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FEDERATION OF EURO-ASIAN STOCK EXCHANGES SEMI ANNUAL REPORT OCTOBER 2005 DOW JONES INDEXES AND STOXX LTD. Lars Hamich Managing Director WHAT LIES BENEATH – THE ESSENTIALS OF INDEX PRODUCTION INTRODUCTION TO DOW JONES INDEXES AND STOXX LTD. Dow Jones Indexes and STOXX Ltd. operate as a globally integrated index provider. Together, they develop, maintain, distribute and market a comprehensive global family of rules-driven and free-float weighted indexes. The Dow Jones Indexes and Dow Jones STOXX index family include a full range of blue-chip and benchmark indexes, including the Dow Jones Industrial Average, the Dow Jones EURO STOXX 50, the Dow Jones Global Titans 50 Index and the Dow Jones STOXX Global 1800. The Dow Jones and Dow Jones STOXX blue-chip indexes are unique as they are maintained at the global, regional, country and sector levels; no other index provider offers so many slices of the blue-chip universe. At the benchmark level, Dow Jones Indexes and STOXX Ltd. provide global, regional and country indexes as well as size, sector and style subindexes. The broadest of these are the Total Market Indexes, which represent 95% of the free-float market capitalization of the covered markets, including all developed markets and the most relevant emerging markets. In addition to that Dow Jones Indexes calculate a range of specialty indexes such as the Dow Jones AIG Commodity index and the Dow Jones Islamic Market Indexes. The latter were created for people who wish to invest according to Islamic investment guidelines. The indexes track Shariàh compliant stocks from around the world, providing Islamic investors with comprehensive tools based on a truly global investing perspective. Certain businesses are incompatible with Shariàh Law. Thus, stocks of companies in these businesses are not considered suitable for Islamic investing. Incompatible lines of business include PAGE 16 Over the past several years the information flow has improved substantially in both quantity and quality. alcohol, pork-related products, conventional financial services (banking, insurance, etc.) and entertainment (hotels, casinos/gambling, cinema, pornography, music, etc.). Shariàh scholars also do not advise investments in tobacco manufacturers or defense and weapons companies. Special care is taken to ensure that all securities selected for the Dow Jones Islamic Market Indexes are acceptable under Shariàh Law. To this end, a Shariàh Board of Islamic scholars has been created to counsel Dow Jones Indexes on matters relating to the Shariàh compliance of the indexes' eligible components. The Dow Jones and Dow Jones STOXX indexes are licensed to companies around the world as underlying for investment products. The market has chosen Dow Jones STOXX indexes as the standard for European equity index derivatives. The Dow Jones EURO STOXX 50 underlies the largest equity index derivative in Europe and the second largest globally. Recently, Dow Jones Indexes has licensed the Dow Jones Turkey Titans 20 index to the Turkey based asset management company Finansportfoy to create the first exchange- traded fund in the Turkish financial market place. STOXX Ltd. is a joint venture of Deutsche Borse AG, Dow Jones & Company and SWX Swiss Exchange. Launched in 1998, in advance of the European Monetary Union, the introduction of the Euro and the creation of the Eurozone, the Dow Jones STOXX Indexes became Europe’s leading equity indexes in a fast and impressive success story. Dow Jones Indexes is part of Dow Jones & Company, which publishes the world’s most vital business and financial news and information. In addition to Dow Jones Indexes, Dow Jones & Company (NYSE: DJ; dowjones.com) publishes The Wall Street Journal and its international and online editions, Barron's and the Far Eastern Economic Review, Dow Jones Newswires and the Ottaway group of community newspapers. Dow Jones is co-owner with Reuters Group of Factiva, with Hearst of SmartMoney and with NBC Universal of the CNBC television operations in Asia and Europe. Dow Jones also provides news content to CNBC and radio stations in the United States. THE PRODUCTION PROCESS Basically, an index is regarded as a number that tells something about the current state of a market for stocks, bonds or some other instrument, be it foreign or domestic. For those that have invested in an index fund, the change in that number from day to day closely represents the movements of their portfolio. Not many think much about what it takes to produce that number, and the few that do usually regard the process as a bit murky no matter how clearly stated the index methodology may be. Like an iceberg, the visible part of an index misleads even informed viewers about the immensity – and the importance – of work that lies beneath the surface. The index provider faces a forever of daily monitoring, research and auditing to keep all its indexes before investors’ eyes. If an index provider does not do this job well, its index numbers sooner or later will be wrong, which probably will cost investors some money beyond what the market itself may inflict, and in turn, investors will stop using indexes from that provider. This is not a business model the index provider wants to follow. To illustrate the process, we focus on two groups known as Index Support and Production. Every index provider, though, faces similar issues and challenges, which demand enormous investments of resources to handle. The support group is responsible for researching and recording all changes to the components of a stock universe from which hundreds, if not thousands, of indexes have
FEDERATION OF EURO-ASIAN STOCK EXCHANGES SEMI ANNUAL REPORT OCTOBER 2005 been derived. The group also notifies licensees of these changes in great detail. There are two main types of changes: ongoing and periodic. Ongoing changes are typically corporate actions. Throughout the quarter, researchers scan news articles for mention of index components. This “corporate actions team” monitors 50,000 companies around the world and devotes a significant portion of every morning to ferreting out events affecting component companies. There aren’t any data vendors offering all the needed information, so this group shoulders the responsibility. The corporate actions team is looking for mergers, acquisitions, spin-offs, bankruptcies, delistings, stock dividends, stock splits and cash dividends. Stock splits are among the best known of corporate actions. They tend to be fairly straightforward and are virtually guaranteed to take place on their pre-announced date. Mergers and acquisitions are another story entirely. From the time a merger or takeover is announced, researchers collect every document released on the topic and regularly call the companies involved to check on the status of the deal and as many details as they can dig out. Regulatory approval must be received before the deal can go through, and some industries, such as utilities, have their own regulatory agencies that must approve the mergers. Differing rules in foreign countries regarding mergers can also complicate the monitoring. Getting this information isn’t always easy. Hostile takeovers in particular seem to bring out some people’s stonewalling instincts. CONTACT INFORMATION And many times, poor communication can be the source of difficulties. In emerging markets, information can be hard to find, and language barriers can throw up additional hurdles. At other times, the timing of a deal’s completion can be elusive. A merger might be delayed for months while approval is sought from various quarters. Once that approval is received, the merger can go through in as little as 20 minutes. In addition to hard-to-find information and complicated corporate actions, bad data from outside sources is an occasional fact of life. Information is gathered from a variety of sources and verifying each piece of data with at least two sources is the rule. Nonetheless, over the past several years the information flow has improved substantially in both quantity and quality. This change could be chalked up to the spread of English in the business world and the rise of the Internet. Several years ago, for instance, the Kuala Lumpur exchange was still using a chalkboard to record the prices of its stocks. Today it has a first-rate website that provides more information than similar sites maintained by some stock exchanges in developed markets. At Dow Jones Indexes and STOXX Limited, customers are alerted to ongoing changes via daily reports that are sent out by the index support team, which is also in charge, not surprisingly, of customer service. The reports list upcoming changes to index components for the next two weeks, including ratings of how likely each corporate action is to take place. Contact Name Mr. Lars Hamich E-mail pr-indexes@dowjones.com Website www.djindexes.com marketing@stoxx.com www.stoxx.com Each corporate action or merger/acquisition is given a 30-, 50-, 75- or 100-percent probability rating. Periodic changes also are made to indexes. Most indexes are reviewed quarterly or annually, meaning new components are selected and shares outstanding are updated. Dow Jones adjusts a company’s shares immediately if it amounts to 10% or more of the market capitalization; smaller adjustments are accounted for during the next review. The reviews are implemented at the end of each calendar quarter, but the review process kicks off in the second month of the quarter. A review basically begins by taking a “snapshot” of the index components as they exist on a specified date and comparing it to the previous quarter’s snapshot to spot what has changed. Deletions, name changes and initial public offerings must be identified. The changes that index support people have researched, tracked and documented then must be incorporated into the indexes being calculated in real-time or at the end of each day. The job of implementing changes falls to the production group. Production also implements routine changes such as stock symbols, identification numbers such as ISINs and switches in primary exchange listings. Production is as close as it gets to the index fairy because it’s the main distribution hub for all indexes created and marketed by Dow Jones Indexes. The Dow Jones STOXX indexes are calculated in Zurich and distributed through the Deutsche Borse in Frankfurt. PAGE 17
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