FTSE/ISS and Glass Lewis launch competing indexes

Two groups are competing on the creation of corporate governance indexes designed to be the basis of index funds and other structured investment products.

FTSE Group and Institutional Shareholder Services Inc.'s FTSE ISS Corporate Governance Indexes was launched April 14, while Glass Lewis & Co. and Standard & Poor's plan on issuing the Glass Lewis Shareholder Rights Index May 15.

"I think it's a very valuable effort, trying to take corporate governance scores and impute them in an index," said Steven A. Schoenfeld, chief investment strategist-global quantitative management at Northern Trust Global Investors, New York, and an authority on indexing.

The FTSE ISS Developed CG Index covers 24 developed markets, including the United States, and consists of 1,350 stocks with a total market capitalization of $17.6 trillion. The FTSE ISS U.S. CG Index has 415 stocks with a total market cap of $9.048 trillion.

The other new FTSE ISS indexes cover Japan, the United Kingdom, the eurozone and Europe.

"We would expect to license index funds in the near future ... by early next year," said an FTSE official at a teleconference. The firms also will customize corporate governance indexes, if requested.

The indexes will be a useful tool to measure companies' corporate governance practices and "a way to assess the potential impact of such practices on portfolio performance," the report said.

"The prime objective behind the indexes is to exclude the highest corporate governance risk companies in each separate market," the report added. Companies are selected based on their corporate governance scores, developed by ISS, Rockville, Md. ISS is modifying its Corporate Governance Quotient scale that ranks companies to produce a scale for the FTSE global index series.

Joining Glass Lewis and Standard & Poor's in their effort is Lucian Bebchuk, a professor of law, economics and finance at Harvard Law School, Cambridge, Mass. The Glass Lewis Shareholder Rights Index will consist of all the companies in the S&P 500 index, with weightings adjusted using an algorithm designed by Mr. Bebchuk. The index will overweight companies with good governance and underweight companies with poor governance.

Officials at all the firms hope the indexes raise the profile of corporate governance as an investment concern and improve corporate governance standards.

"With recent high-profile scandals resulting from poor corporate governance practices, retail and institutional investors are looking for opportunities to invest in products that factor in corporate governance criteria and performance," according to the FTSE/ISS report.

Neither NTGI nor Barclays Global Investors, San Francisco, is creating corporate-governance index funds.

Tom Taggart, director-communications at BGI, said the firm "is not looking at corporate governance indexes, nor are we receiving interest in them from our clients. Numerous studies out there ... suggest little correlation between corporate governance attributes and performance."

NTGI's Mr. Schoenfeld said: "We have explored the idea of building an index fund, but we have not yet seen demand from clients. We are prepared to launch index-basedstrategies if a client is interested.

"But we … aren't prepared to say that corporate governance indexes will outperform (conventional indexes)," he said. "It's critical to have an open discussion, so clients understand when you move away from an established benchmark you are taking new risks."

A five-year backtest, beginning Sept. 30, 1999, shows the corporate governance indexes performing almost identically with their benchmark counterparts, the FTSE indexes, according a report by the firms.

"If you use the FTSE ISS index, there is no guarantee this index will outperform its equivalent FTSE standard index," Mr. Schoenfeld added. "We have not licensed it."

J.D. Nelson, CEO of RhumbLine Advisers LP, Boston, said, "I haven't heard enough to consider (developing corporate governance index funds). No clients have mentioned it."

Officials at Russell Investment Group, Tacoma, Wash., wouldn't comment on whether they are developing a corporate governance index, said Graham Fysh, senior public relations manager. On its multimanager business, he said Russell offers no fund with a corporate governance strategy.

As an index fund manager, Mr. Schoenfeld belongs to advisory committees of major index providers: FTSE global equity indices committee, Russell index client advisory board and the S&P global index and U.S. index advisory committees.

The new indexes will be "a very useful tool to sponsors and managers to provide insight into corporate governance. Its utility as an investment vehicle has yet to be determined," Mr. Schoenfeld said.

"Research shows poor governance undermines shareholder value," he said. "But that doesn't mean a company with a high corporate governance score will do better. Enron had a high score."

Both corporate governance indexes originally were set to launch last fall, but both were delayed to provide more time to develop their distinct methodologies.

"It shows you how complicated it is to systemize corporate governance factors and then indexize them," Mr. Schoenfeld said. "To develop a robust methodology and inject it into an index is very complicated."

"I think the competition (between the two rival indexes) is good," he added.

William Crist, former chairman of the $182.8 billion California Public Employees' Retirement System, Sacramento, and emeritus professor of economics at California State University, Stanislaus, chairs the FTSE ISS committee responsible for the overseeing and development of the ratings methodology.