deal was a joint effort of a prestigious consortium of local, regional and international banks, led by DIB. The issue was managed by a six-member group of banks acting as Joint Lead Managers including DIB, National Bank of Abu Dhabi, Gulf International Bank, Standard Chartered Bank, HSBC and UBS.

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SECTOR REPORT: BREWING

Trouble is a’ brewing in the beer industry. It has been a particularly brutal and rough year for the Molson Coors Brewing Company (TAP), formed only last February by combining Canada’s Molson with America’s Coors. Although it is the world’s fifth-largest brewer and expects to ultimately realise annual savings of $175m as a result of the merger, the outlook is daunting. Eventually, it almost certainly will need to combine with a competitor in order to thrive. Art Detman explains why.

Brewing

A STORM

OES W. LEO Kiely III have the toughest job in the worldwide beer business? A former potato chip executive who joined Adolph Coors Company in 1993 he became chief executive officer (CEO) in 2002. Now after a ‘merger-of-equals’ with Molson Inc., he is CEO of the combined company, which is expected to brew nearly 50m barrels of beer this year that will be sold under more than 40 brands in the United States, Canada, the United Kingdom and Brazil. Revenues are expected to reach $6bn. And profits? Well, it is hard to say what they might be right now. Kiely for one is not making any projections or, for that matter, talking to the press. Little wonder. The fact is that Molson Coors faces big problems in profitability, market share and volume. The company reported a loss of $46.5m for its first quarter this year, catching investors by surprise. That’s not all. The announcement triggered a one-day drop of 18.5% in the stock price, class action lawsuits in the United States and Canada, and an inquiry that is now under way by the US Securities and Exchange Commission (SEC). Then Kiely announced disappointing second quarter results – net profits were $39m, down 46% from the year-earlier quarter. He also restated first quarter numbers, boosting the loss to $75.7m. The fallout began to worsen. “Management of Molson Coors is not off to a good start in the area of credibility,” dryly notes Anthony J. Bucalo, a Bear Stearns analyst in New York. Actually, it should have come as a surprise to no-one. In the US TAP’s margins are being squeezed by AnheuserBusch’s (the producer of Budweiser) refusal to take its usual annual price increase. Instead, it has vowed to do whatever is necessary (in other words prosecute a price war) to maintain its 50% market share against newly invigorated

Miller Brewing, which now has 18% of the market. Coors Brewing – smallest of the Big Three – with only an 11% market share is perforce caught in the crossfire. Miller, now part of SABMiller, the second-largest brewer in the world, has savvy new managers that have boosted the market share of Miller Lite, which competes head-tohead with Coors Light – Molson Coors’ most important brand and perhaps its only important brand in the US. Even as Coors fights for traction in the US, imports and socalled craft beers continue to grow taking market share away from the Big Three. In Canada, TAP’s Molson brand has slipped to second behind Labatt. In the past, Molson and Labatt often traded places at the top yet remained friendly competitors, sharing a duopoly and maintaining generous margins. In 2004, for example, Molson’s operating profit margin was 23% versus only 8% for Coors US. But Labatt is now part of InBev, the world’s largest brewer (formed by the combination of Belgium’s Interbrew and Brazil’s AmBev), and InBev can be expected to put unrelenting pressure on Molson in a drive for dominance. Meanwhile, both Molson and Labatt have lost ground to sub-premium brands, brewed mainly by independents. TAP has responded with its own economy labels such as Keystone, but their economics are unfavourable. “It costs just as much to make discount beer as it costs to make regular beer,” says Michael Palmer, an analyst with Veritas Investment Research of Toronto. “If you reduce the price, you give up margins.” Perhaps worst of all, there has been a near halt in the growth of beer consumption in the US and Canada, Molson Coors’ two largest markets in terms of profits, as consumers turn more and more to spirits and wine.

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SECTOR REPORT: BREWING

In the United Kingdom, TAP’s second-largest market by sales, volume unexpectedly fell 5.8% compared with a 4% decline for the overall beer business. Coors Brewing Limited, whose flagship brand is Carling, remains the United Kingdom’s number two brewer, with a 20% market share, behind Scottish Courage’s 25% share and just ahead of InBev’s 19% share. Although the trend in the UK is disappointing, the situation in Brazil is nothing short of a calamity. Under CEO Dan O’Neill, Molson first acquired the maker of Bavaria, a bit player with 3% of the market. Then it paid $765m for Cervejarias Kaiser, also an economy label but one with a 15% share. Molson then sold a 20% interest in the combined operation to Heineken for $225m, and then watched market share drop steadily to around 8.4% now, versus 68% for InBev’s AmBev. Meanwhile, operating W. Leo Kiely III losses grew, topping $66m in 2004. Much to the irritation of analysts, Kiely has refused to say what he intends to do with the operation. Mark Swartzberg of Legg Mason Equity Research in New York is hopeful that he will sell it and estimates it would go for $150m. This would result in a $390m hit to TAP’s balance sheet, but it would stem any bleeding on the income statement. It’s a fact. There are problems in every one of Molson Coors’ major markets (the US, Canada, the UK and Brazil) – uncomfortable positions for a holding company whose principal operating companies have such rich heritages. Molson Inc. was North America’s oldest brewing company, founded in Montreal in 1786 by John Molson, a 23-year-old English immigrant. At the time of the merger, it was Canada’s largest brewery, and had been headed by a family member for seven generations. Coors Brewing Company dates to 1873, when German immigrant Adolph Coors, then 29 years old, built a brewery in Golden, Colorado, which eventually became America’s largest. Until the merger, a Coors had always been chairman of the board and (until Kiely’s elevation in 2002) the family had provided the company CEO as well. With the merger, Eric H. Molson, who had been chairman of Molson, became chairman of the board of the new company. Two vice chairmen were elected: Peter H. Coors, formerly chairman of Coors, and Daniel J. O’Neill, formerly president and CEO of Molson. Although structured as an acquisition of Molson by Coors, Molson shareholders became owners of 55% of the new company, which has – according to the proxy statement – “dual executive offices and dual operational headquarters” in Montreal and

Photo: Molson Coors, September 2005

GM EDITORIAL 10

Golden. However, Kiely and his chief financial officer, Timothy V. Wolf, work largely out of Golden. The proposed merger was embroiled in controversy from the start. Ian Molson, the company’s former deputy chairman and a distant cousin of Eric’s, vehemently opposed it. So did many institutional owners of Molson stock and Coors stock alike. For a while, the merger appeared doubtful. Then Molson shareholders were offered a special dividend payable upon approval of the transaction. As a show of confidence in the merger, Pentland Securities, the Molson family trust, waived participation in the special dividend. But only when this “sweetener”(as press reports termed it) was increased by a whopping 68% to $532m did approval begin to seem certain. The special dividend was, of course, really a return of capital and made with borrowed money. This caused Standard & Poor’s Rating Service to place TAP on its CreditWatch list, perhaps an overreaction, especially in light of TAP’s subsequent hefty increase in its cash dividend. The sweetener worked however and Molson Coors was established, although even today it still evokes harsh criticism. Palmer of Veritas says of the merger that “there was no need to do it. Molson was having serious problems in Canada, which are going to become evident over the next few months.”He also scoffs at the special dividend.“I surely would not have paid the Molson shareholders extra. I thought Coors overpaid in the first place.” Tom Pirko, president of Bevmark, a California-based consulting firm, is another doubter. “There were several problems at Molson before the merger, and those problems

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Photo: EMPICS. October 2005.

SECTOR REPORT: BREWING

certainly have not been ameliorated or solved by the combination with Coors. Molson is a company that made a very questionable decision to join Coors on what we considered to be disadvantageous terms.” Len Racioppo, president of Jarislowsky Fraser, a Canadian fund manager that sold its 4.5m Molson shares, also opposed the merger, but for quite different reasons. “We didn’t think there was anything brought to the table by merging with Coors US,” he explains.“First, we didn’t think it made strategic sense to tie up with a numberthree player in the States. Second, as an equity shareholder we were being disadvantaged by the principal shareholders – the Molson and Coors families – with their voting stock. And third, because of the outstanding options, the dilution was ridiculous: 11%. As for paying us a dividend, half of that came off the Molson balance sheet. Why should that attract us?” Since the merger, there has been an exodus of highranking executives at the new company. O’Neill, a former president of Star-Kist Foods and Campbell Soup who himself had replaced many senior managers after becoming Molson’s CEO in 1999, left the company with a $4.8m severance package plus $33m in stock profits realised from an options grant. And a dozen senior Coors executives opted to take lucrative buyouts under their change-of-control agreements. Not all their replacements are experienced beer executives. For example, Frits van Paasschen, now president and CEO of Coors Brewing, the US operating company, had been at Nike and before that Disney.

Beer and brand positioning In today’s fiercely competitive US beer market with its heavy emphasis on advertising and brand positioning, consumer marketing expertise is more important than just knowing how to brew beer. Some say that Aldophus Busch,

founder of Anheuser-Busch, believed this in the 19th century when he emphasised selling the most beer, rather than brewing the best beer. Today his descendant August Busch III would insist that Anheuser-Busch is committed to both goals. But certainly a marketing milestone can be traced to the 1969 purchase of Miller by Philip Morris. Is there a lesson here for Molson Coors? There are two problems with marketing campaigns intended to change a beer’s image. One is that they sometimes do not work. The other is that they do. Take, for example, Coors’ reluctant introduction of Coors Light, launched in response to Bud Light and Miller Lite. Coors had produced probably the industry’s first light beer in 1941. Called Coors Light Beer (the Coors were very literal men) it had only 3.6% alcohol by weight instead of the industry standard of 4.5%. It was an instant success, but was discontinued during World War II. However, Coors reduced the alcohol of main brand – what is now called Coors Original – to 3.6%. After the war, as before, Coors could hardly make enough beer to keep up with demand in the eleven western states where it was distributed. In California, which it entered in 1937, Coors accounted for half the market; in Oklahoma, a breathtaking 70%. East of the Mississippi, Coors was an exotic and highly coveted brand. People brought back cases of it when they visited the West. Coors was not as dominant by the time Anheuser-Busch and Miller unveiled their light brews. But management was perplexed. After all, Coors already was a light beer. It said so right on the label: “America’s Fine Light Beer.”Making a lighter beer would be like asking Picasso to paint a paler shade of white. And so Coors Light languished at first, without a strong identity even in its shiny aluminum can. But then someone – and it is not clear who – proposed using the product’s in-house nickname in the advertising. The Silver Bullet was born, and it became a big success. But the Silver Bullet nearly killed Coors Original, whose sales plummeted. Today it ranks 19th, behind even Coors’ economy Keystone label. Beer drinkers decided that Coors and Coors Light were really the same beer, and they liked the Coors Light brand image better. Much the same thing happed to Miller High Life, which was downgraded to an economy beer after the success of Miller Lite and Miller Genuine Draft, which like Coors is a non-pasteurised, cold-filtered beer. Only Anheuser-Busch has been able to keep its original flagship brand a premiumpriced bestseller. Budweiser now ranks second to Bud Light.

Eric H. Molson, Molson Coors Brewing Company chairman of the Board photographed talking to the press after the company’s annual meeting in Montreal May 11th 2005.

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A BOTTLED HISTORY OF AMERICAN BEER

Bottles of Coors roll off the production line in Golden, Colorado on Wednesday July 21st 2004. Molson Coors Brewing Company is the fifth largest brewer by volume reported on April 28th 2005 that it had swung to a first quarter loss due to lower sales volume in key markets and charges related to the recent merger between Molson and Coors.

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Photo: EMPICS. October 2005.

OR WELL OVER a century, beer drinkers in the US and Canada were served primarily by hundreds of small, family-owned breweries, controlled usually by the descendants of their founders, largely German immigrants. Eventually, a handful of breweries – notably Anheuser-Busch of St. Louis and Schlitz and Papst of Milwaukee – became national marketers, selling their premium beers in nearly all major markets. (Originally, “premium” referred to the freight premium paid to ship beer long distances. Today it refers to a price point.) Meanwhile, the number of brewing companies steadily declined. By the 1960s it was clear that industry consolidation would accelerate, driven by economies of scale in both manufacturing beer and – especially – advertising it on national television. At this time Joseph Cullman, the legendary head of Philip Morris, was seeking a way to diversify his company’s revenue stream. He acquired American Safety Razor in 1960 and Clark Chewing Gum in 1963, but neither worked out. He then set his sights on Carling of Canada, but was rebuffed. When Peter Grace offered to sell his 53% interest in Milwaukee-based Miller, Cullman moved quickly. He paid Grace $127m and an additional $100m to the charitable foundation that owned the remaining 47%. It was an unpromising choice. Miller ranked seventh in sales and – with its clear glass bottle, girl-in-the-moon label, and “Champagne of Bottled Beers” slogan – had an image as a woman’s beer. Ironically, the beer itself was more full-bodied and bitter than Coors, which was considered not only a man’s beer but emblematic of the rugged Rocky Mountains. Miller however was undeniably a heritage brand, dating to 1850, and it also had good quality control. Miller beer brewed on the East Coast tasted exactly like Milwaukee-brewed Miller. In contrast, East Coast Schlitz tasted markedly different from its Milwaukee counterpart. Cullman installed a career marketing man as CEO, who quickly replaced most of Miller’s senior managers. Miller High Life’s formula was changed to produce a much lighter, less bitter brew. It was, arguably, Coors beer in a Miller bottle. Coors’ practice of pull-dating beer was adopted, as was its policy of cancelling any distributor who stocked stale beer. However, Miller’s advertising was both unique and inspired. The theme was “If you’ve got the time, we’ve got the beer,” and the commercials showed blue-collar workers at the end of the day rewarding themselves with a cold Miller. Instead of advertising Miller beer, the company was advertising the people who drank it. Sales skyrocketed, and Miller passed not only Coors but everyone except A-B. For a while, Miller management made no secret of its expectation of overtaking its St. Louis rival. That never happened. Or, at least, it hasn’t happened so far. But an important lesson had been demonstrated: Beer drinkers buy image, not just beer. Philip Morris had taken a heavy beer with a feminine image and made it a huge success by changing it into a light beer with a masculine image.

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Coors also has failed in the super premium market segment. Its Herman Joseph 1868 disappeared virtually without a trace. And it has had disappointing results with Molson, which it distributed in the US long before the merger. A haunting question is why Coors (or Miller before it) has not been able to duplicate for Molson the success achieved by Corona, a product of Mexico’s Grupo Modelo that now is 50% owned by Anheuser-Busch and which has overtaken Heineken to become the best-selling import in the US. “Under Coors, Molson could have attained that wonderful position between the pricey European imports and the premium domestic beers,” says consultant Pirko. “But they blew it.” For a while, recalls Racioppo of Jarislowsky Fraser, Molson was making inroads, particularly in the Northeast. “But during the 1990s the craft Molson Coors Chairman Peter H. Coors is pictured in a happy brewers, Boston Beer and many others, mood as the company’s annual meeting in Montreal, May 11th sprang up and took away most of the 2005 draws to a close. Molson Coors had completed a market share that Molson had.” The preliminary assessment of its Brazilian operations said its chief consensus among analysts is that we executive, W. Leo Kiely III, at the first annual shareholders’ should continue to expect that the meeting since the merger in February this year. imports and craft beers (Boston Beer’s Samuel Adams is the largest seller right Ultimately the experienced market watchers believe now) to continue to do well at the expense of the Big Three. “A trading up in the beer market has been going Molson Coors can prosper only by having an established on for about 20 or 30 years,” says Benj Steinman, super premium import to sell in Canada and the US. president of Beer Marketer’s Insights of West Nyack, Heineken, Molson’s minority partner in the ill-fated New York. “It basically has continued even as the Brazilian venture, is most often mentioned. “If Heineken were to move into the US by merging with Molson Coors, industry overall has softened.” A chilling demonstration of that (both figuratively and they would definitely have a great distribution network,”says literally) is offered by beer coolers in upscale California Erin Ashley Smith, an analyst with Argus Research in New neighbourhoods.A big supermarket might devote 20 linear feet York. “So that would definitely benefit both Molson Coors to beer: half to brands of Coors, Anheuser-Busch and Miller, and Heineken.”Legg Mason’s Swartzberg agrees.“Heineken and the other half to imports and super premium craft beers would be at the top of my list, most likely in a merger of and whose sales grow smartly despite little advertising and only equals a la the creation of Molson Coors. I do not think it is imminent, but it would be rare price promotions. very sensible.” If California is where the Molson Coors vs. SABMiller - Premium Lite? Meanwhile, Kiely and his future comes from, Coors’ 300 crew have their work cut out problems won’t be solved 250 for them: resolve the entirely by getting rid of lawsuits and the SEC the Brazilian operation, 200 inquiry; dump Kaiser, strengthening its Coors 150 achieve true economies from Light brand, or mergerthe merger, stabilise market driven cost cutting. 100 shares and volume; and win Analyst Bonnie Herzog of 50 back investor confidence. Citigroup’s Smith Barney And to think that once in New York, for one, Coors’ greatest problem was believes that the savings Molson Coors CL B SABMiller FTSE Beverages Index trying to make enough beer have already gone into to meet demand. price discounts. Price returns (USD). Data as at September 05. Source: FTSE Group / FactSet Limited.

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Photo: EMPICS. October 2005.

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COVER STORY: CARL ICAHN

He early eschewed the role of the Philosopher King from Queens to move into financial positivism. But that does not stop him thinking about the implications of what he is doing. In the best empiricist tradition, he prefers to look at the results, for himself and for the economy, rather than agonize about motives. In an exclusive interview Ian Williams talks with the increasingly activist Carl Icahn about his interventions in Mylan, Kerr McGee and the big daddy of them all Time Warner.

SUPERMAN HEN CARL ICAHN talks, he sounds as if he comes from Queens, and he clearly felt no need to affect a patrician accent while at Princeton. But the clear enunciation shows a tough intellect at work. The son of a cantor and a school teacher, he laughs with easy self-deprecation over his Princeton thesis – on logical positivism and the empiricist criterion of meaning – “I don’t quite understand the thesis now, myself, you know what I’m saying?”he smiles. There is almost a cottage industry in tracking where his Starfire Holding Corporation and related hedge funds have begun to buy stakes that are seen by some as a marker for an impending Icahn intervention, and consequent stock price appreciation. In the past, Icahn has invested in giant companies such as TWA, USX, Nabisco, XO, and Texaco, parlaying the moves into huge personal profits before selling his interests. As he points out though, as often as not, he has forced the management into following his advice and the company he leaves is a better and more highly valued operation than when he arrived. Already this year he has tangled with Kerr McGee and pharmaceutical company Mylan and all the while going after the big one – Time Warner.

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or Lex Luthor?

Carl Icahn Photo: Starfire Holding Corporation, October 2005.

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Asked whether he sees himself as a shareholder activist or hyper-activist shareholder, Icahn replies“You can look at it any way you like, but what we do is quite salutary.”After an era where chief executive officers with untrammelled personality cults have destroyed companies from Enron to Tyco to the seeming applause of institutional investors, he feels, “We might have reached a secular turn in corporate democracy, in shareholders’rights. I think there is a better chance than ever before that we can get minority shareholder representation on boards, and I hope that is the case. It proved out with Blockbuster but we have to see how that works out.”And, he adds topically,“Time Warner could be a good test of that.” “What we have in corporate boards is not really democracy. In fact, a democratic system works really well, but you don’t have real corporate democracy. You really do not have true elections for the most part. And when you have poor accountability, you have poor management, and that’s true in any system.” The seeming unwillingness of many management teams to expense options and their sometimes reluctance to allow anyone on the board who may cavil at the prerogatives they award themselves are for Icahn a challenge to be cracked. Icahn’s tussle with Marvel Comics, for instance, leaves open the question of whether his role model is that of Superman or Lex Luthor. For many American “I think all shareholders management teams there is benefit from what I do,” no doubt. They duck and says Carl Icahn cover under the boardroom Photo: EMPICS. October 2005. table when they hear his knock on the door. Several of his recent targets when approached were reluctant to speak even off-the-record, but their snorts when asked about his shareholder activist role suggest that they see him as corporate raider and rustler and discount any hint of altruism. Relishing the image, Icahn himself once posed for an Institutional Investor cover, toting a shotgun and wearing a six-shooter. Like Kirk Kerkorian, and indeed Donald Trump, Icahn has built up his stake over the years with obsessive work in his respective businesses. But while Trump boasts about the art of the deal, he cannot match the consummate artistry of arbitrage shown by Carl Icahn. His particular method is quite simple, “You find companies that are undervalued relative to the stock price, where there is disconnect between the shareholder price and the real value, like [sic] Time Warner. I think the best purchase this company can make with its capital is to buy back its stock, which I think would work very well for the shareholder.” Recently, of course, some of the other business-Titans have driven their companies into bankruptcy as an inadvertent by-

product of shady business practices. For Icahn, an avid poker player, negotiating restructuring from bankruptcies is his forte. “We have done really well with some of the companies we have taken out of bankruptcy – such as casinos and energy – that we now control,”he says. So do bankrupt airlines offer an opportunity?“Yeah, we have been looking at them. But I don’t think so,”he responds dryly. Indeed. Apocryphally, Icahn won his early seed capital playing poker, a pastime which could be regarded as war-gaming for corporate activism, knowing when to hold and when to fold. He actually lost his first stake. Even so, he rapidly developed a much surer touch, borrowing the cash for a New York Stock Exchange seat. “Yeah”he says laconically when asked if doing good has meant him doing well. Certainly his activities have benefited his bottom line considerably. Forbes has him at 24th position on its Forbes 400 list, with $8.5bn in personal wealth, but his influence is much greater than that. Robert Monks, a pioneer and major proponent of shareholder democracy, inclines towards a more benign interpretation. “He uses the personal remedies of ownership to enhance value. He would always say that Aristotle was a proponent of a quantitative approach to moral value – there are a lot worse people than Carl. In many ways he is the real face of ownership. He does not hide behind a desk, he is a real person. In the Texaco battle, I testified for him. If the lawyers, the courts and the management did what they were expected to do, then you would not have to worry about him. And you would be surprised at [the extent of] his involvement–going to talk to the unions at TWA for example.” Icahn himself cites his involvement in Texaco as something he was proud of.“It had stumbled its way into bankruptcy by buying Getty Oil, and then we bought a load of stock and worked assiduously with them to help them to negotiate their way out the bankruptcy with Pennzoil – and the stock went from $30 to $60.” He’s quick to state,“Look, I’m not saying I’m being Robin Hood, but I think all shareholders benefit from what I do. Look at our record -we have made a 39% return annualised on the companies we have invested in but the other holders have benefited as well. Because we find undervalued companies and make them work and now there is the chance to get representatives on the board, to make sure they do.”He refers to Kerr McGee, the energy company that avoided Icahn’s proxy challenge by agreeing to a major stock buyback. ”We began to buy it at $60 and it is now $92 and $93, and that’s because they did the buyback we wanted.”

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Icahn points out, that his involvement with corporations all over the place, you couldn’t get to them, to unseat or has often been more than a quick five minute ‘stand ’em up challenge incumbents. That’s changing. We won with a 77% and shake ’em down’. “I have owned a number of vote at Blockbuster for minority representation. It’s not companies, some of them for many years. You can check because shareholders agree with everything I’m advocating, with the chief executive officers – for example, I own three say about splitting a company up, but because they ask casinos, and they are doing dramatically better than before ‘What’s wrong with having shareholders represented on the – and all the employees are making more money. We have board? What’s wrong with Icahn having a seat?’” He is scornful of the defences put up by incumbents in raised salaries there and the same with the energy companies, and the rail car business. Employees are paid the face of his sallies describing their excuses with more because the company does better, and the companies comparisons to bovine excreta.“Existing managements talk do better because there is more accountability. The head about disruption, but that’s like saying we should not have man can be called on the carpet, so to speak.” Indeed his a Democratic or Republican party in this country, because American Rail Car corporation has announced an initial it causes disruption. Disruption is really a euphemism for ‘if public offering (IPO) to expand production in the face of he gets on the board he’ll check up on the use of the corporate jet and other perks that might be taking place.’” booming railroad demand. Time Warner definitely fits the Icahn criteria for Far from glorying in capitalism red in tooth and claw, Icahn is appalled at the distortions that options have led to involvement. The assets in the cable, broadcasting, in corporate America.“First of all, I think there are too many internet and publishing business have failed to show the given out. The trouble in America is these guys try to give synergy that was originally advertised. The stock price has plummeted, and while the themselves options at estimated value of the cheaper prices even when separate parts is over a the stock goes down. And “Look, I’m not saying I’m being Robin hundred billion, the stock this great gap between what Hood, but I think all shareholders benefit value is only just over the regular employee earns from what I do. Look at our record -we twenty. Even with debt paid and what the CEO earns, it’s off, there is an estimated just ridiculous. Every day the have made a 39% return annualised on $60bn in value to be tapped. gap gets bigger. But there’s the companies we have invested in but Other shareholders have not no accountability. If you have the other holders have benefited as well. done much about it – apart a board that wants to give Because we find undervalued companies from sell their stock. Icahn you options – because it’s and make them work and now there is the wants a twenty billion share made up of all friends, then chance to get representatives on the buyback and a split of the the attitude is, why not? “ businesses. Management has He is dismissive of the board, to make sure they do.” already responded with passivity of most traditional plans for $5bn. investing institutions, “They That is not enough for Icahn who hopes to rally have gone along with it all for too long, but there has been a secular change, I hope. One of the reasons for that is just two shareholders who may not necessarily agree with all his words: hedge funds.”He explains,“They are so involved with remedies, but who, watching the stock price slowly performance, they are generally much better for corporate sinking for three years in the doldrums, think that any action than most mutual funds and they are more willing to wind in the sails has to be an improvement. Icahn feels vote. They have a trillion dollars and so they are a huge that “shareholders will realise their shareholders will realise that there is no absolutely no downside in having voting group that wants to see companies do well.” At first thought this is counterintuitive. Hedge funds their own representative on the board and a big upside.” were notorious for the lack of interest in the mechanics of He is also counting on their inherent sense of democracy the companies whose stock they traded in. But, Icahn and fair play to see that minority stakeholders can have points out, that is no longer the case. “Financiers are not board representation. With hedge funds weighing in alongside the traditional going to be corporate activists themselves. They will not take the initiative. But the hedge funds are much more corporate governance activists, mutual funds may decide to likely to vote for a challenger and since they really care go with the flow, especially now that their votes are public. about performance, they are focused. Additionally helping The fresh breeze of shareholder activism may well be corporate activism is that there is more transparency now blowing – and Icahn may well have a place on the for mutual funds, and they have to report how they voted.” quarterdeck and a hand on the tiller. Shareholder activists will be cheering if he does. Bob The hedge fund voting power has transformed proxy fights, he calculates.“If you are running for mayor against an Monks congratulates the philosopher-financier who is “a incumbent, if there’s just a lot of individuals voting, it’s very effective accumulator of wealth. Carl is sui generis, (one difficult to mount a challenge, but if you have big blocs of of a kind). The last decade has been a very hard time for voters you can. Before, there were a lot of small shareholders shareholder activists and he has lightened my life.”

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ASIA: CUSTODY

Bringing cohesion to a fragmented market In the US and Europe, custody is the preserve of the super-institution. This is not, however, the case in Asia. Each country has a set of rules and market restrictions all its own. In such a fragmented market sub-custodians have so far maintained their competitive edge. The region also continues to be defined by a series of independent exchanges and clearing houses. With vertical integration gradually changing the market elsewhere how long can Asia’s current custody infrastructure last?

China’s fast economic growth and high savings rate—nearly 40% by some estimates—represents a tremendous opportunity for foreign investment firms.

ROVIDING CUSTODY SERVICES to many of the world’s major markets is fast becoming the domain of the super-institution. Global players such as Citigroup, State Street Bank and Bank of New York have prospered largely through consolidation, gobbling up territory once held by the likes of Deutsche Bank (that had ceded a portion of the bank’s global securities business to State Street in 2002). The adoption of single-currency platforms has made it that much easier for the largest players to deal directly through the local market, in some instances reducing the role of the sub-custodian—once invaluable agents for global providers in regions around the world—to near obsolescence. Journey to the Far East, however, and the stakes change considerably. The financial markets of Indonesia, Taiwan, Philippines, Malaysia and other Asia Pacific locales are still in their nascent phase. Domestic banks once held a dominant position in the local custody market, but fell out of favor following the financial shakeout of the late 1990s. In the meantime, global

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providers, many of whom had relied on local banks as sub-custody agents, began turning to well-established regional players such as Standard Chartered Bank and HSBC for settlement and clearing on a local level. Years of experience, an intrinsic understanding of the market and the ability to work with and lobby local authorities are invaluable attributes, particularly in a volatile market, and today these companies stand tall in a thinning field of subcustodians. But the stakes have been raised. “The demise of paper to a dematerialised process meant that the business as it was died and was reborn in a very different form,” says Colin Brooks, Deputy Head of Securities Services Asia-Pacific at HSBC in Hong Kong. “In the old days you were judged on your ability to shift paper; now the business has moved considerably up the value chain.” “Those with experience operating in China are better prepared to take on the challenges and secure deals with their Chinese partners,” asserts Connie Bolland, regional economist for the Economist Corporate Network in Hong Kong, and a former vice president for Lehman Brothers in Tokyo. China’s fast economic growth and high savings rate— nearly 40% by some estimates—represents a tremendous opportunity for foreign investment firms. In real terms for HSBC this has meant direct investment in China’s burgeoning commercial banking sector; having taken a 20% stake in Bank of Communications and an interest in the Bank of Shanghai, as well as a shareholding in Ping An, a leading Chinese insurance company. At the same time, its securities services operation has benefited from its acquisition of Bank of Bermuda, which enabled HSBC to upscale its fund administration offering. According to Brooks, the opportunity to leverage that expertise is coming fast and strong as individual countries move towards introducing regulations that meet international corporate governance standards. “In Korea,

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Photo: HSBC, Hong Kong. October 2005.

Colin Brooks, Deputy Head of Securities Services Asia-Pacific at HSBC in Hong Kong.

for instance, the AMBA laws now require the introduction of independent trustees and third party fund administration. Similar laws are under consideration in India. These developments inevitably offer opportunity.” That structural propensity to offer new business growth is fuelling interest in the region. Not only that. What accounts for the tremendous differences between Asia and other major markets? In a word: fragmentation. Asia is defined by a series of independent exchanges and clearing houses; cross the border from one country to another and suddenly you’re looking at a whole new set of rules and market restrictions. All of which has helped sub-custodians, such as HSBC and Standard Chartered maintain their competitive edge. Unlike in Europe, where vertical integration has allowed depositories Euroclear and Clearstream to achieve market dominance, the lack of a common currency framework in Asia has kept CSDs and other mass-market settlement and clearance providers out of the picture for the time being.

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ASIA: CUSTODY

“Given the EU development, a lot of people are wondering if these countries excluding Japan would develop a single currency, single stock exchange, and so forth,” says KK Tse, executive vice president and head of investment services in Asia Pacific for State Street.“I think the overall consensus is that it would be very difficult at this time for a single platform to be established, whether it be a currency unit, a securities market or clearing or depository system. The basic assumption here is that every country will need to develop its own infrastructure. The more we work with sub-custodians, clearing houses and stock exchanges we find that in order for Asian markets to develop and at the same time attract enough foreign investors, there needs to be a good blueprint for the future development of the market.”

Sub-custody reigns supreme

Photo: NTGI. Septemeber 2005.

A regional provider with a global perspective, subcustodians such as HSBC and Standard Chartered act as “eyes and ears” for their global clients, while at the same time serving as a gateway to the foreign markets for domestic investors. The potential for long term unbridled growth in China, for instance, has attracted hundreds of foreign financial interests eager to establish mutually beneficial partnerships with mainland companies. At the same time, Asian investors, liberated from old governmental restrictions and with retirement capital to spare, have turned to sub-custodians in record numbers.

Lawrence Au, Asia Pacific general manager for the Northern Trust Company.

“Between the cost of setting up the service, competition from the online providers and the steadily eroding margins, in some markets you really have to wonder how some of the sub-custodians are still able to survive,” notes Richard Surrency of niche-market player Swiss American Securities Inc. (SASI).“Such is not the case over here. There probably will come a time when you will begin to see some consolidation affect the market, but it will probably start at the domestic-bank level. If you look at a pure business model for how an institution can run a custodial service effectively and profitably in any jurisdiction, where consolidation has not yet entered into the picture, this is where you want to be.” HSBC’s Brooks concurs, but adds: “While regional sub-custodians are set to increase their influence, there are still one or two markets where local operations provide reasonable service levels , it will be difficult for them to keep up the level of investment that a multi-market sub-custodian can offer.” Surrency underscores the value of having a longstanding regional presence.“We have had clients out here for over 20 years, and what we have found is that when things start to get remotely bad, as soon as the money flow stops, most of the small and mid-tier institutions as well as the dotcoms close up shop. Clients remember that—and what we’re seeing now is a flight to quality, which was not always the case in the past, when things were more price-driven.” Concurrently, points out HSBC’s Brooks: “Reciprocity is a continuing factor that should not be under-estimated and could help keep some local sub-custodians involved as niche players for some time.” With the gaps in STP and securities processing narrowing in the more developed markets in Asia, the key differentiations are more in terms of local market knowledge and the ability to provide accurate information on corporate actions, notes Lawrence Au, Asia Pacific general manager for the Northern Trust Company. “We would therefore require strong sub-custodian support in these areas as well as continuously educating and training our staff to keep abreast of the constantly evolving market environment. We select the best sub-custodian for the specific market, rather than enter any kind of regional deal in Asia.” For global providers, partnering with a local client is often the best way to lay the groundwork for custody services. Earlier this year, State Street Bank helped launch the China 50, the first exchange-traded fund (ETF) offered on the mainland, developed in conjunction with the China Asset Management Co Ltd. “By doing that, the custody side will get an advisory fee, which is basically a certain percentage of the assets,” says Tse.“So it is like doing custody, even though we are not involved directly. We have been doing these kinds of services free of charge—with the idea that it will pay off in the end.” Swiss American Securities Inc., a member of the Credit Suisse Group, offers international brokerage and custody services for Taiwan-based securities corporation Polaris

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Financial Group. In return, SASI has been able to secure an all-important foothold in the Taiwanese marketplace. “When someone starts their own sub-custody capability, it is usually just to support the internal clients,”says Surrency. “In a lot of cases, it is not even something that they go out and market.”

Despite the ongoing liberalisation of Asia’s financial markets, cultural differences still present custody providers with significant challenges. Valueadded services such as fund accounting and administration have been a major priority for revenue-seeking custody providers in both European and US markets. In Asia, however, control-conscious local institutions have prevented the outsourcing of services from becoming standard practice. “Though widely discussed, we have not really seen any large scale full back-office or middle-office outsourcing deal in Asia, other than in Australia,” says Northern Trust’s Au, whose main clients include central banks, government agencies, charitable organisations and fund managers. “For the most part, Asians are very comfortable handling their own duties. Plus the fact that wages are still relatively lower in Asia, making the argument of cost savings much less convincing.” Superior but costly technological systems such as Straight Through Processing (STP) have been implemented in some markets, but not all.“The region has come a long way in moving from manual settlement to STP, particularly in places such as India and Indonesia,” says Polaris’ Charlotte Wu. “In terms of exchange-traded instruments, a high level of STP settlement is now possible. The challenges are actually in other areas such as corporate actions, where central registry is still uncommon in many countries.” “Frankly, I’ve been surprised at the lack of STP take-up in some areas,” says Surrency, who works with large brokers and private banks as well as small- to medium-tier players. “There are larger institutions that you assume would have complete front- to middle- to back-office reporting capabilities straight through to their execution and custodial arms. When in fact it is just the opposite— many people are still passing tickets around.”

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KK Tse, executive vice president and head of investment services in Asia Pacific for State Street.

Photo: SSCI, October 2005.

Regional challenges

Even so, many countries in the Asia Pacific region have established Market Practice Working Groups that are designed to foster STP within a market by ensuring consistency of use of standards, particularly SWIFT messages. These include Hong Kong, Singapore, Australia, Japan, Thailand, Taiwan, Korea, Malaysia and India. In Taiwan, for example, home to a vast institutionalclient base and where outsourcing has begun to gain some level of acceptance, STP is highly important, says Wu. “Once the trade has been executed, fund managers in particular need to be sure the trade has cleared properly and at what price, immediately. The problem for some brokers, who, for instance, go through a broker like Smith Barney and execute the trade, the next day they’ll need to send confirmation to the client. Obviously when it is being done manually, it is not very efficient. Which is why the Asia Pacific CSD Group is trying reach a global STP settlement process.” To help facilitate STP implementation at the local level, Standard Chartered has provided tools to both fund managers and broker-dealer customers.“In the main, we’re seeing over 95 percent STP rates from our international customer base,” reports Paul D. Hedges, global head of securities services for Standard Chartered in London.“STP is a major element to ensure reduced operational risk and enhance throughput of increased volumes.”

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Growth prospects

model the same way they have elsewhere, by increasing For sub-custody provider Standard Chartered, growth in their client base and bolstering their product line. “I think that many of the sub-custodians understand that the Asian securities markets has been very encouraging during the past year, says Hedges, with Indonesia, Korea, custody is a volume business,”says Tse.“If you talk to some Taiwan, India and Japan leading the pack. “Near term of the major regional custodians in Asia, you’ll find that expectations are that Malaysia and Thailand will see some of them are struggling to come up with value-added increased development following regulatory change,” says products. Usually that means fund administration, which Hedges, “with expansion of our fund-services activities to puts them in competition with their global-custodian clients. For instance, if we’re using a particular bank in an increase the regional securities services offering.” Although SASI has only recently entered the market, Asian country to do sub-custody for a fund, after a while Surrency says the growth prospects are phenomenal.“Since that custodian will decide that they need to grow as well, we’ve been here we’re already looking at a 35% growth rate and will take a look at the value-added services that State year-on-year, based on a seven-month period,” says Street can provide, such as securities lending, performance Surrency, “with a probable 50% growth for next year, as management, fund administration and so forth. If there is a planned. There is money back in the region, a lot of the local fund in that country, sure, they may want to try and institutions have re-organised and are in a much better offer some of the same services. But where these regional custodians are concerned, the strategic question is do they position from an international standards standpoint.” In Taiwan and Hong Kong, the growth has been more on really want to compete with their major clients?” While China’s banking industry will open completely to the institutional side, says Wu. “Particularly since deregulation, retirement-based assets have been flowing foreign banks during the coming year in accordance with its World Trade Organisation into the market, mainly with agreement, the provision for a a focus on US-based stock.” full range of securities services Double-digit compound For global providers, partnering with a by foreign banks has been annual growth has been the local client is often the best way to lay the restricted, which will allow norm in the region since groundwork for custody services. Earlier local banks to remain 2000, says Au, who this year, State Street Bank helped launch dominant over the near term, anticipates that the the China 50, the first exchange-traded says Hedges.“The local banks momentum will continue, fund (ETF) offered on the mainland, have very strong influencing particularly as additional factors, including a broad countries begin opening up developed in conjunction with the China branch structure which favors to foreign markets while at Asset Management Co Ltd. distribution capabilities, and the same time permitting leverage through bankdomestic funds to invest offshore. “In addition to existing key markets such as account facilities. In the meantime, foreign banks such as Singapore, Hong Kong and Australia, China and Korea are ourselves will most likely be used to provide more valuecoming up strong as the new growth areas,” says Au, added and performance related services—securities lending, compliance reporting, attribution reporting, and so forth.” “followed by Taiwan, Malaysia, and India.” For HSBC’s Brooks, the stakes are continually being raised. Excluding Japan, China is already the most important economic growth engine in Asia, says Au. “The complete “The old client/supplier model is becoming redundant. We opening of its financial markets in 2006 will provide even are seeing the emergence of business structures built on a more business opportunities for foreign institutions for partnership approach. As our clients increasingly focus on direct participation without going through joint ventures or revenue generating opportunities, they are looking to pass on other types of partnerships, which are often not very to us an increasingly large slice of their back-office activities successful in the longer term due to conflict in which are non-revenue generators for them. The model is management style, culture and other reasons. We are very being extended beyond its normal bounds.” From Hedge’s point of view, the need for efficient excited about the opportunities offered to custodians with the rapid growth in social security funds, corporate regional securities services and traditional sub-custody pensions, mutual funds and insurance funds in China. We facilities for both Asian and international investors will have opened a representative office in Beijing in March help sustain the market over the near term. “The two with a view of applying to upgrade it to a branch after two combine extremely well, and offer enhanced services to years’ time. At the same time, we are exploring other both customer segments. I do see that there will be more consolidation or exits in Asia, as whilst Europe has options of participating in the market.” benefited from vertical integration of securities markets utilities and platforms, Asia is only looking at horizontal What lies ahead? With technology paving the way for a more efficient integration, and as such, a regional provider such as brand of custody in the region, increased competition will Standard Chartered provides that vertical linkage across ultimately force sub-custodians to tweak their business our markets.”

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MISSION

Impossible?

RISK MANAGEMENT SOFTWARE

Risk management software vendors are on the threshold of a dream. Models developed for one asset class are giving way to standardised systems that offer consistent results across multiple classes. Users are demanding integrated software that can handle portfolio construction, performance attribution and compliance for all asset classes on a single platform. Neil A. O’Hara reports from Boston on an industry’s quest for the impossible.

Dan Cashion, president of Axioma

SSET MANAGERS USE risk management software for two different purposes, says Dan Cashion, president of Axioma, a leader in portfolio construction technology. The programs help managers ensure they receive an adequate return for the volatility associated with the securities they hold. “How do you avoid unintended bets, things you just don’t know are out there? That is portfolio positioning – trying to earn appropriate returns for the risk,”he says. Firms also use the software as a silent policeman to keep an eye on managers. “You want to see what is going on in the portfolio and make sure you are comfortable with what the manager is doing,”Cashion notes. Software stole into risk management from the bottom up. As modern portfolio theory seeped from academia into industry practice money management firms needed better ways to measure risk in their portfolios. The solutions emerged piecemeal, often as proprietary models tailored to specific asset classes. Equity managers developed risk models independently from fixed income managers

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because the assets have quite different risk profiles. Among third party providers, Barra established an early lead in equities using a linear factor model that tries to identify what contributes to returns on individual securities. Wilshire Associates made its mark in fixed income with a similar approach. Both companies prospered and their success drew others to the field, including Northfield Information Services. Meanwhile, companies such as Algorithmics, SunGard and RiskMetrics applied simulation techniques to address the need for enterprisewide risk management across multiple asset classes, particularly at sell side firms. Russ Hovanec, Northfield’s senior vice president for business development, says money managers prefer factor models (which use statistical variance to divide up risk exposure by country, currency, investment style and asset class – all the way down to individual securities) over value at risk measures popular among banks and securities houses.“Banks care about the absolute risk number. Value at risk has been adopted because it is more easily

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measurable across different asset classes,” he says, “Portfolio managers are managing to a benchmark. We focus on asset managers because factor models help them understand both how much and what the sources of tracking error are. It’s part of their added value.” Although linear factor models work well for a single asset class, they have limitations. Most factor models do not handle change, so vendors must update their models periodically as the market evolves. Traditional models also do a better job of performance attribution than forecasting, especially when the market undergoes a major shift. Jamie Ridyard, managing director of international operations at APT, explains that if a model treats a factor as idiosyncratic (that is, stock specific) when it is systemic (shared with other stocks) the predictions can go awry. “It happened during the dot-com bubble,”says Ridyard, “One leading system’s risk forecasts went all over the place.” Mean variance optimisation, the statistical process on which most models rely, contributes to the problem, according to David Reilly, director of portfolio strategy at

Photo: ATP, October 2005.

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Jamie Ridyard, managing director of international operations at APT

Rydex Investments.“It is extremely sensitive to changes in asset returns,”he says,“If you get small changes in expected returns you get radically different portfolios because it uses a single figure for returns.” Rydex has developed its own optimiser that uses a range of expected returns for each asset class to reduce the sensitivity. “It averages out the estimation errors in expected returns,”he explains,“It does not require a lot of constraints to get portfolios that intuitively make sense.” APT found out the hard way how important intuitive results are. It designed a factor model based on the efficient market hypothesis that securities prices always reflect all relevant information. Rather than weighting pre-selected fundamental factors based on past price movements, APT derives factors from a statistical analysis of historical prices, a process that automatically incorporates changing market conditions as well as non-linear asset classes like options and derivatives. It avoids the problems associated with prespecified factors, but the original version delivered results that were not intuitive. “You have these unnamed factors which are statistical constructs,” Ridyard says, “When someone says you are overexposed on factor six, the portfolio manager asks,‘Well? What do I do?’.” APT’s answer is to add pre-specified intuitive factors on top of and constrained by its statistical constructs. Ridyard argues that the statistical foundation is more robust and flexible than linear factor models while the intuitive overlay delivers actionable results.“What we have done allowed us to simulate the factors, which gives us all the benefits of Monte Carlo simulation, all the non-linearity,” he says, “We can deal with options, derivatives, convertibles, all that stuff, but it’s completely consistent with the traditional model.” In some respects APT is trying to bridge the gap between single class factor models and simulation techniques that handle multiple asset classes with ease. Ron Papanek, head of hedge fund business at RiskMetrics Group, a leading provider of risk management services, believes that demand is increasing as institutions move into alternative asset classes.“Risk managers are interested in one analytical framework that will handle everything they are involved in as opposed to going à la carte to satisfy each individual investment and not having a way to roll it all into an aggregated risk analysis,”he says. Papanek acknowledges that other providers do a good job solving problems

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conversion ratio, the call for specific asset classes but sees schedule, the maturity and the cross-class capability as critical to coupon. There is a lot of RiskMetrics’ success. Pension information to be gathered and funds want a consistent it’s extremely difficult to get hold methodology to compare not only of.” RiskMetrics has a separate one hedge fund with another but division, DataMetrics, just to also alternative investments with manage data. It screens input traditional equity and fixed from multiple sources and sells income portfolios. what Papanek calls a “golden Other vendors are moving in copy”of terms and conditions. the same direction. Wilshire Wilshire has a similar data recently launched its iQuantum collection and monitoring product, which offers integrated group, according to Michael risk management for equity, fixed Olson, managing director income and balanced portfolios. responsible for client service at “Money managers use too many Ron Papanek, head of Wilshire Analytics. The systems,” says Bob Raab, a senior hedge fund business at problems go beyond simple managing director who oversees RiskMetrics Group errors like a bad coupon or a Wilshire Analytics,“When you use Photo: RiskMetrics Group, September 2005. missed corporate action.“A data multiple vendors you are going to vendor may have a different be faced with using multiple prepayment assumption than methodologies. The way that we do on mortgages,” he says, Wilshire calculates a particular Pension funds want a consistent “Our clients would see they are risk statistic or return number methodology to compare not only getting a slightly different may be different than how it’s one hedge fund with another but number here than there.” He done by one of our competitors.” also alternative investments with sees delivering good data as an In addition to analytical traditional equity and fixed important part of the service consistency across asset Wilshire provides. classes, iQuantum provides a income portfolios. Even if the data is clean, central database integrating users have to recognise that risk performance, risk and management software delivers attribution that can also satisfy compliance needs. “We find more and more regulatory estimates, not truths, Cashion says. Money managers compliance being put on money managers worldwide,” increasingly use more than one model as a cross-check. Raab says, citing as examples the Global Investment “The models are all dependent on a lot of methodological Performance Standards (GIPS) and the European Union’s assumptions, which we know with absolute certainty are Undertakings for Collective Investments in Transferable not perfect,” he says, “Getting a ‘second opinion’ makes Securities III (UCITS III) standard, which allows funds to be sense. If two different methodologies provide very similar sold throughout the EU subject only to local marketing answers you would say this is probably capturing what is happening. If they tell you completely opposite things you rules in each member state. Regulators are getting smarter, too. The rules need to understand why.” Axioma is about to launch its implementing UCITS III in Germany explicitly require own risk models based on software it acquired in August money managers to use the same risk tools for portfolio from Goldman Sachs Asset Management. In a novel management and reporting. That dovetails with what departure, Axioma’s models will incorporate an estimate Ridyard considers best practice among money managers: of the uncertainty in their forecasts.“If we are not perfect those who integrate risk analysis into portfolio by a little bit, what does the model tell us to do management, treating risk and reward as two sides of differently? The results are very sobering,”Cashion says. The demand for integrated systems is forcing software the same coin. “At less sophisticated firms portfolio managers may not account for risk in their process, developers to re-examine core assumptions underlying especially if another person or team is tasked with their existing models. “Factor models try to understand a stable correlation structure of the market, how things relate policing it,” he says. The output from any risk model is only as good as the to each other,” Ridyard says,“Monte Carlo approaches are data input, however.“Merely getting hold of everything you much better at dealing with market volatility.” Both own is a huge task. There are organisations with hundreds methods have their drawbacks. Linear factor models of thousands of positions,” says Papanek, “Terms and assume constant volatility, while Monte Carlo simulations conditions are a critical part of the process because you rely on a simple covariance matrix which Ridyard decries as cannot evaluate a convertible security without the “demonstrably rubbish and unstable” to describe the

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RISK MANAGEMENT SOFTWARE

Photo: Northfield, October 2005.

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Russ Hovanec, NIS’s senior vice president of business development.

market structure.“As you bring together all the asset classes you can’t make do with simplistic assumptions about market structure or volatility,”he says. APT has managed to combine the two approaches, although Ridyard admits its model does not yet have all the features of the established Monte Carlo systems. The industry is tackling other challenges besides integration. Northfield applies its optimisation engine – the company’s crown jewel, according to Hovanec – to solve other problems. One product aimed at the burgeoning high net worth market helps managers who are rebalancing portfolios reduce taxes by offsetting gains and losses and avoiding wash sales. Another product developed in partnership with Instinet tries to minimise the cost and market impact of rebalancing, a process called algorithmic trading. “Managers want to execute rebalancing trades in the most appropriate manner, taking risk into account. At many firms trade prioritisation is lost or not communicated between the manager and the buy side trading desk,” Hovanec explains. No matter how sophisticated the models become, risk management software will always have flaws.“Optimising

takes a leap of faith,”says Reilly,“You are trying to cram the future into a model using the past to do it.” Although models perform well in normal market conditions, they do not capture “fat tail events” – like the 1987 crash or the collapse of Long Term Capital Management – that occur infrequently, but cause dramatic shifts in asset values. “Optimisation has its place,”he says,“Things tend to follow a pattern from the past–until they don’t.” Like King Arthur’s knights, programmers are searching for a Holy Grail destined to remain forever out of reach. Nevertheless, the industry seems poised for growth over the next few years.“Managers should focus on picking alpha,” Hovanec says,“These tools take away all the other analytical stuff managers do and do that for them.” In effect, portfolio managers can concentrate on what they do best – security selection – while the software tells them how much to buy and how to curb trading costs. Ridyard thinks lower costs will fuel demand, too. “Risk systems are just about to become commodities,” he says, “Everyone is looking to do all the asset classes now. It’s easier to do it and the price is coming down.”

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COLLATERAL MANAGEMENT

The range of acceptable collateral, once confined to cash and government bonds, now encompasses corporate debt, structured financial instruments and equity. Banks, brokerdealers and money managers are trying to eke out higher returns by pledging their securities inventories. Somebody has to keep tabs on all that collateral, a critical task many participants prefer to outsource.

KING COLLATERAL OLLATERAL IS KING. Secured transactions already dominate the repo, OTC derivatives and securities lending markets, a trend the Basel II regulatory capital regime will only reinforce. A sturdy foundation underpins the growth in collateralised financing. “Collateral has been proved to work,” says Ted Allen, a principal consultant at SunGard Adaptiv. “It worked in the collapse of Long Term Capital Management, Enron and others. A lot of the banks had collateral agreements in place and it proved to be an effective tool for managing the credit risk.”Allen is responsible for Adaptiv, SunGard’s collateral management software designed for the over-the-counter (OTC) derivatives market.

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Although collateral does not eliminate credit risk, it transforms the exposure into other risks over which the exposed counterparty has greater control, Allen explains. Those include the operational risk of managing a collateral agreement, the legal risk that the lender can perfect a lien in the event of default, concentration risk and the correlation risk between the collateral and the exposure it purports to collateralise. Collateral managers focus on the operational risk. They police what the parties to a trade agree: what to accept as collateral, concentration limits, haircuts, unsecured thresholds, minimum transfer amounts and other contractual restrictions. Managers ensure that any collateral received is eligible, value both the underlying

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Saheed Awan, head of product management, global securities financing services at Clearstream

exposure and the collateral to determine who owes what to whom, demand or deliver collateral as required and handle substitution of collateral. Third party managers act as custodians and may handle cash management, too. A few years ago, when collateral was mostly cash or government bonds, market participants could handle the administration in-house, according to Art Certosimo, executive vice president for broker-dealer services at The Bank of New York. Today, volumes have increased and collateral schedules may include equities as well as fixed income with percentage limits on exposure to individual securities, countries and credit ratings as well as liquidity thresholds.“Somewhere along the line the suppliers of the collateral said,‘I can’t filter collateral like that’,”he says. The Bank of New York and other custodians saw an opportunity to automate collateral management and let dealers outsource the back office function. Custodian banks thrive on services such as collateral management, which requires a big IT spend up-front that drives the marginal cost of incremental volume close to zero. Collateral management leverages the extensive security databases custodians already maintain to support their core operations. “An individual collateral taker will probably work with about 1000 different ISINs,” says Olivier Grimonpont, a director of Euroclear who heads product management for collateral services and securities lending and borrowing, “We work with about 400,000 different ISINs in Euroclear Bank. We know exactly what they are and how to price them because we have them in custody as well.” That knowledge facilitates collateral filtering, too. For example, some Euroclear customers do not want to take asset-backed securities (ABS), which are illiquid and hard to price. The description associated with

Photo: Clearstream. October 2005.

GM EDITORIAL 10

an ISIN may not reveal whether a bond is an ABS, but Euroclear will know. Quite how that dovetails with the increased volumes in the overall collateral management sector is yet to be fully quantified for the 2005 operating year. However, an indication is exemplified by clearing and settlement specialist Clearstream. According to Saheed Awan, head of product management, global securities financing services at Clearstream, “volumes have been rising steadily. Nowadays we clear and settle over €200bn of purchase and sales every night, of which 60% are related to financing transactions.” Individual transaction sizes are also rising geometrically. “When we began back in 1994, to do a trade of €5m was good, €10m was better and €100m was exceptional. Today we are seeing single tickets €21bn in size.” There are a number of additional characteristics explains Awan. For one, the European market is still not seeing institutional investment firms coming to the market. By comparison in the United States, he explains, some 80% of triparty business is driven by the institutional market. In Europe that figure is only 2%. “It is one of our greatest frustrations,” he frankly admits. “While the size and amounts of business have grown exponentially, in Europe the business is still largely dominated by financial institutions “such as the giant German Landesbanks and G9 broker dealers,”he says.“Perhaps institutional investors are working through the broker dealers,“he posits.“But we cannot say that with any degree of certainty.” The repo market accounts for the largest share of collateralised transactions. And European totals are dwarfed by those in North America. A June 2005 survey by the International Capital Markets Association valued the

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Triparty services for securities collateral. High on value, low on cost. Two good reasons to

smile Enjoy the benefits of a single collateral management platform for equities and fixed income. Consolidate your financing activity with Europeâ&#x20AC;&#x2122;s leading triparty agent. Find out how we can bring added value to your securities business, contact Olivier Grimonpont +32 2 224 1133.

triparty@euroclear.com

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European repo market at €5.3trn ($6.4trn), an increase of at least 16% over the previous year. In the United States, meanwhile, the Federal Reserve Bank of New York tallied average daily repo amounts outstanding at $5.5trn in June 2005, up from $4.9trn at the beginning of the year. The global repo market, in turn, dwarfs collateralised OTC derivatives. A March 2005 International Swaps and Derivatives Association survey, for example, put the amount of collateral supporting OTC derivatives contracts at $1.2bn. For OTC derivatives and securities lending, third party collateral managers act like any other outsourced vendor: they provide a service to a single party for a fee. In the repo market, participants often take the arrangement one step further to a tri-party agreement, in which the agent acts as collateral manager for both counterparties. Banks and broker-dealers, the principal repo players, trade their positions actively and often switch collateral during the day. Tri-party agents such as Euroclear, Clearstream, JPMorgan Chase and The Bank of New York have developed systems that not only automate valuation and collateral transfers, but also make the best use of collateral assets. The Bank of New York’s tri-party books handles about $1.1trn today—almost triple the average volume in 1998.“The Bank of New York has invested tens of millions of dollars in these systems in the last six years alone,”Certosimo says,“They optimise the collateral based on the available pool taking into account the parameters in each agreement.” He estimates that tri-party agents

manage 50% of US repo collateral versus only 10% in Europe. As an independent pricing source, tri-party agents eliminate disputes over valuation that can crop up in bilateral arrangements. The counterparties may have better protection in the event of default, too, because tri-party agents take custody of the collateral. Under some bilateral arrangements, the dealer holds the lender’s collateral in a segregated account, Certosimo explains. “A third party manager adds a level of credit comfort,” he says, “The lender can feel they have stronger rights to the collateral through the tri-party agreement if there is a default against the dealer.” The tri-party model reduces settlement costs, too. A broker-dealer that does business with multiple lenders must transfer the collateral to the agent, but thereafter most daily flows show up as entries on the agent’s books. “You don’t move securities in the market as often, so there is less settlement risk and less settlement cost,”says Rajen Shah, global head of collateral management at JPMorgan. Tri-party agents have not penetrated the OTC derivatives market, where trades tend to stay in place for extended periods and counterparties do not switch collateral as often as repo traders. Derivative contracts are hard to value so automation is less pervasive.“In derivatives, you still e-mail out the margin call and then agree over the phone or by email as to what assets are going to be moved,”Allen says. SunGard specialises in bilateral collateral management; its

CLEARSTREAM LEADS WITH QUAD-PARTY TRADES

N SEPTEMBER, CLEARSTREAM launched a new quad-party securities financing trade together with Citigroup Global Transactions Services and Barclays Capital. The service involves Citigroup Global Transaction Services acting as Clearstream’s collateral sub-custodian, and vice versa on a non-exclusive basis. This allows their clients to mobilise assets held both overseas and at home in their domestic markets to help maximise collateral usage under existing tri-party financing facilities. Quad-party Repo is an extension of the Clearstream’s tripartite repo service. The fourth party involved - the local agent bank appointed by the cash taker to hold their domestic assets - becomes an extension of the triparty set up. Instead of forcing the cash taker to move the assets from their domestic agent bank into the international market for financing, quad-party enables the triparty repo to be extended into domestic markets, thereby respecting the cash takers choice of where they want to hold their assets. “Quad is our invention,” says Saheed Awan, head of product management global securities financing, in London. “We began working on it last September. It is a way of addressing the fragmentation of the European settlement infrastructure. It will certainly not put any banks out of business. We will work with them instead. It is a very pragmatic approach.” Awan explains that acting as a single settlement engine, Clearstream does not require customers to come to “us, instead we go to the customer. Say, for example, a client has done a deal worth €1bn, and at the same time have only €900m in collateral with us, but that they also have €100m in their Citibank account, we will know through our quadparty lines that they have that collateral. As we will also have an account with Citibank Milan, if the client then mobilises that €100m into Clearstream’s account, then the deal is covered.” The quad party structure was developed by Citigroup and Clearstream, while Barclays Capital, a key user of collateralised financing services at Clearstream, executed the first trade last week. The new service allows for improved depository management, as externally financed assets stay with their local settlement agent. It also results in lower book entry transaction and back office costs and, according to Clearstream’s Awan, provides flexibility in terms of collateral allocation, including same-day substitutions. “It also does not interfere with any existing relationships with service providers and cash lenders,” explains Awan.

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Photo: JPMorgan, October 2005.

Rajen Shah, global head of collateral management at JPMorgan.

Adaptiv software drives CommanD, a third party management service for OTC derivatives that JPMorgan recently launched. Clearstream meanwhile has gone one better and launched a quad party service (please refer to Box: Clearstream leads with quad-party trades). The European Central Bank has played a key role in extending the range of acceptable collateral, according to Thomas Klepsch, vice president of product & technology solutions at State Street Corporation (SSC). “The ECB’s decision to accept corporates as collateral has really opened up the entire securities universe for collateralisation purposes in Europe,”he says. That proliferation of collateral is spreading to the US among private market participants, although the Federal Reserve Bank eligibility criteria remain relatively tight. As collateral has become more complex, the demand for third party management has grown. The expansion of eligible collateral to more exotic securities that seldom trade has compounded valuation problems. When Euroclear Bank launched its tri-party service in 1993, most collateral was government bonds, whereas corporate bonds now account for 60%. Grimonpont sees a shift to lower rated bonds and smaller pieces of collateral – as little as €10,000 in principal amount for Eurobonds. “The need is getting bigger,” he says, “People are obliged to use whatever they have as collateral.”Euroclear acts as tri-party agent for collateral valued at €225bn, up 40% since the beginning of 2005. Market participants see their securities inventory as an asset that should contribute to the bottom line. Banks and broker-dealers boost their return on capital by putting

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otherwise idle assets to work as collateral. Asset managers can increase the return to investors, too. “People are looking for alpha on any of their investment strategies,” says Peter Cherecwich, senior vice president and head of product and technology solutions at SSC,“They are able to get more return by using the derivative marketplace and instruments like swaps.” SSC tailors its collateral management service to asset managers looking to outsource; it does not enter into tri-party agreements. Regulatory actions and market developments ensure the growth in collateralised finance will continue. The Basel II framework for financial institutions, which takes effect in 2007, favours secured lending because it imposes a smaller capital requirement than for unsecured loans. According to Clearstream’s Awan,“To this day, I cannot figure out banks that allow dealers to deal on an unsecured basis. What Basel ultimately does is make banks realise the value of mobilising assets and, at the same time, to be secure. Show me a better money market.” Tim Douglas, managing director and global head of securities lending for Citigroup Corporate and Investment Banking, concurs and believes the Basel II obligation to measure operational risk could boost demand for third party collateral managers as well. “Having a truly automated way to measure collateral, track it and value it allows you to control it and minimise the operational capital,”he says. Awan thinks there are three key considerations. “Credit risk, which is essentially the quality of the counterparty; market risk on the collateral itself and now Basel II has brought in a third element, operational risk, which affects around 12% of the capital adequacy charges.”

COLLATERAL MANAGEMENT

Photo: Euroclear, September 2005.

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Olivier Grimonpont, a director of Euroclear

JP Morgan’s Shah agrees that Basel II favours secured transactions but points out that much of the impact may already have occurred during the long gestation period. He believes consolidation among banks is fuelling the growth in secured lending, too. Combined entities tend to scale back unsecured credit limits after they merge. “When JPMorgan and Chase were two separate companies, clients had a credit limit against each entity,” he says, “After the merger they didn’t offer the combined credit limit. It may be more than each institution had but it is not the sum of the parts.”

Secured financing brings more lenders into the market as well. Grimonpont at Euroclear points out that banks that may shun counterparty as too small or too risky for unsecured exposure are willing to lend on a secured basis. Collateral givers – borrowers – also benefit. “It enables them to do more business because the counterparties will be happy to trade with them as long as they receive collateral to mitigate the risk,”he says. Collateral management would still be growing even without these inducements, according to Douglas, who points out that unsecured lines of credit can be hard to manage, expensive and sometimes unreliable. “Secured financing has proven through various crises to be consistent and price effective,” he says. “If you are a leveraged player with a lot of collateral you would be remiss if you weren’t thinking about the best way to obtain collateralised financing of those positions,”he adds. Higher volume may not translate into profits for third party collateral managers, however. Pricing pressures are intense. Depending on the market, instrument type and volume, fees have dropped to below 0.5 basis points (bps) from 3 to 5 bps a few years ago. He believes the collateral management business is ripe for consolidation and will gravitate to institutions such as Citigroup that have their own custody network. “Even some of the larger players are questioning whether they want to be in this business,” he says, “Having your own proprietary network means that collateral never needs to move, which makes the service more efficient. Moving collateral from your custodian to your collateral agent, domestically or cross border, is expensive.”

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Paul Spendiff Tel:44 [0] 20 7074 0021 Fax:44 [0] 20 7074 0022 Email:paul.spendiff@berlinguer.com

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FUND PROFILE: ABP

Jan Straatman, chief investment officer capital markets at ABP

For those that follow the machinations of European pension funds two stories will have caught the eye over the summer. The first was a private equity deal that saw merchant bank NIB Capital sold for €2.1bn. The second was the emergence of details of a court action in which US entertainment giant Time Warner was being sued for $200m. Both stories involved the world’s biggest private pension fund Stichting Pensioenfonds ABP. That alone might not be surprising. Paul Whitfield explains why.

ABP:

IG INVESTMENT DEALS, shareholder advocacy and (as a result) headlines tend to follow the biggest pension funds. With almost 2.5m members, drawn from the Dutch public and education sectors and with assets under management of some €168bn few pension funds come any bigger than ABP. But pioneering investment deals and shareholder advocacy are not things that have historically been associated with ABP. While the Dutch fund’s closest equivalent, the $166bn California Public Employees’Retirement System (CalPERS) fund has regularly attracted plaudits and criticism for its shareholder advocacy and investment leadership ABP has, until recently, kept a low – some might say anonymous – profile. Yet as the summer’s stories testify, this sleeping giant is stirring. Freed of government ownership, and therefore a political gag, by its 1996 privatisation, and further driven to boost

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performance by a funding ratio that deteriorated sharply between 2000 and 2003, ABP has re-invented itself – both an outspoken advocate of shareholder rights and a pioneering investor. Nowhere is this more evident that in the fund’s new found fervor for corporate social responsibility (CSR) among the companies it invests in. Since 2000 the fund has invested hundreds of millions in support of its CSR convictions and on CSR research, backing its belief that a company’s social, ethical and corporate governance performance are important risk factors that impact long term investment performance.“We believe that if we want to take a stake in a company over a period of a couple of years then we must have a clear understanding of the quality of the company and more importantly the quality of the management of the company,”says Jan Straatman, chief investment officer capital markets at ABP . “High quality management means a high level of awareness of corporate social responsibility factors,”he adds.

Photo: ABP, October 2005.

THE NEW SHAREHOLDER ADVOCATE

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ABP treats CSR factors as risk elements. A poor CSR conferences, writing articles and publishing research work rating at a company means a greater risk that its share – the fund publishes a regular CSR report that is price will suffer as a result of a CSR related shock – such distributed to all its stakeholders. But there is a sharp end as the discovery of poor book keeping or an to the fund’s CSR advocacy too, of which the court case environmental disaster. “Our prime goal is to maximize against Time Warner is just the latest manifestation. ABP’s claim for $200m against the US media giant is investment returns and I believe there is a strong overlap between the social and ethical themes we are exploring related to the discovery of alleged accounting and risk, particularly of unexpected events and thus long irregularities that inflated results at America Online, which merged with Time Warner in 2001. The term performance,” says Straatman. ABP thinks that the impact of CSR on longer term subsequent discovery of these irregularities led to a performance is particularly pertinent to its investments. sharp fall in the merged group’s share price, and the The fund has an unusually long term investment horizon of value of ABP’s investment in the company. Time Warner one-to-two years - against a more typical horizon of three- has now reportedly set aside $3bn to cover any future to-six months for many commercial fund managers. That settlements with disgruntled investors, with most of that leaves it more exposed to CSR factors, which tend to be of expected to go to claimants in class action suits. ABP believes it will get more money acting on its own, less importance to shorter term investors. ABP’s CSR policy is more nuanced than simply using though admits it is unlikely to get the full $200m. The fund has made something of a habit of confrontation ethical or corporate governance factors as a screen in stock selection – though the fund does that too. “We do in recent months. Earlier in the year it won $4.5m in compensation from drugs rate companies on an company Bristol-Myers individual level but we also Squibb – some $3.75m more rate CSR factors across the than it would have received whole fund. At a broad level Since joining the fund in early 2002 had it taken part in a classI am happy to let other Straatman has stripped external managers action suit. That is on top of themes develop but we will of ABP mandates, reducing the the class actions in which it then aggregate all our is participating against holdings and study the risks percentage of externally managed equity various companies, such as associated with CSR factors assets from almost 70% to 40%. the Shell/Royal Dutch and then adjust that to a Straatman says: “We are only interested Petroleum, the telecoms level we are comfortable in working with companies that provide group Quest, Canadian with,”says Straatman. explicit expertise in a niche field, we can communication firm Like all risk, the impact of do the rest. That means we look for things Nortel Networks and the CSR factors on investment US automobile parts performance varies over such as local players in emerging maker Delphi. time. To reflect this ABP also markets, independent research houses “It is a measure of last adjusts the weight it gives that provide something that the brokers resort,” says Straatman. “In CSR in its investment do not, such as research over a much most cases we hope that by decisions and portfolio. “If longer investment horizon.” talking to companies at an you accept that corporate early stage we can avoid governance and socially legal action and drive responsible investment improvements in companies. factors influence the valuation of a company then you must also accept that I have no intention of building an army of lawyers and these factors can be given a premium or a discount in the adding to the liability culture but we have a fiduciary valuation and as such you have to make adjustments to responsibility to get the best results for our members.” The fund’s increasingly active pursuit of its interests is that – it is not a static concept,”says Straatman. ABP believes CSR’s influence on investment in keeping with ABP’s newly adopted philosophy of performance has fallen since 2003 as lower volatility and taking direct control of its portfolio. The fund has an increased taste for risk have emerged as dominant become a leading advocate of both active management forces in the market. That has not, however, lead to a and of bringing asset management in house, where it believes it can do a better job than external fund reduction of the fund’s CSR advocacy. “There is a lot of management that would like to bring managers and for less. Since joining the fund in early 2002 Straatman has these themes to the table but there is a resistance or lack of interest amongst analysts. We think this is a weakness, so stripped external managers of ABP mandates, reducing we have an obligation as a large investor to open the the percentage of externally managed equity assets from almost 70% to 40%. Straatman says: “We are only dialogue and increase the awareness,”explains Straatman. For the largest part that obligation means speaking at interested in working with companies that provide

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explicit expertise in a niche field, we can do the rest. That means we look for things such as local players in emerging markets, independent research houses that provide something that the brokers do not, such as research over a much longer investment horizon.” The decision to manage assets in-house means ABP has an unusually large investment division of about 400 people, of which about 300 are investment professionals, making it about twice the size of CalPERS in that respect. The muscle provided by that investment division, coupled with the funds financial strength and its focus on long term returns means ABP has been able to back its CSR convictions in a way that very few pension funds could and in a way that few commercial funds would dare. In 2001 it launched two experimental socially responsible investment portfolios, which have since been merged into a single fund called the Loyalis Global Sustainability Fund. The aim of the portfolio, in which all investments are partly determined by social, ethical and environmental performance, is Dick Sluimers, chief to test the impact of CSR factors on financial officer, ABP investment performance in the real-world. Loyalis has about €200m in assets under management and has grown year on year but, said ABP in report, published in August in ABP’s Corporate Social a recent report, has not been running long enough to Responsibility Newsletter charged that investors continued establish a definitive link between CSR factors and better to underestimate the economic impact of global warming. ABP’s interest in the impact of such trends on equity long term performance. ABP has also bought stakes in two CSR research markets has increased significantly in recent years as it companies, Innovest which provides CSR screening for has slimmed down its fixed income exposure and upped specialist indices, and Governance Metrics International, the equity allocation in its portfolio. That shift in also known as GMI, which ranks companies’ corporate allocation, which began prior to privatisation, has gained governance performance. The fund also backs external further pace in recent years after a sharp decline in ABP’s investment research. “We work with professors and funding ratios, in the three years after 2000, forced a more faculties across the globe that are specialised in areas drastic rethink of its investment policies that have seen that we believe we can use in our investment process,” the fund add significant new exposures to alternative investments too. says Straatman. From 2000 to 2003 the funding ratio, which measures ABP was one of three pension fund sponsors behind the Pharma Futures project – the other two were the US- the value of investments against the value of liabilities, fell based Ohio Public Employees Retirement System below 110%, down from 150% just a couple of years (OPERS), and the UK’s Universities Superannuation earlier. It has since recovered to 115.5%, though it slipped Scheme (USS) – a research initiative tasked with from the end 2004 mark of 121.3% and is still well down identifying the long term risks & opportunities facing the on ABP’s long term target of 135% to 140%. Equities, pharmaceutical industry. More recently it has which in 1994 accounted for a meager 8.8% of the fund’s underwritten research into the investment impact of portfolio today account for about 36%. The funds has also global warming and in particular the effects it may have added a 10% exposure to alternative investments and on the performance of insurance and energy sectors. boosted its real estate exposure to 10%. That has meant a “What we are doing is analysing climate change in an reduction of its fixed income exposure from nearly 80% in investment context and looking at how it should affect the early 1990s to 44% today. Over that period the fund has also shifted its investment our investment strategy,”says Straatman. The funds’ conclusions have been typically forthright; a focus from the Dutch market, which in 1994 accounted for

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Photo: ABP, October 2005.

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more than 90% of its assets to become a global investor, with for example just 3% of equity investments drawn from the Dutch market. In 2003 ABP’s managers drew up a “Recovery Plan” for the fund which markedly accelerated the process of change in the investment composition of the fund. “When we decided our new investment strategy one of the key questions was what competitive advantage do we have,” says Straatman. “One of the key factors was that we have a freedom to be innovative and be at the front end of new strategies and the deployment of new themes. Other investors are constrained by commercial mandates and the need to build track records. We can capture a complexity premium because of our longer investment horizons and our ability and willingness to pursue new and innovative strategies.” That willingness to adopt new strategies, and the assets that ABP has at its disposal, has seen the fund aggressively move into areas many other pension funds are only dabbling in or have shied away from. For example, ABP, along with Dutch pension fund peer PGGM have mandated €6bn to be invested in private equity over the three years to the end of 2005. Straatman says the funds total allocation to the asset class currently stands at about €4bn. The private equity investments are managed by AlpInvest Partners, a private equity company with some €20bn under management and which is owned by the two pension funds. The August sale of NIB Capital, which ABP owned 50/50 with PPGM, for €2.1bn to a consortium lead by US investment fund JC Flowers & Co, allowed the pension funds to realise about €2 bn from an investment it had held for less than four years, according to reports. Even with successes like that, Straatman says that other pension funds are unlikely to want, or be able to, follow ABP’s lead into private equity. “If you look at the average firm’s price-earnings returns the asset class is not that attractive, there is a lot of variance but the mean return does not provide an enormous boost relative to straight equity investment,”he says.“Partnering with the right firm, so you can find the

right investments, is key. We were in a position to do that by taking control of AlpInvest (in 1999), not every fund can do that.” That kind of commitment to new investment classes is not a one off. When ABP in 2001 decided it would make an allocation to hedge funds it established an eight person team in New York to oversee the assets. ABP has about 2.5% of its assets, about $5bn, in hedge funds. ABP’s 20% allocation to alternative assets, John Neervens, chairman of the which includes private ABP board of directors equity, real estate, commodities, hedge funds and index-linked bonds, are all part of a diversification strategy, on which ABP is pinning much of its hopes of sustaining better-than-market levels of return. The fund’s investment targets are challenging, all the more so in the low interest rate, low return environment that most investment professionals, including ABP, foresee for the medium term. Its long term liabilities are growing at a rate of 6% to 6.5%, dictating that the fund must have a minimum investment return target of about 7% to 7.5% in order to hit its funding targets. Over the past decade the fund has met those targets; its ten year average return is just south of 8%. Straatman admits that performance like that has becoming increasingly difficult to achieve and does not believe the market will turn a corner in the near future. While he has been pleasantly surprised by the resilience of the US equity markets he believes that equity valuations are “at least fair” and sees little potential for significant growth in valuations. Similarly he sees little reason for optimism in the bond markets based on his expectations of “slight rises” in interest rates. That ABP is in a position to continue to prosper through this period is largely due to the changes to both its culture and investment practices which have been implemented in the past few years. “The positive element of the problems that we had was that it has created a lot of pressure on the organisation to drive excess return and improve our funding ratios, and the organisation has changed to make that more possible”says Straatman.That new organisation also makes it unlikely that the fund will retreat back into its shell and should ensure plenty more ABP headlines over the coming years. Photo: ABP. October 2005.

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The second half of the year will see a further €56bn of mortgage-backed bonds issued, according to analysts in London, defying the prophets of doom who signaled a sharp decline in the European residential mortgage-backed securities (RMBS) market. Andrew Cavenagh explains why the bulls are still outflanking the asset-backed bears. HE EUROPEAN MARKET for residential mortgage backed securities (RMBS) has defied the prophets of doom so far in 2005. This was the year, the bears maintained, when a decade of annual growth would come to an end. Issuance in the UK – the biggest market – would decline in the face of stagnating house prices and an increasing preference among the big serial issuers for covered bonds. Meanwhile, tough economic conditions in the Netherlands would inhibit the second-ranking market in Europe, and fears of a market bubble in Spain – where average house prices have risen by 80% over the past 10 years – would restrain issuers in the country that had seen the fastest rate of growth over the past two years. This pessimistic scenario has failed to materialise, however, as any concerns about the underlying property markets have utterly failed to diminish investor appetite for RMBS bonds. “It has proven quite clearly not to be the case,” says Rob Ford, head of European ABS Trading at Barclays Capital. “The market feels very comfortable with the quality of these assets – they are all nice big deals and they’re entirely tradeable.” Ford says one reason for the sustained strength of demand is that the investor base for mortgage-backed securities continues to widen, with more and more “real money”investors, such as fund managers and insurers with money-market funds, seeing the bonds as an attractive alternative to gilts.“It offers the perfect gilt alternative for the risk-conscious investor,” he maintains. “These people are gradually coming more and more on board, and they’re back in the market on a regular basis.” As a result, European RMBS issuance in 2005 seems certain to exceed last year’s figure. According to the

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Moody’s rating agency, the United Kingdom (UK) saw the equivalent of €41.8bn of RMBS issued in the first half of the year, up from €38.1bn in the first six months of 2004. Not only that. The overall figure for Europe showed a 12% increase on the comparable period of last year, climbing from €80.1bn to €90bn. Spain was the largest market after the UK with issuance of €17.1bn – up from €12.7bn – followed by the Netherlands (€14.3bn), France (€6.2bn) and Italy (€5.4bn). The securitisation research team at Barclays Capital expects RMBS to account for 65% of a projected €225bn market for all assetbacked securities in Europe in 2005, which implies the second half of the year will see a further €56bn of mortgage-backed bonds issued. Neither is this booming market being sustained by issuers’generosity, as the marginal widening of spreads across asset-backed bonds that began in April – particularly further down the credit curve – has now clearly gone into reverse. Dresdner Kleinwort Wasserstein’s daily spread monitor in September 22 indicated that the secondary spreads on most triple-A European RMBS paper had tightened since the end of August. Dutch bonds had come in the most from 11.75 basis points (bp) over 3-month Euribor to 10.25bp,

ASSET-BACKED SECURITIES: RMBS

RESISTING THE PROPHETS OF DOOM

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Photo: GMAC RFC, October 2005. Photo: Barclays Capital, October 2005.

DEBT REPORT: RMBS

AYT Hipotecario BBK1 while Spanish and Italian transaction supported by instruments were trading half a loans originated by Bilbao point tighter at 11.25bp and 11bp Bizkaia Kutxa. The Spanish over respectively. And Ford says it market also saw the repeat is a similar story further along the issuers adapting their credit curve. “They’ve pretty structures to meet changing much all come back a little bit.” regulatory requirements with The trend is also evident on different techniques for new issues. The senior triple-A funding the reserve pieces on tranche of the €1.25bn Dutch deals. These included the Mortgage Portfolio Loans issue securitisation of equity that priced on 22 September, for tranches, the use of multiple instance, came in at 10 basis tranches to minimise the points over 3-month Euribor, reserve funds, and the which achieved the tightest Dutch introduction of interest-only RMBS triple-A print since April. tranches – moves designed to Earlier in the spring, in March in ensure the structures qualify fact, Delta Lloyd’s €1.005bn Arena for off-balance-sheet 2005-1 became the first deal out treatment under the Bank of of the jurisdiction to achieve a Spain’s interpretation of the single-digit margin when it priced latest IFRS and IAS at 9bp over 3-month Euribor, accounting rules. which set the precedent. The sharp increase in Also in September, UK subFerdinand Veenman, managing director of GMAC RFC’s Spanish RMBS issuance in the prime lender GMAC-RFC, the Continental Capital Markets Group first half coincided with a indirect subsidiary of the General commensurate rise in the use Motors Acceptance Corporation, of covered bonds (cedulas launched its £600m RMAC 2005cajas), providing further NS3 with the four triple-A evidence that the big tranches pricing at 2bp inside the mortgage originators will use market talk and the two triple-B both instruments in tandem tiers at 5bp and 7bp inside. “It is for their future funding needs. definitely a very, very strongly bid Gustavo Celli, associate market right now,”says Ford. director for RMBS at Fitch This year has also seen Ratings, says there is still a structural innovations across strong deal pipeline in Spain Europe that may well have laid and he expects to see several foundations for further growth more jumbo transactions – in of the market in the near future. excess of €1bn – before the One was the reconfiguration of end of the year. Northern Rock’s Granite RMBS The Italian market was master trust at the start of the another to prosper in the first year to enable it to issue bonds six months, notwithstanding of any rating - in response to the legislative amendment in reverse inquiries – provided the May that established a legal debt is supported by the framework for covered bonds. requisite level of subordinate The record volume of RMBS debt on a trust-wide basis. Rob Ford, head of European ABS Trading at Barclays Capital. issuance in the country during Northern Rock says the change will enable it to exploit better pricing on subordinated the second quarter was led by the €2.98bn Cordusio issue debt, and Ford expects to see other originators set up from Unicredito Banca, which many observers had thought similar arrangements to take advantage of the issuing would raise the funding through a covered bond. The large flexibility they provide.“I think we’ll see these structures number of smaller, lower-rated financial institutions in Italy expanded into other areas – even the sub-prime market,” and Spain also seem certain to continue using securitisation to fund their mortgage lending, as it is difficult to issue he says. While most of the growth in Spain came from repeat covered bonds with a rating below single-A. Perhaps the most striking Continental development, issuers, one significant new issuer emerged with the €1bn

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however, came in Germany when in June GMAC RFC launched the first true-sale RMBS securitisation in the country for five years. The deal securitised a young portfolio of high loan-to-value mortgages and was notable for the way it circumvented the legal and tax hurdles that had deterred true-sale mortgage deals in the country since Deutsche Bank’s Haus 2000-1 transaction. The €301.5m EMAC DE 2005-1 deal was similar in structure to the seven issues that GMAC has launched in the Dutch market and avoided the chief obstacles to truesale deals in Germany – the requirements to re-register mortgages individually with the land registry to effect full legal transfer and to obtain specific consent from the borrower to sell on the loan – through the use of transferable certified mortgages (briefgundschulden). These agreements secure the borrower’s consent at the outset to transfer the loan under certain conditions and to pass on detail of the loan’s performance to third parties – something Germany’s strict data protection law do not generally allow borrowers to do. A diverse group of investors in eight countries bought the deal - which priced at a small premium to established RMBS programmes (the triple-A notes with a weighted average life of 5.4 years came in at 21 basis points over 3month Euribor) – and GMAC RFC expects to launch a second €400m-€500m German deal before the year end,

and then two annually from 2006 onwards. “I would like to stress the fact that this is a series issue,” says Ferdinand Veenman, managing director of GMAC RFC’s Continental Capital Markets Group. He believes that the structure will also prove an attractive option for some other lenders in what is the second biggest market for mortgages in Europe after the UK, and market analysts support this view. “There are still some deals to come out of there [Germany] on the back of that,” maintains Maddi Patel, the securitisation research analyst at Barclays Capital who covers the sector. There are nevertheless some grounds for caution over the performance of European housing markets in the next years. In the UK, for instance, the Council of Mortgage Lenders reported a significant increase in the number of repossessions in the first six months of the year – 4,460 versus 3,070 in the second half of 2004 – along with a sharp (15%) rise in 6-12 month arrears over the same period. The latest report on fixed-income strategy from the Global Securities Research and Economics Group at Merrill Lynch forecast a slight increase in arrears and losses over the next 12 months and said the performance of the mortgage pools in the five big UK master trusts would deteriorate slightly – and not uniformly – opening up “some relative value opportunities for investors”.

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The Pfandbrief

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ECNS

The

Exchange The information technology revolution has provided investors with new execution choices. While the possibility of a silent, auction-less, completely computer-driven New York Stock Exchange (NYSE) may be a sobering thought to traditionalists, to others, an all-electronic stock exchange is welcome news. Dave Simons talks us through the pros and cons of the new electronic communication networks (ECNs) trading era. ERY FEW BRICK-and-mortar entities have managed to sidestep the mad rush of information technology, yet ironically, one of the last bastions of person-to-person paper peddling has been the allpowerful New York Stock Exchange. Each morning at 9:30 am a sea of screaming stock specialists converge in a manic ritual that is as much a part of the American social fabric as baseball or the Top 40. Unlike uptown rival NASDAQ that has steadily built upon its all-electronic infrastructure, the NYSE has remained steadfast in its reliance on good old-

Change fashioned human trade executions, despite the inexorable march of data throughput. Leading the changing face of the markets during the 1990s were the popular ECNs spearheaded by Instinet Group Inc., the industry’s premier electronic network founded in 1969. ECNs worked outside of the financial mainstream and, for years, catered almost exclusively to large institutions, offering thinner spreads by eliminating the middleman and reducing execution time. In 1997 came the SEC’s “Order Handling Rules,” which threw the electronic markets open to smaller investors, paving the way for a flock of upstart ECNs, among them Archipelago, Island and SelectNet.

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Photo: EMPICS, September 2005.

US Commerce Secretary Carlos M Gutierrez (left) and New York Stock Exchange (NYSE) CEO John Thain walk the trading floor after Gutierrex rang the NYSE opening bell on Thursday 29th September 2005.

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While computer-driven trade executions were revolutionising the brokerage industry, the multi-layered machinations of the NYSE had begun to show its age and reveal its weaknesses. Charges of trading inefficiencies became rampant, as did allegations of behind-the-scenes improprieties. By the end of the decade, the expanding menu of e-brokerages had caused stock commissions to tumble, and with margins eroding, the major exchanges began scrambling for ways to preserve market share. Like nearly every other industry, ECNs were not immune to consolidation, and by the start of 2005, two leading players, Instinet and Archipelago, controlled the market, and continued to sap revenue from the NYSE and NASDAQ. Then almost overnight, the future of the United States equities industry shifted abruptly. On April 20, the NYSE announced a definitive merger agreement with Archipelago to form the combined entity NYSE Group, Inc., subject to a two-thirds approval of its shareholders. According to the terms of the deal, the NYSE would maintain 70% of the combined company, Archipelago the remaining 30%, with each of the NYSE’s 1300-plus seat holders receiving $300,000 in cash. Just days later, NASDAQ upped the ante with the news that it would purchase the stock of Arch-rival Instinet at $5.10 a share, or $1.88bn, in the process combining the two largest electronic markets for domestic equities. As part of the deal, Instinet’s Institutional Broker Division would be sold off to a private equity firm. While not completely unexpected – rumours of both deals had been buzzing around the industry for months – the NYSE/Archipelago and NASDAQ/Instinet acquisitions, if approved, represent a potentially historic turn of events. For NASDAQ, buying into Instinet and its proprietary technologies is the culmination of an intensive effort to regroup after years of ceding territory to ECNs. Meanwhile, the NYSE acquisition would not only transform the centuries-old stock exchange into a public entity, it marks the possible beginning of the end of human-based paper trading in the name of rapid-fire computer buying and selling.

Bucking the Trend Change doesn’t always come easy. For many leading NYSE seat holders, rolling 200-plus years of traditionbased investing into a nine-year-old tech entity is hardly a cause for celebration. Stalwarts such as Warren Buffett, chairman of Berkshire Hathaway, have led a chorus of prominent investors opposing the deal – none more vocal than billionaire and Home Depot Inc. co-founder Kenneth Langone, a former Big Board director and current NYSE seat holder. Langone’s attempts to enlist private-equity funding in an effort to make a bid for the exchange have largely fallen on deaf ears. Even so, he still remains vehemently opposed to the reverse merger, and has urged board members to join with him in voting down the deal. Others, including NYSE seat holder William Higgins, have filed suit against the

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Photo: NASDAQ, September 2005.

GM EDITORIAL 10

Christopher R. Concannon, executive vice president, transaction services for NASDAQ.

Just days later, NASDAQ upped the ante with the news that it would purchase the stock of Arch-rival Instinet at $5.10 a share, or $1.88bn, in the process combining the two largest electronic markets for domestic equities. As part of the deal, Instinet’s Institutional Broker Division would be sold off to a private equity firm.

NYSE in an attempt to halt the proceedings. Not that the marketplace necessarily shares their viewpoint. Archipelago’s stock price has risen nearly 70% since the deal was announced. Meanwhile, NYSE seat holders who have not joined the battle have, in some instances, profited handsomely. In late September, for example, a single seat in the 1300-seat exchange sold for a record $2,800,000 – or about $2m higher than a similar sale just eight months earlier. For many, the NYSE’s move to join the ranks of the wired wasn’t really a bombshell, but a necessity – particularly in light of the SEC’s approval of Regulation NMS, a collection of rules reforms issued just weeks before the acquisition announcements, aimed at bringing the arcane infrastructure of the market system into the modern era.“Ultimately, the biggest impact Regulation NMS will have on the US equity markets is that floor-based trading will become a thing of the past,” contends Jodi Burns, senior analyst in Celent’s Securities & Investments group, who authored a report on Regulation NMS.“Regardless of who individually wins and loses under Regulation NMS, overall the equity markets will improve and moderniSe as they stop straddling the worlds of manual and electronic trading and embrace wholeheartedly the benefits of technological innovation.”

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Things have been considerably more tranquil over on public companies are without research at all and the result the NASDAQ side of town. In late September, Instinet could be a two-tier market, with relatively few corporations shareholders voted to approve the company’s merger with having regular coverage by one or more ‘name’ analysts.” NASDAQ, having settled a lawsuit filed earlier by several shareholders. Though the deal still requires regulatory Taking Stock approval, a closing may occur sometime during the fourth Who profits the most from the ECN amalgam? The quarter. “We have been able to structure a cost-savings Archipelago deal would give the NYSE a 17% stake in OTC plan internal to NASDAQ on our own, which gets stock. By contrast, Instinet’s share of NYSE stock was a accelerated with the INET purchase,” reports Christopher scant 2% at the time the NASDAQ deal was announced. In R. Concannon, executive vice president, transaction addition to bringing traditional OTC offerings such as services for NASDAQ.“We are committed to sharing those options trading to its clients, the NYSE has announced that savings with both shareholders and market participants, it will create a second listing business for companies that which will be accomplished through pricing. That is the do not currently qualify for NYSE listing, in an effort to direct savings that we envision [sic]. The other is how you compete directly with NASDAQ.“That is going to be a very execute – having the liquidity centralised in this manner interesting and attractive business for us,”says NYSE CEO gives you a little more efficient infrastructure. So that is an John Thain. “It will make it easier for companies to move indirect savings the industry will feel as we migrate toward when they get bigger and do, in fact, qualify. It is a little bit a single platform.” harder to move these companies when they’re on a While fragmentation of the quote will continue to exist, competing market, but it will be an easier transition to says Concannon, under the move a company from an new system there will be Archipelago listing to a New reduced fragmentation of York listing as they grow and Things have been considerably more liquidity.“And ultimately the get bigger.” tranquil over on the NASDAQ side of town. fragmentation of the quote Some see this as a clear In late September, Instinet shareholders keeps the big liquidity pool NYSE advantage, but not voted to approve the company’s merger cautious on price. Which is NASDAQ’s Concannon. “I exactly what Regulation can understand why people with NASDAQ, having settled a lawsuit NMS does – it fragments the would come away with that filed earlier by several shareholders. quote, but it is not opinion,” says Concannon. Though the deal still requires regulatory necessarily going to “On the other hand, we did approval, a closing may occur sometime fragment the liquidity that not pay 30% of our company. during the fourth quarter. we are consolidating.” We bought a system for There are skeptics $900m that had a 26% (among them Warren market share in NASDAQ Buffett) who worry that the increased efficiency and ultra names and is known among the industry as the premier low-cost commissions of an all-electronic marketplace platform for trading US equities. It is one thing for will encourage rampant trading, rather than prudent Archipelago to have 17% over-the-counter (OTC) market buying-and-holding. “I idoliSe Warren, so I have a hard share, but that is down from 20% a year ago and 22% the time disagreeing with him,” says Concannon. “We are year before that. And with a platform that is not considered learning from Warren every day – things that he has done the industry’s leader. So I kind of like where we stand.” with Geico, for example, where he has used technology Chris Rice, manager of State Street Global Advisor’s and low price to scale, and dramatically so.You might say Boston regional trading desk, says that investors should be that we are attempting to mimic the master. I am hopeful the ultimate winners.“Investors will enjoy a greater choice that his opinion will change, because we are using his of where to trade and how, and at a lower cost. The new own techniques.” entities will essentially create a market-based consumer But there are other considerations as well. Hank Boerner, taste test for preferred market structures. Investors will be a corporate consultant and former officer and senior able to choose among electronic, floor-based or hybrid communications manager for the NYSE, believes that models combining the first two.” further erosion of trade-execution costs could lead to a crisis in equity research. Floor No More? “Falling prices – say to 1 cents per share traded – will While the possibility of a silent, auction-less, completely eliminate today’s 3 cents to 5 cents per share per share computer-driven NYSE may be a sobering thought to cushion that pays for much financial analysis and traditionalists, to others, an all-electronic stock exchange is research,” says Boerner. “Who will pay for research is the welcome news. “I think investors get a better deal in the huge, undecided question and the NYSE-Archipelago electronic markets,” notes Wharton finance professor proposal could be disastrous for the broker-sponsored Jeremy Siegel, who agrees that the time has come for the stock research as we have known it. Already, hundreds of Big Board to get with the program.

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Wharton finance professor Marshall E. Blume meanwhile, who along with Siegel and writer Dan Rottenberg authored the book Revolution on Wall Street: The Rise and Decline of the New York Stock Exchange, contends that the electronically based consolidation of NYSE’s multi-layered membership system can only bring positive results to the investment community. “We were commenting [in the book] that there were a large number of different interests in the membership of the exchange,”observes Blume.“It was very difficult to get anything done.” Still, the argument for continued human intervention is a compelling one. Particularly when one considers the indisputable advantages of trading stock through a specialist, who, unlike automated systems, might fill a sell order at a higher price or even negotiate between parties until an agreement is reached. Yet Siegel maintains that the increased speed and liquidity and reduced price spreads Former New York Stock make the electronic markets Exchange Director Kenneth the clear choice going forward. Langone leaves a law office in “The NASDAQ market is New York on Wednesday 20th more efficient than the NYSE is July 2005. now under the specialist system,” notes Siegel. Adds Blume,“The NYSE can provide both services, and the market markets as we do today, or we can make remote markets if will determine how valuable each is. My suspicion is that for that’s better.” From his vantage point at NASDAQ, Concannon says many trades the electronic market will be preferable, because investors can look forward to a radical change to the basic you get it done with minimal costs and quick turnaround.” In reality, floor trading may not vanish overnight, and market structure in the US during 2006. “It is something specialists will likely continue to shepherd stocks with that has never happened before in quite this fashion,”notes lower volume and higher volatility for the foreseeable Concannon.“If you think back to NASDAQ’s transition to future. Meanwhile, specialists may find themselves filling a an all-electronic entity, it occurred over a five to six year new role in a possible niche market comprised of global period – it was not a single-day event. A lot of people refer electronics exchanges.“We’ll make markets wherever there to this in the same terms as the London markets or the is order flow, and it is going to be on a hybrid market or a futures industry going all-electronic. But it is really not the traditional block-trading market where brokers come into case. The difference is that there is a very viable, very your crowd,” says Michael LaBranche, chairman, president efficient competitor sitting on the sidelines as they go and chief executive officer (CEO) of specialist firm through their transition. That is what we have to look LaBranche & Co, in a recent conference call.“We can make forward to in the coming year.”

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2005

Photo: EMPICS, September 2005.

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WEALTH ALLOCATION INVESTING

Building portfolios without prices A new long-term non-speculative strategy for equity investors has emerged, called “Wealth Allocation Investing”. Intended for core portfolios, it is an alternative to indexing strategies and claims to protect large institutional investors from the speculative forces that dominate today’s markets. Simply put Wealth Allocation Investing builds equity portfolios without referring to stock prices. David Morris of Global Wealth Allocation explains why and how in a free market system, speculators provide liquidity.

T HAS BECOME a curiosity to the modern day investor that there is a social purpose to the stock market. John Maynard Keynes in his General Theory of Employment, Interest and Money defines the social purpose as “directing capital to the most profitable channels in terms of future long term profitability”. The importance of allocating capital in this way is that new investment is more easily and efficiently generated in sufficient quantity to achieve full employment— continuously. So, determining long-term profitability of capital is central to the social purpose of the stock market. “Forecasting the prospective yield [expected future returns] of assets over their whole life”, is the main concern of long term investors according to Keynes, and rely upon the discounted cash flow or internal rate of return calculation. Another important feature of a successful stock market is liquidity. Without it, there can be no long term investment. Unless the investor can

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change his mind, he will be reluctant to commit risk one year or less, which has been the case for the past five capital to new investments. Such disinclination would years. This fact demonstrates that currently, speculators and speculative forms of investing dominate our inhibit movement toward full employment. This type of investor is concerned with forecasting the markets. In other words, the dominant convention in movement of asset prices over a short period of time. Long- valuing stocks today is to correctly anticipate short-term period returns to capital assets are of no concern. Speculators price movements. Speculative investing, however, is a zero sum game. The are essential to successfully functioning free markets because, without the liquidity they provide, the long-term investor will gains of any one speculator must be the losses of one or many others. Loosely speaking, we could say that half the not commit his capital to new investment. Everyone knows that we can get too much of a good speculators must under-perform. After taking into thing. And this is true of liquidity. Too much speculation consideration manager fees and turnover costs, the odds ruins markets. A case in point is the high-tech bubble of worsen. Perhaps it is this predominance of speculative 2000 where the NASDAQ reached 5048, before collapsing investing that explains why so many investors have lost to 1119 in 2002. Likewise Japan’s Nikkei index, currently faith in active management. It is ironic that this loss of trading at around 13,000, is now recovering from the faith occurs at a time when there are more markets than speculative bubble which carried the index to 40,000 in ever in which to invest. One consequence of this loss of faith in active 1988. Conversely, too little speculation can also ruin markets. The great depression of the 1930s demonstrates management is the increase in passive investing, or what is known as index tracking. Market capitalisation indices the harm caused by a lack of liquidity. These periods of misdirected capital were caused by an are the only definitive measure of stock market imbalance of long term and speculative investors. They performance. Prudent investors choose a relevant market illustrate just how crucial it is that neither one nor the cap index to monitor the performance and risk of their other predominate. In order for the stock market to fulfill active managers. A passive investor is one who chooses to its social purpose, there must be a balance of these very make the performance target the active investment strategy. The success of passive investing is evidenced by different, symbiotic investors. The application of technology to capital markets has the fact that more than one fifth of the world’s stock market is invested this way. made stock market investing, At least another fifth is accessible to ever increasing invested in quasi-passive numbers of diversely As a result a new breed of speculator, strategies, or enhanced motivated investors. Modern the ‘day trader’, utilising complex index investing which seeks technology enables mathematical models, has emerged to track closely these instantaneous online trading, unbound by geographical or economical performance target indices. access to infinite amounts of There are advantages to this financial information, cheap constraints. The convergence of passive approach. It is high volume data storage, technology in the capital markets has cheap, transparent, easy to and super fast calculation enabled stock trading to flourish virtually implement and outperforms capabilities. As a result a new anywhere in the world. more than half the breed of speculator, the ‘day investment manager trader’, utilising complex universe, much of the time. mathematical models, has emerged unbound by geographical or economical It also offers very high capacity which is essential for the constraints. The convergence of technology in the capital core portfolios of institutional investors, while at the same markets has enabled stock trading to flourish virtually time guaranteeing liquidity. There are some disadvantages, however. Performance anywhere in the world. This fluidity of capital means that companies compete benchmarks are pure price constructs that swing with for capital on a global basis. Consequently we have seen market price fluctuations. When speculation dominates a huge increase in the number of global investable any market these benchmarks become more volatile. markets in the last decade, all of which offer easy access Abrupt price movements can cause a major shift in to investors. The proliferation of market capitalisation concentration and diversification within the benchmark. indices worldwide is a response to investor demand for These market capitalisation indices become susceptible to performance measurement for these new markets. Most the boom bust cycle. Many active managers, who are of the new investors however are speculators. The world ultimately judged against these indices, tend to follow the benchmark in an attempt to manage the perceived risk in stock market capitalisation totals $25trn. Surprisingly (to me at least) the aggregate annual their portfolios. This forces them against their better turnover is about the same — $25trn. Put crudely, the judgment to buy stocks rising in price and sell stocks world stock market trades itself once a year. By this declining in price, the exact opposite to what successful calculation, the average holding period for equities is managers do.

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As a consequence, performance benchmarks may fail to achieve their intended purpose in highly speculative markets, paradoxically causing more volatility and hence risk. Passive portfolios in these conditions become more speculative as they effectively fuel the volatility as they seek to replicate the benchmark. This can have unintended consequences for the passive investor. It also leads to a misallocation of capital, which threatens future economic growth. Neither the choice of performance benchmark (by definition a cap weighted index), nor passive investing, can protect investors or their closely monitored managers from these waves of speculation which occur continuously in free markets. The only remedy is to restore the balance of long term investors. Those of us who are fund managers must develop genuine long term investment philosophies and those of us who are investors must develop long term expectations. For our part , Global Wealth Allocation offers investors a new, non-speculative, long term, investment strategy called “Wealth Allocation Investing”. Intended for core portfolios, it is an alternative to indexing that can protect large institutional investors from the speculative forces that dominate today’s markets, without sacrificing capacity and liquidity. Simply put Wealth Allocation Investing builds equity portfolios without referring to stock prices. The investment philosophy begins with the principle that, although share prices are volatile in the short term, over the long term they must mirror the growth of the underlying company wealth. Prices are not wealth. Company wealth consists of four fundamental measures: net profit, cash earnings, book value and dividends. So we focus on wealth to the exclusion of prices. Another principle of Wealth Allocation Investing is that all our portfolios must contain the same constituents as the client’s relevant benchmark. This ensures diversification. We do not pick stocks. Our process weights each company in the relevant investable universe according to its wealth. For example, in the UK each constituent company’s share of the FTSE 100 cash flow of £150bn per annum becomes an active weight. We make no forecasts. Similarly, each company holds a share of the index total book value and net profit. We blend these three different active weights to create our portfolios for implementation. Avoiding prices in this way provides a more rational allocation of investment and is a practical application of Keynes’ marginal efficiency of capital or, as we know it, internal rate of return. The result is that our portfolios hold every company in the relevant benchmark in proportion to wealth, not market capitalisation. It is important to stress that this approach produces an active, long-term strategy and not a new index. In order to implement these portfolios we have adopted a business model that wraps the active strategy in an index. This we call a strategy index to differentiate it from a performance index. GWA has formed a joint venture with FTSE to launch, this autumn, nine new strategy indices. These are

Another principle of Wealth Allocation Investing is that all our portfolios must contain the same constituents as the client’s relevant benchmark. Our process weights each company in the relevant investable universe according to its wealth. For example, in the UK each constituent company’s share of the FTSE 100 cash flow of £150 billion per annum becomes an active weight. Similarly, each company holds a share of the index total book value and net profit. We blend these three different active weights to create our portfolios for implementation.

to be implemented for clients by two of the largest index fund providers in the UK, State Street and Legal & General. The process out-performs by exploiting price volatility. Our wealth weighted portfolios are rebalanced every 90 days and the re-balancing generates sell orders for shares whose market cap weight has risen above their wealth weight and buy orders for shares whose market cap proportion has fallen below it. This creates a bias to buy low and sell high, opposite to benchmark tracking processes. It is this attribute that protects portfolios from speculative waves. Turnover rarely exceeds 23% and the average holding period is 4-7 years. This holds true for both international as well as single country applications. The contra direction of the trades creates the potential for crossing, reducing transaction costs. The portfolios possess huge capacity, since they contain every company in the relevant benchmark. They can handle mandates almost as large as any index fund without curtailing performance. They are very liquid. Wealth weighted portfolios exhibit consistent risk adjusted returns which are contracyclical to the index and market fashion. When included in large multimanager funds, wealth portfolios work to lower risk. This strategy had its first live implementation in June 1998 with Honeywell pension fund in the US. Wealth Allocation Investing is high capacity and, like indexing, is capable of capturing and ordering a major share of the core portfolios if institutional investors. It is a stabilising force in the stock markets. The greater the amounts invested in this long-term process the more stability there will be. By attempting to direct investment into the most profitable channels, in terms of future long-term returns, Wealth Allocation Investing aligns with Keynes’ intended purpose of free markets. This is to ensure that new investment is always forthcoming at a steady, full employment rate.

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The arguments for and against index based investment strategies have long polarised the global institutional investment market. Here FTSE Global Markets gives Steven A. Schoenfeld, chief investment strategist for Global Quantitative Management at Northern Trust Global Investments (NTGI), room to make the case for today’s index investor where he argues that the index versus active debate is over.

HE FIRST INSTITUTIONAL index fund was established in 1971 and the first retail index fund was launched in 1976. Since then domestic equity, international equity and fixed income indexing, index futures, options, swaps, exchange-traded funds (ETFs) and other index products have put theory into practice. The fundamental principle that underlies indexing however (a focus on minimising costs and controlling risks) remains unchanged and this principle is increasingly shared by index and active managers alike. The industry’s future is no longer a simple debate between index and active investing and the growth of index based strategies is a testament to this. Instead it is about ensuring that the investor chooses an appropriate mix of investments on the risk continuum. The timeless efficiency and utility of index based strategies is evident in the increasing role that they play in strategic allocation, risk budgeting, tactical allocation and transition management. This is demonstrated by the dramatic growth of assets under index based management in, for example, institutional funds, retail, mutual funds, unit trusts and ETFs. Furthermore, ‘pure passive’ strategies used by tax-exempt institutions in the United States has grown steadily and in 2004 surpassed US$1.8trn. This is clearly shown in Figure 1: The growth of US institutional taxexempt indexed assets.

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2005

Similarly, global index ETF assets surged past the US$250bn mark in 2004. Furthermore ETFs are now listed in more than 20 countries, including many emerging markets. In addition, the volume and variety of index based derivatives – such as listed futures/options and over the counter products such as index swaps – has grown even faster than the underlying assets. In the US equity indices are becoming increasingly difficult for active managers to beat, as shown in Figure 2: The percentage of active managers outperforming their benchmark. As of December 2004, for example, less than half of active managers outperformed the benchmark in all domestic funds. Even fewer managers outperformed when the broad universe is decomposed by capitalisation, as only 38% of large cap and mid cap mangers were able to beat the S&P 500 over the last year and only 15% of small cap managers were able to outperform. This trend is something that is not exclusive to the US. For North American investors, international equity indices are becoming harder for active managers to beat as well. As indices continually improve methodology and broaden their coverage, there are fewer opportunities for outperformance by active managers. In aggregate, Continental European plan sponsors index less of their equity exposure than their American, British,

INDEX REVIEW: INDEX-BASED STRATEGIES

Timeless Efficiency and Utility

Photo: iStockphoto.com. August 2005.

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INDEX REVIEW: INDEX-BASED STRATEGIES

portfolio. Index based Japanese and Canadian products for style, sector and counterparts. Although index … the volume and variety of index capitalisation sizes can be based strategies are still at the based derivatives (such as listed used to adjust the risk level core of asset allocation, the futures/options and over the counter of the total portfolio as use of index based strategies products such as index swaps) has grown active managers may sway can be expanded to fulfill from intended targets, various roles within the even faster than the underlying assets. without diluting or portfolio. Sophisticated compromising the potential investors increasingly combine index, enhanced index, risk-controlled active, value expected from the active managers employed. As an traditional active and absolute return strategies to maximise efficient cost effective instrument, index based products risk budgeting along an ‘efficient frontier’, trading off higher again provide an easy tool for realigning original strategic expected alpha for higher risk. The precise roles and mix of allocations and targets. Institutions that maintain positions in broad asset classes index based and active products depend on the owner’s investment objectives, which are generally determined by can rebalance to their stated benchmarks by simply reassigning asset surpluses into temporary index accounts funding level, size and maturity. With strategic asset allocation, many investors use index that adjust asset exposure while awaiting assignments to funds to provide a core position in one or more asset classes managers. In fact, these institutions can implement with around which they can add satellite active managers. In this low transition cost index funds or index derivatives to structure, the index fund delivers benchmark returns (or temporarily alter the overall plan asset allocation. This beta) while active managers are expected to add alpha relative risk-adjustment can capture these modified above their relevant benchmark. Frequently, the index fund, outcomes without disrupting the performance with its market level risk, prompts the investor to give the characteristics of the existing manager mix. Such products active managers a higher risk budget than would be the as ETFs and index futures may be used to shift allocations case without the index fund. Clearly indexing is not only at between different sectors and markets globally. It is a rapid the core of many plan sponsor allocations but is also a vital and efficient solution for tactical allocation strategies. Perhaps the preferred approach involves assembling the tool for risk budgeting. The second approach involves an asset allocation overlay. optimal combination of managers, where the optimum Strategic asset allocation plays a central role in determining scenario is viewed in the dimensions of expected alpha long term portfolio performance. However, when returns versus active risk. Instead of singling out one manager, this begin to diverge across different asset classes, the portfolio approach should be holistic, focusing on the combination of mix soon starts to deviate from the target allocations. Plan managers as an entire portfolio carrying desirable risk and sponsors who want to adhere to their allocations closely return characteristics. The approach will maximise the often find that the costs of reassigning mandates among portfolio’s expected alpha while controlling active risk. The various managers can be prohibitive. The low costs efficient frontier shown in Figure 3: Optimal allocation across associated with index management have led it to become a candidate investment managers illustrates the impact of useful solution to this challenge. The relatively easy and combining managers in different proportions to build alphaefficient implantation of index based strategies therefore is adopted to address the divergent portfolio. Figure 2: The percentage of active managers Index management can also be used to plug “risk holes”, outperforming their benchmarks as the selection of active managers may cause the resulting portfolio mix to deviate from the intended risk of the overall 49% All Domestic Funds

Figure 1 – The growth of US institutional tax-exempt indexed assets

40%

One year Three year

2 ,0 0 0 1,837 1,731

1 ,8 0 0 1,637

1,619

Dollars in billions

1 ,6 0 0

1,559

1 ,4 0 0 1 ,2 0 0

38%

All Large Cap Funds

1,272

1,251

31%

1,110

1 ,0 0 0 793

800

38%

674

600 348

400 178

200

244

453

393

All Mid Cap Funds

233

03 20

20 04

20 02

20 0

19 99

98 19

19 95

94 19

19 92

19 9

19 8

19 89

21%

389

All Small Cap Funds

15% 23%

Year

Source: Pensions & Investments, Spring 2005

Sources: S&P SPIVA as of 12/31/04, Northern Trust Global Investments

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INDEX REVIEW: INDEX-BASED STRATEGIES

index assets under maximising portfolios at many management for US plan different levels of active risk to sponsors now exceed improve the portfolios overall This advanced investment framework $300bn and rarely a month risk/reward characteristics, goes by without an using managers, which the outlines where index, enhanced index, additional institutional asset owner has a high degree risks controlled active, traditional active search for such strategies. of confidence in producing and absolute return strategies fall on the However, despite the consistent alpha. efficient frontier. When closely examining growth of assets dedicated Where on the frontier is the the expected verse actual dispersion of to enhanced portfolios, best trade-off for investors? alpha and risk within each type of there is deep confusion Asset owners strive to choose surrounding the definition the best mix of managers and investment the spread tends to widen as of enhanced index products. approaches for each asset class you increase up the frontier. Enhanced strategies are (such as domestic equity, nonoften defined by expected domestic equity, fixed income, ex-post or ex-ante alpha, etc). Optimisation is based on expected risk or expected risk and return preferences and reliance on the confidence of managers to deliver on their information ratios. Various approaches are used as well, objectives. Usually, the efficient frontier will level off well such as stock based factor and trading models and also before it prescribes a portfolio that is 100% active as a total derivative-based strategies. As allocations to enhanced active portfolio provides little additional alpha for its increased indexing grow, clarifying the definitions of the category will level of risk and higher incremental cost. The optimal become much more vital. I believe that a ‘combined combination will combine high expected information ratios definition’ will become prevalent – one that looks at past and low levels of active risk. Thus, enhanced index and risk- and expected information ratios as well as the functional controlled active managers and market-neutral long-short approach used to produce the enhanced returns. Yet the role of traditional active managers continues to managers (usually equitised) have earned their growing roles in investor portfolios, often at the expense of traditional active be supported wherever their skill is identifiable and repeatable. Indeed, the alpha provided by consistently managers. This advanced investment framework outlines where good performing active managers is more valuable than index, enhanced index, risk-controlled active, traditional ever as asset owners reach for return in an era of lower active and absolute return strategies fall on the efficient performance expectations. This manager structure frontier. When closely examining the expected verse actual optimisation, or risk-budgeting, approach is focused on the dispersion of alpha and risk within each type of investment investor’s need to control risk and return. It also rejects the the spread tends to widen as you increase up the frontier. ‘indexed versus active’perspective as an irrelevant manager Burdened by higher costs, turnover, fees and uncompensated centric argument between competing providers. As these trends continue and assets dedicated to index risks the traditional active and absolute return strategies have greater dispersion than the lower risk strategies. Thus more and enhanced index strategies increase, it is vital for and more pension funds are shifting “down the efficient investors to understand the many uses of index based frontier” to achieve their core beta through index and risk products in the portfolio mix. Institutional investors and controlled strategies and simultaneously shifting up the curve sophisticated individual investors will continue to strive for for long/short alpha and other absolute return strategies the optimal/mix on the efficient frontier of expected alpha which are less correlated to beta capturing strategies. It is the and risk. Due to its inherent efficiency, indexing will be at traditional active managers that are currently under the the core of these approaches, and thus continued growth of most pressure to deliver returns commensurate with the index-based strategies is inevitable. risk and costs they incur. These, “managers under pressure” are located on the middle part of the curve in Figure 3: Optimal allocation across candidate investment Figure 3: Efficient allocation to a range of investment managers 2.0 approaches. 1.8 Enhanced indexing is the sweet spot in this type of risk 1.6 budgeting as it provides return enhancement without 1.4 significant increased risk. As a high information ratio 1.2 strategy, enhanced indexing is growing in use in the core 1.0 0.8 asset classes (such as domestic equity, international equity 0.6 and fixed income). Many large US and European public 0.4 and private pension plans have created a dedicated 0.2 allocation for enhanced indexing. For example, in a recent 0.0 10 12 survey by Pensions & Investments in May 2005, enhanced 0 2 4 6 8 M anager 5

Expected alpha (%)

M anager 4

M anager 3

M anager 2

M anager 1

Expected active risk (%)

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Company Name

Page

ABN AMRO ABN AMRO Bank ABN AMRO Capital Alpha Bank AlpInvest Partners AltAssets America Movil America Online American Safety Razor APT Archipelago Argus Research Athens Stock Exchange Axioma Bahrain Monetary Authority Banco Itaú Banco Pactual Bank Austria Creditanstalt Bank Millennium Bank of America Bank of Bermuda Bank of Boston Brazil Bank of Communications Bank of Greece Bank of New York Bank of Shanghai Bank Pekao Barclays Capital Bayerische Hypo- und Vereinsbank Aktiengesellschaft Benson Oak Capital Berkshire Hathaway BNP Paribas BNP Paribas Securities Services Boston Beer BRE Bank Bulgaria’s Bulbank CalPERS Campbell Soup Capital Intelligence Capital Market Commission Carling Cemex Central and Eastern European Securities and Clearing Houses Association Ceskoslovenska Obchodni Banka China Asset Management Company Ltd Citibank Citigroup

27 32 32 20 70 33 36 68 47 58 75 48 8 59 43 39 39 27 27 39 53 39 53 22 52 53 27 36 27 32 75 43 28 48 27 27 1 46 43 22 47 36

26 27 8 32 27

Company Name

Page

Clark Chewing Gum 47 Clearstream 26 Cohen and Steers 14 Coors Brewing 46 Copernicus Capital Partners 33 Council of Mortgage Lenders 73 Credit Suisse Asset Management 39 Crescent Petroleum 42 CVC 32 Cyprus S.E. 8 Dana Gas 42 Delphi 68 Delta Lloyd 72 Deutsche Bank 39 Deutsche Börse 26 Disney 46 Dow Jones Index 8 Dresdner Bank 29 Dresdner Kleinwort Wasserstein 37 Dutch Mortgage Portfolio Loans 72 EFG Eurobank 20 EIRIS 8 Enterprise Investors 32 EPRA 8 Euroclear 53 Euroclear Bank 65 Euronext 8 European Central Bank 65 European Central Securities Depositories Association 26 European Union 59 Federal Reserve Bank of New York 64 Fitch Ratings 72 Foundation for Fiduciary Studies 18 FTSE Group 6 Gamet 32 General Motors Acceptance Corporation 72 GMAC-RFC 72 Goldman Sachs Asset Management 59 Grisoft 32 Gulf International Bank 42 Hang Seng 8 Hedging Griffo 39 Heineken 48 Home Depot Inc. 75 Honeywell 80 Hong Kong Housing Authority 10 Hoyt Advisory Services 14

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2005

Company Name

Page

HSBC HSBC Brazil HSBC Middle East HVB IMF ING Bank ING Bulgaria ING Wholesale Banking INOGATE Instinet Group Inc. Intel Capital International Capital Markets Association International Monetary Fund International Swaps and Derivatives Association Intesa Jarislowsky Fraser Johannesburg Stock Exchange JPMorgan JPMorgan Chase KBC KBC Investco KBC Private Equity Kereskedelmi es Hitelbank Kerr McGee Latibex Latsis Group Legal & General Lehman Brothers Lloyds Bank Merrill Lynch MFS Financial Investment Miller MobilTel Morgan Stanley Mylan Nabisco NAREIT NASDAQ National Bank of Abu Dhabi National Bank of Dubai National Bank of Greece New York Stock Exchange NIB Capital Nike Nordic Exchanges Nortel Networks Northern Rock Northfield Nova Ljublijanaska Banka Ohio Public Employees Retirement System

53 39 42 27 37 27 32 28 22 74 32 62 23 64 27 46 8 39 64 27 33 33 27 49 8 22 80 53 39 34 19 46 32 36 49 49 8 10 43 43 20 74 70 46 8 68 72 60 27 69

Company Name

OMX Ortelius Papst PGGM Pharma Futures Philip Morris Ping An Piraeus Bank Privredna Banka Quest RiskMetrics Group Russell RZB Santander Schlitz Securities and Exchange Commission Shell/Royal Dutch Petroleum Siveco Romania SKB Banka Smith Barney Societe Generale Standard & Poor’s Standard Chartered Bank Star-Kist Foods State Street Bank Stichting Pensioenfonds ABP Stratosphere SunGard Adaptiv Supervisory Committee of Private Insurance Taageer Finance Taiwan Stock Exchange Tel Aviv Stock Exchange Texaco The Bank of New York The Leuthold Group Time Warner TWA UBS Unibanco UNICEF Unicredito Italiano Universities Superannuation Scheme US Congress USX Wal-Mart Wilshire Analytics Xinhua Financial News XO

Page

26 33 47 70 69 46 53 20 27 68 58 8 27 39 47 18 68 33 27 48 27 43 43 46 52 67 1 61

COMPANIES IN THIS ISSUE

FTSE Global Markets Company Directory

22 42 8 10 49 62 14 49 49 43 39 8 27 69 18 49 36 59 8 49

Au st F FT TS rali E a SE Au AC Be s lg tria iu FT m/ AC SE Lu x C FT A SE ana C De da A n FT C m SE ar k F A FT inla C n S FT E F d A SE ran C Ge ce FT SE FT rma AC ny Ho SE AC Gr ng Ko eec e ng FT Ch AC SE in Ir a A e C FT land SE A Ita C F FT T ly SE SE A FT Ne Jap C a t SE he n Ne rla AC nd w s Z FT eala AC SE nd A FT No SE rw C Po ay FT rtu AC SE g Si ng al A a C FT por e S FT E S AC SE pa F i FT TSE Sw n A e SE Sw de C n Un i ite zerl AC a d Ki nd ng AC d F T om SE A US C A AC

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11/10/05

31 -M

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MARKET REPORTS BY FTSE RESEARCH

FT SE

MARKET REPORTS 10.qxd

Page 86

FTSE Global Equity Index Series – Global, Year to Date

31st December 2004 - 30th September 2005

FTSE Regional Indices Performance (USD) 150

FTSE Global AC

140

FTSE Developed Europe AC

130

FTSE Japan AC

120

FTSE Asia Pacific AC ex Japan

110

FTSE Middle East & Africa AC

100

FTSE Emerging Europe AC

FTSE Latin America AC

% FTSE North America AC

FTSE Regional Indices Capital Returns (USD)

FTSE Developed Country Indices Capital Returns

Dollar Value

Local Currency Value

-10

Key: AC = All Cap, LC = Large Cap, MC = Mid Cap, SC = Small Cap, LC/MC = Large and Mid Cap

NOVEMBER/DECEMBER 2005 • FTSE GLOBAL MARKETS

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Page 87

FTSE All-Emerging Country Indices Capital Returns 120 100 80

Dollar Value 40

Local Currency Value

20 0

FT SE

Ar ge FT ntin SE a B AC FT raz SE i l A F T Ch C ile S FT FTS E C A hi C SE E na Cz Col A u ec C h mbi Re a A p FT ub C li S FT E E c A SE gy C Hu pt A n F T ga C FT SE ry SE In AC In dia do A FT nes C SE ia A C FT Isr S a FT E K el A SE or C M ea FT alay AC SE si FT M a A C SE ex ico FT Mor A SE oc C Pa co AC ki s FT FT tan SE SE AC Ph Per u ili F T p p i n AC SE es AC Po F FT TS lan SE E R d A So us C sia ut AC FT h A SE fric FT Ta a A S E iw C Th an F T a i l AC SE an Tu d A rk C ey AC

-20

FTSE Global All Cap Sector Indices Capital Returns (USD) 50 40 30 20

Capital

% 10

Total Return

0 -10

tru

M O inin il Bu & g ild Ch G in em as St For g M ica ee es at ls El Ae l & try eria ec tro D ros Oth & P ls ni iv pac er ap e c e & rsi e & Me r En Ele fied D tals gi ctr I efe ne ic nd n er al us ce Ho i E t us Au ng qu rial eh to & ipm s ol mo Ma e d n b Fo Go ile chin t od od s & er Pe y Pr s rs od & Pa on T rt uc a er B ext s Ph l Ca s ev ile ar re & e s m & Pr rag ac H oc e eu ou es s tic se so al h o s H rs l & d ea Bi Pr lth ot od ec uc hn ts Ge o ne To log b y M r ed Lei al R acc ia su et o & re ai En & ler Su ter Ho s pp tai tel or nm s Te F tS e le oo co d er nt m & v m D Tra ice un ru ns s ica g R po tio et rt n aile S e rs r Ut El vice ilit ec s ie tric s - O ity th In B er ve L In an st ife su ks In m r fo S en As anc rm pe t C su e at cia om ran So ion lity c ftw Te & Re pan e ar ch Ot al ies e no he Es & lo r ta Co gy Fin te m H an pu ar c te dw e rS a er re vi ce s

-20

Stock Performance Best Performing FTSE All-World Index Stocks (USD/%) Dongwon Financial Holding 209.3 High Tech Computer 203.0 Orascom Construction 202.2 Catcher Technology 200.9 Lotte Midopa 195.9

Overall Index Return FTSE Global AC FTSE Global LC FTSE Global MC FTSE Global SC FTSE All-World FTSE Asia Pacific AC ex Japan FTSE Latin America AC FTSE All Emerging Europe AC FTSE Developed Europe AC FTSE Middle East & Africa AC FTSE North Americas AC FTSE Japan AC

Worst Performing FTSE All-World Index Stocks (USD/%) Doral Financial -73.5 Delphi Corporation -69.4 Elan Corporation -66.1 Nakornthai Strip Mill -64.7 ReignCom -58.6

No. of Consts

Value

3 M (%)

7,915 1,160 1,864 4,891 3,024 1,845 200 103 1,599 200 2,596 1,372

325.01 314.72 435.45 389.86 194.09 386.68 651.29 612.24 344.04 493.29 298.23 353.17

7.2 6.5 8.4 7.5 7.1 8.3 27.9 33.7 7.6 22.5 4.3 17.4

6 M (%) 12 M (%) Actual DIv Yld (%)

7.7 6.4 10.2 9.2 7.5 11.5 37.4 38.2 5.5 23.0 6.2 13.3

19.3 16.2 26.1 25.0 18.6 29.3 68.6 62.5 22.5 49.2 13.8 25.7

2.01 2.16 1.65 1.61 2.06 2.96 3.26 1.76 2.63 2.58 1.68 0.94

Key: AC = All Cap, LC = Large Cap, MC = Mid Cap, SC = Small Cap, LC/MC = Large and Mid Cap

FTSE GLOBAL MARKETS â&#x20AC;˘ NOVEMBER/DECEMBER 2005

io n

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ns t

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11/10/05

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FT SE

MARKET REPORTS BY FTSE RESEARCH

MARKET REPORTS 10.qxd

Page 88

FTSE Global Equity Index Series – Developed ex US, Year to Date

31st December 2004 - 30th September 2005

FTSE Developed Regional Indices Performance (USD) 125

FTSE Developed (LC/MC)

120

115

FTSE Developed Europe (LC/MC)

110

FTSE Developed Asia Pacific (LC/MC)

105

FTSE All-Emerging (LC/MC)

100

FTSE Developed ex US (LC/MC)

FTSE US (LC/MC)

%10

FTSE Developed Asia Pacific ex Japan (LC/MC)

FTSE Developed Regional Indices Capital Returns (USD) 25

% 15

FTSE Developed ex US Indices Sector Capital Returns (USD)

Capital

-10

Total Return

-20

Key: AC = All Cap, LC = Large Cap, MC = Mid Cap, SC = Small Cap, LC/MC = Large and Mid Cap

NOVEMBER/DECEMBER 2005 • FTSE GLOBAL MARKETS

MARKET REPORTS 10.qxd

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Page 89

Stock Performance Best Performing FTSE Developed ex US Index Stocks (USD/%) Sumitomo Metal 158.9 Chiyoda Corp 152.3 Nexen 135.1 Daido Steel Co 126.0 Hanshin Elect Railway 120.8

Overall Index Return

Worst Performing FTSE Developed ex US Index Stocks (USD/%) Elan Corporation -66.1 Privee Zurich Turnaround Group -58.6 Arisawa Mfg -53.7 Net One -52.8 TIS -52.5

No. of Consts

Value

3 M (%)

1,375 733 2,108 916 517 785 294 3,824 561 1,864 4,891

212.09 508.16 189.25 319.36 206.84 204.32 328.71 356.64 333.84 411.28 447.90

10.2 3.4 6.5 16.8 7.4 15.0 8.8 10.3 10.0 10.8 11.0

FTSE Developed ex US (LC/MC) FTSE USA (LC/MC) FTSE Developed (LC/MC) FTSE All-Emerging (LC/MC) FTSE Developed Europe (LC/MC) FTSE Developed Asia Pacific (LC/MC) FTSE Developed Asia Pacific ex Japan (LC/MC) FTSE Developed ex US (AC) FTSE Developed ex US LC FTSE Developed ex US MC FTSE Developed ex US SC

6 M (%) 12 M (%) Actual Div Yld (%)

8.5 5.0 6.6 20.7 5.1 13.5 13.1 8.6 8.3 9.1 9.3

24.0 11.5 17.1 42.8 21.3 26.7 30.1 24.8 22.7 29.2 32.4

2.32 1.73 2.01 2.68 2.70 1.66 3.34 2.27 2.41 1.65 1.61

FTSE Global Equity Index Series – Asia Pacific, Year to Date 31st December 2004 - 30th September 2005

FTSE Asia Pacific Regional Indices Performance (USD) 115

FTSE Global AC

110

FTSE Developed Asia Pacific (LC/MC)

105

FTSE Developed Asia Pacific ex Japan (LC/MC) FTSE Asia Pacific (LC/MC)

100

FTSE All-Emerging Asia Pacific AC 95

FTSE Japan (LC/MC)

5 30

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Key: AC = All Cap, LC = Large Cap, MC = Mid Cap, SC = Small Cap, LC/MC = Large and Mid Cap

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2005

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Page 90

16 14 12 10

8 6 4 2

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Total Return

0 -10

M O inin il & g ild Ch G in em as St For g M ica ee es at ls El Ae l & try eria ec tro D ros Oth & P ls ni iv pac er ap e c e & rsi e & Me r En Ele fied D tals gi ctr I efe ne ic nd n er al us ce Ho i E t us Au ng qu rial eh to & ipm s ol mo Ma e d n b Fo Go ile chin t od od s & er Pe y Pr s rs od & Pa on T rt uc a er B ext s Ph l Ca s ev ile ar re & e s m & Pr rag ac H oc e eu ou es s tic se so al ho s H rs l & d ea Bi Pr lth ot od ec uc hn ts Ge o ne To log M r b y ed Lei al R acc ia su et o & re ai En & ler Su ter Ho s pp tai tel or nm s Te F tS e le oo co d er nt m & v m D Tra ice un ru ns s ica g R po tio et rt n aile Se rs r U t E l vice ilit e c s ie t r i c s - O ity th In B er ve L In an st ife su ks In m r fo S en As anc rm pe t C su e at cia om ran So ion lity c ftw Te & Re pan e ar ch Ot al ies e no he Es & lo r ta Co gy Fin te m H an pu ar c te dw e rS a er re vi ce s

-20

tru

MARKET REPORTS BY FTSE RESEARCH

FTSE Asia Pacific Regional Indices Capital Returns (USD)

Stock Performance Best Performing FTSE Asia Pacific Index Stocks (USD/%) Dongwon Financial Holding 209.3 High Tech Computer 203.0 Catcher Technology 200.9 Lotte Midopa 195.9 Mitac International 189.3

Worst Performing FTSE Asia Pacific Index Stocks (USD/%) Nakornthai Strip Mill -64.7 ReignCom -58.6 Privee Zurich Turnaround Group -58.6 Prodisc Technology -55.1 LG Card -55.0

Overall Index Return FTSE Global AC FTSE Asia Pacific AC FTSE Asia Pacific (LC/MC) FTSE Asia Pacific LC FTSE Asia Pacific MC FTSE Asia Pacific SC FTSE Developed Asia Pacific ex Japan (LC/MC) FTSE Developed Asia Pacific Index (LC/MC) FTSE All-Emerging Asia-Pacific (LC/MC) FTSE Japan Index (LC/MC)

No. of Consts

Value

3 M (%)

7915 3217 1345 514 831 1872 294 785 560 491

325.01 366.88 208.25 352.63 403.55 418.04 328.71 204.32 226.06 131.27

7.2 13.1 13.5 13.7 12.5 10.1 8.8 15.0 8.3 18.0

6 M (%) 12 M (%) Actual DIv Yld (%)

7.7 12.5 13.0 13.3 11.5 9.0 13.1 13.5 11.0 13.7

19.3 27.2 27.2 26.9 28.2 28.7 30.1 26.7 29.0 25.2

2.01 1.86 1.87 1.91 1.70 1.81 3.34 1.66 2.63 0.93

Key: AC = All Cap, LC = Large Cap, MC = Mid Cap, SC = Small Cap, LC/MC = Large and Mid Cap

NOVEMBER/DECEMBER 2005 â&#x20AC;˘ FTSE GLOBAL MARKETS

% Eu ro pe SC

M C

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FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2005

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O inin il & g ild Ch G in em as St For g M ica ee es at ls El Ae l & try eria ec tro D ros Oth & P ls ni iv pac er ap c er e M er & si & e En Ele fied D tals gi ctr I efe ne ic nd n er al us ce Ho i E t us Au ng qu rial eh to & ipm s ol mo Ma e d n b Fo Go ile chin t od od s & er Pe y Pr s rs od & Pa on T rt uc a er B ext s Ph l Ca s e v ile ar re & e s m & Pr rag ac H oc e eu ou es s tic se so al ho s H rs l & d ea P B i r lth ot od ec uc hn ts Ge o ne To log M r b y ed Lei al R acc ia su et o & re ai En & ler Su ter Ho s pp tai tel or nm s Te F tS e le oo co d er nt m & v m D Tra ice un ru ns s ica g R po tio et rt n a ile S e rs r Ut El vice ilit ec s ie tric s - O ity th In B er ve L In an st ife su ks In m r fo S en As anc rm pe t C su e at cia om ran So ion lity c p ftw Te & Re an e ar ch Ot al ies e no he Es & lo r ta Co gy Fin te m H an pu ar c te dw e rS a er re vi ce s

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Page 91

FTSE Global Equity Index Series – Europe, Year to Date

31st December 2004 - 30th September 2005

FTSE European Regional Indices Performance (EUR) 125

FTSE Global AC (EUR)

120

FTSE Developed Europe ex UK LC/MC (EUR)

115

FTSEurofirst 300 (EUR)

110

FTSE Developed Europe AC (EUR)

105

FTSEurofirst 100 (EUR)

100

FTSE Eurozone LC/MC (EUR)

FTSEurofirst 80 (EUR)

FTSE European Regional Indices Capital Return (EUR)

FTSE Developed Europe Sector Indices Capital Returns (EUR)

Capital

Total Return

-10

Key: AC = All Cap, LC = Large Cap, MC = Mid Cap, SC = Small Cap, LC/MC = Large and Mid Cap

MARKET REPORTS 10.qxd

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Page 92

MARKET REPORTS BY FTSE RESEARCH

Stock Performance Best Performing FTSE Developed Europe Index Stocks (EUR/%) OMV 122.9 Vestas Wind Systems 119.9 Sacyr-Vallehermoso 98.2 Cairn Energy 86.9 Metso Corporation 81.0

Overall Index Return (EUR) FTSE Global AC FTSE Europe AC FTSE Europe LC FTSE Europe MC FTSE Europe SC FTSE Developed Europe AC FTSE All-Emerging Europe AC FTSE Eurobloc AC FTSE Developed Europe ex UK AC FTSEurofirst 300 FTSEurofirst 80 FTSEurofirst 100

Worst Performing FTSE Developed Europe Index Stocks (EUR/%) Elan Corporation -61.7 Kingfisher -27.6 AGFA-Gevaert -19.7 Portugal Telecom -16.5 InterContinental Hotels Group -15.6

No. of Consts

Value

3 M (%)

7915 1702 236 345 1121 1599 103 809 1120 300 80 100

325.01 331.63 366.07 401.99 428.99 328.58 584.73 341.05 343.96 1228.68 4279.32 4074.03

7.2 8.5 7.6 8.6 10.6 8.1 34.3 8.4 9.0 7.6 7.8 7.0

6 M (%) 12 M (%) Actual Div Yld (%)

7.7 14.3 13.0 14.4 17.4 13.7 49.0 13.2 14.2 13.2 11.3 12.5

19.3 26.9 23.4 31.4 38.6 26.2 67.4 28.7 28.8 24.5 25.1 22.9

2.01 2.61 2.75 2.31 2.06 2.63 1.76 2.56 2.42 2.67 2.85 2.89

FTSE UK Index Series – Year to Date 31st December 2004 - 30th September 2005

FTSE UK Index Series Performance (GBP) 120

FTSE 100

115

FTSE 250

110

FTSE 350

105

FTSE SmallCap

100

FTSE All-Share 95

FTSE AIM FTSE techMARK

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% 20

Capital

Total Return

0 -10

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-20

Key: AC = All Cap, LC = Large Cap, MC = Mid Cap, SC = Small Cap, LC/MC = Large and Mid Cap

NOVEMBER/DECEMBER 2005 • FTSE GLOBAL MARKETS

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Page 93

FTSE UK Index Series - Capital Return YTD (GBP) 16 14 12 10 8 6 4 2

FT SE

gl in ed

FT SE

l-S

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FT SE

ha re

0 35

0 25 FT SE

FT SE

Stock Performance Best Performing FTSE All-Share Index Stocks (GBP/%) Stanelco BTG Oxford Biomedica SCI Entertainment Group Dana Petroleum

Overall Index Return

Worst Performing FTSE All-Share Index Stocks (GBP/%) Sanctuary Group -86.4 Phytopharm -77.7 Gresham Computing -68.8 Patientline -66.9 Superscape Group -57.7

202.3 171.6 161.4 121.8 114.3

No. of Consts

Value

3 M (%)

6 M (%)

100 250 350 340 690 294 791 100

5477.71 7951.11 2794.56 3158.36 2745.79 3596.07 1093.81 1281.13

7.1 7.9 7.2 8.2 7.3 8.1 9.6 6.9

11.9 11.5 11.8 8.6 11.7 6.3 0.5 12.9

FTSE 100 FTSE 250 FTSE 350 FTSE SmallCap FTSE All-Share FTSE Fledgling FTSE AIM FTSE techMARK 100

12 M (%) Actual Div Yld (%)

19.8 26.8 20.8 23.5 20.9 26.2 19.0 18.3

3.10 2.52 3.02 2.00 2.99 1.97 0.51 1.51

Net Cover

P/E Ratio

2.24 2.13 2.23 1.29 2.21 -1.71 0.05 –

14.4 18.68 14.86 38.87 15.16 0 3973.59 –

FTSE Xinhua Index Series 31st December 2004 - 30th September 2005

FTSE Xinhua Index Series Performance (RMB/HKD) – H1 2005 140

FTSE/Xinhua China 25 (HK$)

130

FTSE Xinhua All-Share (RMB)

120

FTSE Xinhua Small Cap (RMB)

110

FTSE/Xinhua China A50 (RMB)

100

FTSE Xinhua 600 (RMB) FTSE Xinhua China Bond Total Return Index (RMB)

5 30

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FTSE Xinhua Index Series Index Name

FTSE/Xinhua 25 (HK$) FTSE/Xinhua China 50 (RMB) FTSE Xinhua All-Share (RMB) FTSE Xinhua 600 (RMB) FTSE Xinhua Small Cap (RMB) FTSE Xinhua China Bond Total Return Index (RMB)

Consts

Value

3 M (%)

6 M (%)

12 M (%)

Actual Div Yld (%)

25 50 993 600 393 31

9404.92 3846.79 2122.21 2284.27 1532.91 98.13

10.7 0.9 4.4 3.8 7.3 3.3

13.9 -5.9 -6.1 -6.2 -5.6 8.3

18.8 -17.6 -21.9 -20.9 -27.1 13.8

3.07 3.14 2.19 2.36 1.18 2.79

Key: AC = All Cap, LC = Large Cap, MC = Mid Cap, SC = Small Cap, LC/MC = Large and Mid Cap

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2005

MARKET REPORTS 10.qxd

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FTSE Hedge Management Styles (USD) – 5-Year Performance 160

FTSE Hedge

140

FTSE All-World

120

Directional

100

Event Driven Non-Directional

80 60

5 ar -0

pSe

4 M

pSe

ar -0

3 M

ar -0

2 ar -0

01 pSe

ar -0

MARKET REPORTS BY FTSE RESEARCH

FTSE Hedge Index Series

FTSE Hedge – Management Styles & Strategies (NAV Terms) Index Level*

5-Year Ann 3-Year 6 M (%) 12 M (%) Return (%) Volatility (%)

3 M (%)

FTSE Hedge Index * 5093.55 Directional 3063.72 Equity Hedge 2152.00 Commodity Trading Association (CTA) / Managed Futures 1932.55 Global Macro 1868.06 Event Driven 3148.89 Merger Arbitrage 2033.06 Distressed & Opportunities 2158.47 Non-directional 2970.87 Convertible Arbitrage 1927.28 Equity Arbitrage 1965.27 Fixed Income Relative Value 2013.96 * Based upon indicative NAV index values as at 30 September 2005

1.7 2.5 3.8 -3.2 3.8 1.7 0.9 2.5 0.5 0.8 -0.2 1.0

1.2 1.7 4.3 -5.2 0.4 2.0 1.3 2.7 -0.2 -1.2 -1.0 1.1

3.2 4.0 8.2 -0.6 -3.6 5.8 3.0 8.3 0.1 -3.4 -0.1 2.1

5.7 8.3 7.8 11.5 6.4 3.2 1.0 5.2 3.6 6.5 3.7 2.0

2.9 5.0 3.4 14.7 6.4 2.9 1.4 4.7 1.7 4.8 2.0 1.4

FTSE EPRA/NAREIT Global Real Estate Index Series FTSE EPRA/NAREIT Global Real Estate Index Series Performance (Total Return) – Year to Date 135

FTSE EPRA/NAREIT Global Total Return Index ($)

130 125

FTSE EPRA/NAREIT North America Total Return Index ($)

120

FTSE EPRA/NAREIT Europe Total Return Index (€)

115 110

FTSE EPRA/NAREIT Eurozone Total Return Index (€)

105 100

FTSE EPRA/NAREIT Asia Total Return Index ($)

-0 ep -S 30

-A

-0

5 -Ju 31

n-Ju 30

ay -M 31

l-0

5 -0

5 pr -0 -A

-M 31

5 ar -0

05 b-Fe 28

-Ja 31

-D

-0

n05

Key: AC = All Cap, LC = Large Cap, MC = Mid Cap, SC = Small Cap, LC/MC = Large and Mid Cap

NOVEMBER/DECEMBER 2005 • FTSE GLOBAL MARKETS

MARKET REPORTS 10.qxd

11/10/05

5:56 pm

Page 95

FTSE EPRA/NAREIT Global Real Estate Indices (Total Return) Index Name

Consts

Value

3 M (%)

6 M (%)

12 M (%)

Actual Div Yld (%)

296 144 86 36 66

2408.86 2971.04 2516.35 2798.83 1733.87

6.1 3.9 6.7 9.6 10.4

15.9 18.1 21.3 28.0 14.4

29.9 28.2 39.8 50.4 29.3

3.77 4.43 2.83 3.40 3.20

FTSE EPRA/NAREIT Global ($) FTSE EPRA/NAREIT North America Index ($) FTSE EPRA/NAREIT Europe (€) FTSE EPRA/NAREIT Euro Zone (€) FTSE EPRA/NAREIT Asia ($)

FTSE Bond Indices FTSE Bond Indices Performance (Total Return) – Year to Date FTSE Eurozone Government Bond Index (€) FTSE Euro Corporate Bond Index (€) FTSE US Goverment Bond Index ($) FTSE Pfandbriefe Index (€) FTSE Gilts Index Linked All Stocks (£) FTSE Japan Government Bond Index (¥)

108 106 104 102 100 98

-0 -S

FTSE Euro Emerging Markets Bond Index (€) FTSE Gilts Fixed All-Stocks (£)

-A

-0

5 31

-Ju

n-Ju 30

ay -M 31

l-0

5 -0

5 pr -0 -A

-M 31

5 ar -0

05 b-Fe

n-Ja 31

-D

-0

FTSE Bond Indices (Total Return) Index Name

Consts

Value

3 M (%)

6 M (%)

12 M (%)

247 330 44 323 10 29 116 230 31

155.44 178.07 208.97 144.80 1945.02 1883.65 146.14 110.13 98.13

0.6 0.3 2.8 0.7 1.4 0.4 -0.9 -1.3 3.3

4.2 3.4 7.2 3.7 5.5 5.1 2.7 -0.3 8.3

8.5 6.7 12.1 7.1 8.7 8.2 2.8 0.9 13.8

FTSE Eurozone Government Bond Index (€) FTSE Pfandbrief (€) FTSE Euro Emerging Markets Bond Index (€) FTSE Euro Corporate Bond Index (€) FTSE Gilts Index Linked All Stocks (£) FTSE Gilts Fixed All-Stocks (£) FTSE US Government Bond Index ($) FTSE Japan Government Bond Index (¥) FTSE China Government Bond Index (RMB)

Actual Div Yld (%)

3.21 2.98 3.92 3.43 1.55* 4.26 4.45 1.20 2.79

* Based on 0% inflation

FTSE Research Team contact details Carl Beckley Director, Research & Development carl.beckley@ftse.com +44 20 7866 1820

Andy Harvell Head of Research andy.harvell@ftse.com +44 20 7866 8986

Jamie Perrett Senior Index Design Executive jamie.perrett@ftse.com +44 20 7866 1817

Andreas Elia Research Analyst andreas.elia@ftse.com +44 20 7866 8013

Gareth Parker Head of Index Design gareth.parker@ftse.com +44 20 7866 1805

Key: AC = All Cap, LC = Large Cap, MC = Mid Cap, SC = Small Cap, LC/MC = Large and Mid Cap

FTSE GLOBAL MARKETS • NOVEMBER/DECEMBER 2005

GM EDITORIAL 10

15/10/05

11:50

Page 96

CALENDAR

Index Reviews November – Early February 2006 Date

Index Series

Review Type

Effective Data Cut-off (Close of business)

Oct/Nov 24-Oct 11-Nov 16-Nov 30-Nov Nov/Dec Early Dec Early Dec 1-Dec 1-Dec 5-Dec 7-Dec 7-Dec 7-Dec 9-Dec 9-Dec 9-Dec 9-Dec 9-Dec

FTSE/ ASE 20 OMX H25 Hang Seng MSCI Russell US Indices NZSX 10 ATX IBEX 35 OBX KFX DAX FTSE JSE Africa Index Series FTSE All-Share FTSE UK Index Series FTSE techMARK 100 FTSE Euromid FTSE Eurofirst 300 FTSE eTX FTSE Global Equity Index Series (incl. FTSE All-World) NASDAQ 100 S&P MIB 30 S&P US Indices DJ Global Titans 50 STOXX S&P Europe 350/ S&P Euro S&P/ ASX 200 S&P/ TSX S&P 500 S&P Midcap 400 PSI 20 CAC 40

Semi-annual review Quarterly review Quarterly review Quarterly review Quarterly review / Additions Quarterly review Quarterly review Semi-annual review Semi-annual review Semi-annual review Quarterly review Quarterly review Annual review Quarterly review Quarterly review Quarterly review Quarterly review Quarterly review Annual review / North America

30-Nov 31-Oct 11-Dec 30-Nov 16-Dec Dec 31-Dec 1-Jan 16-Dec 16-Dec 16-Dec 2-Sep 16-Dec 16-Dec 16-Dec 2-Sep 16-Dec 16-Dec 16-Dec

30-Sep 24-Oct 30-Sep

Annual review Quarterly review - shares & IWF Quarterly review Quarterly review Quarterly review Quarterly review Quarterly review Quarterly review Quarterly review Quarterly review Semi-annual review Quarterly review

16-Dec 19-Dec 16-Dec 16-Dec 16-Dec 16-Dec 16-Dec 16-Dec 16-Dec 16-Dec 2-Jan Jan/Feb

1-Dec

9-Dec 13-Dec 14-Dec 14-Dec 14-Dec 14-Dec 14-Dec 14-Dec 14-Dec 14-Dec 15-Dec Dec/Jan

12-Dec

30-Nov 30-Nov 30-Nov 16-Sep 6-Dec 6-Dec 30-Nov 16-Sep 2-Dec 2-Dec 30-Sep

14-Dec 15-Nov

30-Nov

Sources: Berlinguer, FTSE, JP Morgan, Standard & Poors, STOXX

GETTING THERE IS EASY

FTSE Global Markets is your passport to 20,000 issuers, fund managers, pension plan sponsors, investment bankers, brokers, consultants, stock exchanges, and specialist data providers. If you would like to order reprints of any of the articles in this issue or discuss advertising insertions, tip-ons, supplements, sponsored sections, bookmarks or your own special requirements Contact: Paul Spendiff Tel: 44 [0] 20 7074 0021 Fax: 44 [0] 20 7074 0022 Email: paul.spendiff@berlinguer.com

NOVEMBER/DECEMBER 2005 • FTSE GLOBAL MARKETS

GM EDITORIAL 10

14/10/05

09:15

Page IBC1

ETFR exchange-traded funds report

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ETFR exchange-traded funds report

The shadow of the tax man By Marsha Zapson

It’s tax time. Or rather, it’s time to start implementing strategies that will make April 2005 a little less painful. For investors bemoaning losses in their portfolios, take heart. Those losses can be the basis for year-end tax harvesting strategies. And this year, such strategies are particularly applicable since most equity markets are significantly below their five-year highs. Portfolios with stocks, mutual funds, closed-end funds, or ETFs that have unrealized losses might just benefit from tax management strategies before year end. Tax swaps and fund substitutions can improve a portfolio’s tax efficiency by offsetting losses for 2004 as well as realized or future capital gains. With 160 passively managed equity index-linked ETFs and 111 actively managed equity closed-end funds suitable for swaps, investors have a wide palette to choose from, says Paul Mazzilli of Morgan Stanley. Both types of funds offer diversified portfolios that trade as

Issue No. 49 December 2004

IN THIS ISSUE DVY doubles Cover QQQ home coming Page 4

individual stocks on almost every major US exchange. In many cases, he says, investors might favor strategies using combinations of ETFs and closed-end funds because certain market segments or countries have only one of each fund type. For those using ETFs, Mazzilli’s list of potential tax swap candidates is reproduced on page 8 and includes the percent each ETF is below its five-year high and above its two-year low.

Golden ETFs Page 7 ETF swap list Page 8 Minding '03 tax changes Page 9 ETFR databank Page 11

Swapping strategies Until ETFs became available in just about every conceivable flavor, Sean Clark had a major headache come tax time every year. These days, Clark, who is CFO of family run advisory Clark Capital Management in Philadelphia, swaps stocks for ETFs and the reverse. Only a very small segment of his business uses mutual funds, and ETFs are generally used as mutual fund substitutes. However, at year end, Clark relies heavily on ETFs because of “the 8

Dow Jones Indexes plans to double the number of constituents in its Select Dividend Index to 100 stocks from its current 50 on December 20, 2004. The Select Dividend index is the basis for the iShares DJ US Select Dividend fund (DVY) that trades on the New York Stock Exchange. I n t roduced a year ago, the index m e a s u res the perf o rmance of dividend-

exchange-traded funds report

The power of dividends By Marsha Zapson

When Divy doubled its girth recently, it was an event that went largely unnoticed in the investment community. Yet this reconstitution—or more accurately, redesign—is the single most comprehensive overhaul of an ETF the industry has so far seen. The iShares Dow Jones Select Dividend Fund, known colloquially as Divy because of its DVY ticker, added 51 stocks to its coffers in December 2004. Originally, Dow Jones’ Select Dividend Index (and the iShares fund tracking the index) held 50 of the highest dividend paying stocks in the DJ US Total Market Index, which covers 95% of US market capitalization. That change, along with the introduction of a new liquidity screen, has meant radical surgery rather than a mere rebalancing for the DVY portfolio. An obvious example: Banc of America, formerly the largest holding at 4.9% of the original index, was demoted to fourteenth, weighing in at a mere 1.4%. (See

paying stocks selected for their high yields, their track re c o rdsof maintaining or increasing dividends over the past five years, and their ability to sustain c u rrent payouts in the coming year. Ye a r-to-date through November, the index gained 15.1% compared to 5% to 6% for most US broad-market indexes. “Given that about 55% of the 1,617 companies in our DJ US Total Market Index pay a cash dividend, and that more companies are joining the trend or are increasing their existing payouts, we decided that doubling the 3

IN THIS ISSUE

Coveting gold Page 6 Modeling with ETFs Page 6 Ryan Beck offers ETF portfolios Page 7 Pick your poison Page 8 ETFR databank Page 11

Index Development Partners, Inc. (IXDP) is planning to get into ETFs in a big way, according to Business Wi re. In midNovember, IDP raised $9 million by issuing 56.25 million shares of common stock at $0.16 per share to a group of

K K K K

Company: Address: State:

Investors look overseas for returns By Marsha Zapson

The top five

As the US dollar lost more ground among world currencies last year, it spurred US investors to—once again—seek investments outside the US. In fact, 2004 saw the largest single-year purchase of foreign stocks by Americans from January through October, totaling $62.1 billion, according to the US Treasury Department. By year’s end, that number is expected to exceed the previous $71 billion record set in 2003. Not surprisingly, ETFs tracking non-US capital markets outperformed their domestic brethren. The soft dollar not only enhanced modest gains in Europe, it magnified returns for US investors who swapped those foreign currencies back into greenbacks. US-based marquee indexes, like the Dow (up 3.2%), S&P 500 (up 9%) and Nasdaq 100 (up 8.7%), lost ground last year to Europe’s DJ/Stoxx 600 index, for example. It rose 9.5% in euros, but 18% in US dollars. The currency lift propelled the DJ/Stoxx beyond the S&P 500 for the third consecutive year.

Of the five ETFs that topped 2004’s performance chart, four were iShares MSCI c o u n t ry funds. The stellar performer here was the iShares Austria (EWO), up a whopping 73.1%.* After that came standouts iShares Mexico (EWW), up 49.0%; the iShares Belgium (EWK), up 44%; and the iShares South Africa (EZA), up 44%. Austria, which was also up about 67% in 2003, owes much of the run up to its role in the development of eastern Europe, and has become viewed as a gateway to that region. The economies of Poland, Hungary and Czechoslovakia, which entered the European Union last year, are today robust, and Austria, in particular, was a beneficiary of that success. Both the iShares Austria and Belgium funds are dominated by diversified financials, with Austria devoting about 27% of the index to that sector and Belgium some 30%. “But, if you look across the entire list of companies, the outperformance is really across the board 10 and not isolated to one or two

Issue No. 51 February 2005

IN THIS ISSUE Turkey Titans ETF launches Cover China’s first ETF Page 3 Russell index adds 40 IPOs Page 5 New options for SPDRS Page 7 Pick your poison Page 8 ETFR databank Page 11

U P D AT E S

Steinhardt completes $9m financing, and plans ETFs

Name:

investors led by hedge fund aficionado Michael Steinhardt. IDP intends to use the financing proceeds to sponsor ETFs and other financial products based on proprietary stock indexes created and owned by the firm. The investing group includes the private equity firm RRE Ventures, cofounded by former American Express chairman and CEO James Robinson III, and Quantitative Financial Strategies, Inc. The company's new board of directors includes: Michael Steinhardt as 3 non-executive chairman, RRE

Turkey Titans ETF launches Even as Merrill Lynch upgraded Turkish equities to overweight from neutral in its global emerging markets portfolio, a new ETF tracking the 20 most liquid blue-chip stocks in Turkey’s market was launched early in 2005. On its first day of trading (January 14), the Dow Jones Istanbul 20 ETF (TR20I) traded 3.2 million shares, or around US

ORDER

$15 million. For the three days prior to launch, the ETF had an initial public off e ring, attracting seed money from institutional investors in Spain, the Netherlands, the UK and US, among others. The new ETF—which is UCITS III compliant—tracks the DJ Turkey Titans 20 index and is comprised of the 20 most liquid stocks in Turkey’s market. It is highly correlated with the MSCI World Turkey Index, FTSE All World Turkey Index, and the Istanbul Stock Exchange’s National30 Index. Finans Portföy, a Turkish3

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Steinhardt completes $9m financing Cover

graph below comparing the top ten holdings of the original and reconstituted indexes.) “Dow Jones tweaked it for the better, and by adding more names, the index better represents dividend-paying stocks in the US market,” says Patrick O’Connor, senior portfolio manager with iShares. The DJ Select Dividend Index is among the youngest indexes on which an ETF has been based. It owes its existence to the Bush administration’s tax cuts, one of which resulted in dividend income being treated at the lower capital gains tax rates, rather than as ordinary income. All of a sudden, dividends became hot. And over the last three years, the percent of dividend-payers among the 1,600 or so names in the DJ Total Market Index has risen from around 50% to 55%, and many of the original 50% have lifted their payouts, in some cases dramatically. That benefit coincided with many stock investors who were bat- 8

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Issue No. 50 January 2005

U P D AT E S

Popular DVY doubles its girth

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