07/01/96 MORGAN'S INDEXES ARE UNDER THE MICROSCOPE (int'l edition)

MORGAN'S INDEXES ARE UNDER THE MICROSCOPE (int'l edition)
Are these popular benchmarks truly objective?
When Taiwan's stock market jumped by 5.6% in mid-June, fingers pointed halfway around the world to Geneva. That's where Capital International Perspective, a unit of a Los Angeles-based mutual-fund giant and business partner of Morgan Stanley, compiles the Morgan Stanley Capital International indexes. The Swiss gnomes had announced that as of Sept. 2, they would begin including Taiwan in the MSCI Emerging Markets Free index and other popular benchmarks. ``Morgan fever!'' blared Taiwanese headlines, as investors loaded up on shares to match the new index weightings.
It's hard to overstate the clout of MSCI indexes. Like the S&P 500 in the U.S. or the Nikkei in Japan, they are the standard that portfolio managers around the world strive to match or beat. Managers' compensation often depends on whether they can outperform the indexes. Covering more than two dozen markets, MSCI has little competition. But now, some market watchers are worried that the indexes themselves are driving share prices. Other critics have charged that MSCI's benchmarks sometimes have technical flaws. And in Asia, Morgan Stanley & Co. has been accused by some market players of using index inclusion to build up business relationships.
MOCK MARKET. Spokesmen in Asia and New York for Morgan Stanley, which has naming and marketing rights to the indexes, say it has no influence over their composition. Building the indexes is the job of technicians at Capital International, they say. Adds Giacomo Fachinnotti, MSCI manager in Geneva: ``These indices are very widely used, and we can't help it if markets move as a result of them.''
To create an index, technicians try to replicate a local or regional stock market. The weighting of a company, industry, or country is supposed to reflect each element's market capitalization, adjusted for realities such as ease of trading. Although indexes are hard to compose, especially in emerging markets, investors trust them to be as accurate as possible.
That's why MSCI has drawn so much flak for deciding to put Taiwan into its regional and world indexes at a weighting equal to a hefty 50% of its relative market capitalization. Fund managers say that Taiwan's 20% limit on foreign investment in any stock, plus other restrictions, make that weighting unrealistic. ``It's such a shock,'' says Hun Soo Kim, who manages the $65 million Baring Taiwan Fund. Morgan Stanley's spokesman for index products in New York, Mark Sladkus, says Taiwan was included strictly because it had made ``huge strides'' in liberalizing its market.
Taiwan isn't an isolated case. In Thailand, ceilings on foreign ownership also make it tough to imitate MSCI's index weightings. ``Morgan Stanley doesn't take sufficient account of the investability of the index they compile,'' says Elizabeth X. Q. Tran, chief investment director for Asia at IDS Fund Management Ltd. in Hong Kong. Sladkus says these problems simply reflect the challenges of describing developing markets that are not yet fully open.
REWARD? But the Taiwan move also fueled complaints that Morgan Stanley uses indexes to further its own interests. In Taiwan, as in other countries, there have been persistent rumors that Morgan Stanley buys or sells shares for its own account in anticipation of index changes. The firm was said to have been an active buyer in the Taiwan market in the months ahead of the index announcement. Morgan Stanley vehemently denies trading on any proprietary information.
Disgruntled fund managers also note that late last year, MSCI's Indonesia index replaced PT Indosat with PT Telkom, shortly after Morgan Stanley had advised Telkom on a stock issue. Fund managers tracking the Indonesia index would now be buying Telkom shares. Morgan Stanley says that Telkom was included because its market cap more closely reflected the weight of telecommunications in the Indonesian economy.
There are fund managers who think that MSCI is doing as well as can be expected. Accurate indexing is just one risk of investing in developing markets. ``It's part of the cattiness of our industry,'' says Regent Fund Management Ltd. director Peter D. Everington of the criticism.
Still, the benchmarks could be improved. So far there's no hard evidence of anything more than questionable judgment calls in the way MSCI manages its indexes. But as they gain importance for investors looking further afield, MSCI may need to perfect its communications skills with the investment community if it wants to keep its clout.
By Mark L. Clifford in Hong Kong, with Jonathan Moore in Taipei