ZURICH -- The fight for the hearts and souls of European institutional investors will take place on the battlefield of the benchmarks.
For years, Morgan Stanley Capital International and the Financial Times/Standard & Poor's-Actuaries have slugged it out. The MSCI indexes -- clear winners among U.S. pension funds -- are the leader in France and Germany, while the FT/S&P owns Britain and dominates the Netherlands and Scandinavia.
The introduction of the euro on Jan. 1, 1999, is creating a new opportunity. Investors are expected to shift from a heavy domestic bias; regulatory restraints on foreign investment -- at least within the "euro zone" -- will be eased and sectoral investing approaches are succeeding top-down country allocation.
Into the fray has stepped STOXX Ltd., a joint venture between SBF-Bourse de Paris, Deutsche B"rse AG, Swiss Exchange and Dow Jones & Co.
Taking Dow Jones' existing European index of 66 companies in 16 countries as a starting point, Zurich-based STOXX has renamed it the Dow Jones STOXX index and added three indexes:
* The Dow Jones STOXX 50, covering 50 blue-chip companies in the European-wide index;
* The Dow Jones Euro STOXX, including 326 companies from 10 countries expected to be in the euro zone (Luxembourg companies are not included because prices are not available in real time yet);
* The Dow Jones Euro STOXX 50, covering blue-chip companies in the euro index.
Plus, STOXX will offer 19 sector industries for both Europe-wide and Euro indexes. In the long run, the broad and narrow indexes should converge if economic and monetary union proves a success, said John A. Prestbo, editor of Dow Jones Indexes, Monmouth Junction, N.J.
The idea is that STOXX will offer investors a complete package of benchmarks and derivatives, Mr. Prestbo said.
Derivatives contracts on both the Europewide and the Euro blue-chip benchmarks are in the works. The German, French and Swiss exchanges are discussing which of the exchanges will offer futures, options and options on futures; contracts should start trading by midyear, he said. Derivatives contracts based on the 19 sectors will follow.
Linking benchmarks and derivatives should keep tracking error to a minimum, making the contracts better hedging devices. Back-testing between the blue-chip indexes and the broader indexes reveals correlations between 0.97 and 0.99 with tracking error ranging from 2.22% to 2.9% during three-year periods since 1992.
The problem, though, is that institutional investors are going to be reluctant to switch their benchmarks. In fact, runs made in the past at the U.S. market by MSCI's competitors have shown investors tenaciously hold onto their existing benchmarks.
The reasons underlying that reluctance are sound: both portfolio turnover, as investors adjust to a new benchmark, and changing of systems are expensive, noted Sandy Rattray, head of Goldman Sachs International's equity derivatives research team, London, which has a stake in FT/S&P.
(FT/S&P officials have said they will unveil euro-related indexes once the countries involved are named officially in early May. MSCI officials declined to comment, although euro-specific indexes from MSCI are anticipated.)
Also, learning a new benchmark is a time-consuming task, Mr. Rattray said. It will be far easier to win over those starting from scratch, he said.
In addition, officials at the London Financial Futures and Options Exchange said they plan to beat STOXX to the punch by launching a futures contract based on the FTSE-Eurotop 100, an index jointly sponsored by FTSE International and the Amsterdam Stock Exchange. Contracts based on the FTSE-Eurotop 300 and Eurobloc indexes also are under consideration, a LIFFE spokeswoman said.
Correlations between the Eurotop 100 index and MSCI and FT/S&P indexes are higher than for the STOXX 50 indexes, simply because Eurotop has twice as many stocks in it, Mr. Rattray observed.
Rob Barrett, senior investment manager for State Street Global Advisors, London, concurred Eurotop will be an interesting index because of its derivatives contracts.
STOXX also has some technical hurdles to jump. While the German and Swiss exchanges are linked and moving toward a common platform, the French exchange "is doing its own thing," Mr. Prestbo said.
Still, the capability of seeing transactions in different markets on the same screen exists. Even if linkage is not accomplished by summer, it will not hold up launch of the derivatives, he said.
In any event, pension funds are unlikely to switch to a pan-European or euro zone approach overnight. Cultural factors and predominance of local vs. foreign investors still will prevail for some time, said John Stannard, managing director of Frank Russell Co.'s U.K. operation, London.
"Producing a new index does not change investors' habits," he explained.
That's why STOXX's best opportunities might lie in the retail sector. Daily reporting of the Euro 50 index's performance on television news will boost its presence among individual investors, creating opportunities to build retail-oriented index funds.
So far, German institutions have shown the strongest response among institutional investors, perhaps influenced by the gentle persuasion of the Deutsche B"rse.
Mr. Prestbo, however, thinks others might follow suit. "What's happening in Europe is there is a change coming that's bigger than all of us. So institutions have to start over again. So this is a good opportunity for us."
