"Free" or "Investable" Emerging Market Stock Indices

Definitions

Fiduciaries who have not had the misfortune to participate in what one publication has labeled "the war for a single emerging markets benchmark" often ask why the adjectives "Free" or "Investable" appear in descriptions of emerging markets benchmarks. Here is why: the governments of many emerging markets restrict share ownership by foreigners, thereby compounding what is already a serious problem for index constructors. The problem is this: how does one construct an index that is reasonably representative of the universe of securities from which investors are free to choose without attempting to track every issue? Although some indices attempt to track every security in a given market for which a price quotation is readily available � the Wilshire 5000 Index of US stocks being perhaps the best example � the costs and hassles of such comprehensive tracking are prohibitive in most markets, especially the foreign markets commonly labeled "emerging." The "Free" or "Investable" versions of emerging market stock indices are simply narrower versions of the representative (as distinct from comprehensive) benchmarks that index vendors routinely report. The "Free" or "Investable" benchmarks are narrower than counterpart indices not qualified by such adjectives because they reflect both legal restrictions on ownership and, in some cases, exclusions based on annual trading volumes.

Relevance to TIFF Members

In addition to clarifying why the benchmark for the TIFF International Equity Fund includes the word "Free," the foregoing discussion is included to sensitize fiduciaries to the arbitrariness that can creep into index design and selection. Professional investors disagree sharply on the appropriate classification of some foreign countries (developed vs. emerging), and they disagree even more violently on index weighting methodologies. Unlike campus politics, where it is said the arguments are so violent because the stakes are so low, the arguments over benchmarks are violent because the stakes are so high, with many clients hiring and firing managers based solely on short-term benchmark comparisons. In this context, it is instructive to note that one emerging markets manager whose results compare favorably to standard benchmarks nonetheless endorses this view: "Emerging markets investing," says Madhav Dhar of Morgan Stanley Asset Management (MSAM), "should be regarded as a concept � investing in radical change and development � not as an asset class."