FTSE Global Equity Index Series

each Supersector are eligible for inclusion in the index. Any
remaining constituents in the lowest 20% by investable
market capitalisation are excluded. This process is repeated
for each of the Supersectors. Finally, Supersectors are
combined to form the Regional or Country FTSE ISS
Corporate Governance Index.
This review procedure inevitably narrows the number of
constituents in the FTSE ISS Developed CGI universe to
1,350 constituents, down from the original 2,089
constituents. In comparison, the FTSE ISS UK CG Index is
focused on some 315 constituents (compared with the 578
in the FTSE All-Share Index universe).
During the market consultation exercise FTSE assessed
various different methods of producing an appropriate
index series that accurately reflected the corporate
governance performance of the world’s listed companies.
Three choices of methodology were available to the index
design team. They could adopt an exclusion policy or they
could retain all the traditional index constituents, but
overweight companies with good corporate governance
performance and underweight the poorer performers.
Alternately, they could produce best and worst in class
indices with a limited number of stocks.
Before a decision was taken, each of the options was
thoroughly investigated. Difficulties became obvious very
quickly. The overweight versus underweight methodology, for
instance, did not give major differences to the exclusion policy.
The reason was simple. Removing a proportion of stocks is
just another way of radically underweighting them, which
then will automatically overweight the remainder. Any
resulting performance would therefore be more reliant upon
the particular mix of stocks that are included (or excluded)
from the index. This mix relates to both relative market
capitalisation sizes and then individual stock performance.
The other issue on exclusion is that of turnover. The more
constituents that are excluded from the index the higher the
turnover can potentially be. This has an influence on
deciding what level of market capitalisation could be
excluded from the index. Removing a large amount of
market capitalisation may have more influence on
performance but would theoretically lead to higher turnover.
Removing less than 20% would not have had a sufficiently
FTSE GLOBAL MARKETS • JULY/AUGUST 2005
useful effect, but removing more would begin to have
implications for turnover. Having looked at this issue it was
clear that an 80/20 split gave the right balance between
inclusion and exclusion.
Indeed it is this last point that ensured that at least in
these early stages our third option of producing the “best”
and worst”indexes could potentially lead to high turnover.
In the end, the team opted for an exclusion
methodology. The majority of participants in the market
consultations process had suggested that for the first
phase of the Corporate Governance Indices, investors
were most interested in an index where constituents
that tended towards poor corporate governance practices
were excluded.
Exclusion Performance
The FTSE ISS CGI Series aims to track its underlying
benchmark indices very closely. This is helped by its sector
neutral approach and by removing only 20% of the
underlying market capitalisation at review.
As a result of using this methodology, we would expect
similar historical correlations and performance as the
underlying benchmarks. The main issue with looking at
historical performance is determining constituent changes
in corporate governance practices.
FTSE used FactSet software to run a series of backcast
index values to highlight any performance differences. The
backcasts are based on a current set of constituents for each
index and are calculated backwards for a period of five
years. As this methodology does not take into account
constituent changes throughout time the same
methodology was applied to the relative underlying
benchmarks to remove any calculation biases.
The analysis is mixed as to whether corporate
governance has an overriding effect on company
performance. Equally, the evidence of a clear link between
corporate governance standards and share price
performance is mixed. The FTSE ISS UK CGI outperforms
its equivalent FTSE index over one and three years, and the
FTSE ISS Developed CGI, FTSE ISS Japan CGI, and FTSE
ISS US CGI outperforms over a five-year period. The FTSE
ISS Europe and Euro CGIs underperform their respective
Table 1: FTSE ISS Corporate Governance Indices versus their respective benchmarks
CG Index Stocks Net Market Net Market Benchmark Index Stocks Net Market Net Market
Cap Cap (Local Cap Cap (Local
(USD Bn) Curr. Bn) (USD Bn) Curr. Bn)
FTSE ISS US CG Index 412 9,048 9,048 FTSE US Index* 743 12,216 12,216
FTSE ISS UK CG Index 315 2,176 1,140 FTSE All-Share Index* 578 2,713 1,421
FTSE ISS Japan CG Index 353 1,647 172,988 FTSE Japan Index* 479 2,077 218,217
FTSE ISS Developed CG Index 1,350 17,600 17,600 FTSE Developed Index* 2,089 22,828 22,828
FTSE ISS Europe CG Index 347 5,590 4,259 FTSE Developed Europe Index* 502 6,985 5,321
FTSE ISS Euro CG Index 194 2,892 2,203 FTSE Eurozone Index* 277 3,516 2,678
*Excludes Investment Companies Data as at 3rd March 2005
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