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Academics cast harsh light on composition of S&P index

For some listed companies, gaining membership in a major stock index is like joining a monopoly club that has been recognized for many years of effort. But this week, three scholars have hypothesized to participate in another way. It’s a shortcut with cash.

NS Working paper Companies purchasing credit ratings from S & P Global’s rating business could be added to the S & P 500, a US blue chip benchmark index operated by another subsidiary, S & P Dow, according to a statement released by the National Bureau of Economic Research. It had a statistically significant effect on sex. Jones index.

S & P categorically denies the findings of a treatise entitled “Is Stock Index Membership For Sale?” As “defective.” The company’s two units are “separate businesses with policies and procedures to ensure that they operate independently of each other.”

Nevertheless, the report focuses on the dual role of S & P. “The objectivity of key market indexes is very important,” said Shang-Jin Wei, a professor of finance at Columbia University and one of the co-authors of the NBER treatise.

Credit rating agencies are very influential. Widely criticized for its role in the 2008 financial crisis, it has given high marks to the pool of high-risk professional loans, but for more than a decade since then, it has helped debt investors determine the creditworthiness of a company. It continues to be one of the evaluation companies.

The S & P 500 is one of the most popular and prestigious indexes in the world, dating back to the 1920s surge in the US stock market. With approximately $ 13.5 trillion in assets directly tracked or benchmarked on the S & P 500, the index compiler has become a traffic police officer who determines the flow of funds for investors.

S & P recognizes the risks that may undermine investor confidence in equity benchmarks.

“For me, it’s [S&P 500] The committee has some rules that make it more transparent like other indexes. This helps avoid this type of claim, “said Lawrence Bragg, a former index designer who now runs Index Standard, a professional consultancy.

S & P Dow Jones separates the analytics and commercial teams to protect index integrity. Although S & P Global owns a 73% stake, the business is also operated as a joint venture between S & P Global and CME Group, a US derivatives exchange.

David Blitzer, who headed the S & P Index Committee for more than 20 years until 2019, said it was impossible for a rating purchase to relate to who participated in the index.

“When I chaired the Index Committee, I was forbidden to talk to anyone in the S & P rating without the presence of a lawyer .. Even if the CFO of the company purchased more ratings. The Index Committee never knows, “he said.

The newspaper claimed that many companies “seem to believe in buying S & P ratings.” .. .. Helps with the possibility of being added to the index. Scholars analyzed rating purchase information from S & P’s own database, along with data from other providers such as Moody’s and the University of Chicago’s Security Pricing Research Center.

Scholars increased S & P rating purchases when potential candidates to participate in the S & P 500 found an opening in the index, such as when two existing members agreed to merge. I found that. Meanwhile, when S & P changed its rules in 2002 to prevent it from joining the index, purchases by foreign companies fell sharply. In each case, there was no similar change in rating purchases from S & P’s biggest rival, Moody’s. S & P argued that the paper “contains many misleading and inaccurate statements about the S & P 500, its methodology and eligibility rules, and the impact of index inclusion.”

S & P competes with rivals such as MSCI, FTSE Russell and Morningstar and offers what investors consider to reflect the “truth” of the stock market. According to Burton Taylor International Consulting, this is an industry worth more than $ 4 billion annually, with S & P’s 25% market share slightly outpacing MSCI and FTSE Russell. For S & P Global, the index business accounts for only 13% of revenue. Credit ratings account for half.

David Blitzer, Former Chairman of the S & P Dow Jones Index

David Blitzer, Former Chairman of the S & P Dow Jones Index © Jin Lee / Bloomberg

Experts said the unique approach to selecting the components of the S & P 500 is particularly vulnerable to suspicion and misunderstanding because it has a discretionary component.

Index Standard Black said the S & P 500 is a “real anomaly” compared to other benchmarks, such as the FTSE Russell 1000, which is almost entirely based on market capitalization.

The S & P 500 is primarily treated as an agent for the largest US company, but does not make up the largest 500 shares in the US market.

Instead, it consists of what S & P Dow Jones calls “a major company in a major industry.” In general, a company must have a market capitalization of at least $ 13 billion and meet the minimum standards of profitability and liquidity. Ultimately, membership is at the discretion of the monthly full-time S & P Dow Jones Index staff committee. It employs a so-called “informed approach” that allows for quick adjustments when a company’s financial position or overall market conditions change.

“It speaks to their problems,” said Gareth Parker, chair of Morningstar’s UK subsidiary Moorgate Benchmark.

The NBER Paper emphasized the range of discretion used by the S & P Index Committee. Approximately one-third of the additional 2015-2018 meet at least one of S & P’s published standards, despite the fact that hundreds of alternative candidates meet the rules more clearly. It is said that it is not. He added that these “arbitrary” additions tended to perform worse after joining the index than “rule-based” participants.

The fact that S & P has difficulty predicting which companies will be added to the index is one of the benefits of a commission system that helps prevent hedge funds from trading with expected changes prior to announcement. Say that.

It also downplays the impact on businesses of being in that index, Recent reports That increased liquidity contributed to the “structural decline” in the additional stock price gains generated after being added to the S & P 500.

Nonetheless, the findings could encourage US regulators to take further action. S & P has been repeatedly criticized for potential conflicts of interest in its rating business. It paid in 2015 $ 1.4 billion settlement The US Department of Justice provided mortgage derivatives to win business from rivals in the face of the 2008 financial crisis after being accused of inflating ratings. The SEC has also accused it of a “series of federal securities law violations” that lasted for several years.

US regulators do not have the same authority as the UK and EU to control benchmarks. Nonetheless, they have some ability to regulate “from the back door” because they oversee financial instruments and their prospectuses. Industry practitioners say their scrutiny of index providers has increased in recent years.

“The SEC has put a great deal of emphasis on quality, methodology, and conflicts of interest, which gives further impetus to US benchmark regulation,” said Moorgate Parker. The SEC declined to comment.

Asked if S & P can do more to increase confidence in its products by increasing transparency, one senior employee has already said, “We’re probably doing everything we can.”

Blitzer said the treatise “would annoy some of his former colleagues,” but hoped that discussions about it would “disappear” in a short period of time. If not, S & P needs to step up its efforts to fight back.

“The S & P 500 is based on its reputation. You and I were able to index 500 shares this afternoon, but didn’t know the S & P brand name, reputation, or history,” Blitzer said. ..

Academics cast harsh light on composition of S&P index Source link Academics cast harsh light on composition of S&P index

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