Special Report: Index Power

By Phil Boeyen, ShareChat Business News Editor

Friday 30th March 2001

Indices are ubiquitous in the financial world.

The FTSE, Dow Jones, Nikkei, Australian All Ords, NZSE40. They all try to encapsulate a view of the financial health of a particular country or industry.

So when a New Zealand stock such as Telecom (NZSE: TEL) manages to hop the Tasman for inclusion in Australia's major benchmark index, exactly how does it affect the share price?

Unfortunately there's no easy answer. And for those waiting to see if there'll be a price bonanza next week, don't hold your breath because much of the buying has probably already been done.

The Australian indices in which Telecom will be represented as of April 2nd are the S&P/ASX 50, 100, 200 and 300, but it's the company's inclusion in the 200 index which probably holds most sway.

The new indices were introduced early last to replace the All Ords, which used to comprise around 230 companies. It was at that time that the job of putting the indices together was handed to Standard & Poor's.

The All Ords still exists but now represents the top 500 Australian stocks based solely on market capitalisation. It mainly measures the price performance of the market and is often referred to as a 'headline' or 'television' index.

The S&P/ASX 200 index, on the other hand, measures both market cap and liquidity. It represents around 91% of the Australian market.

The index is reviewed quarterly and has become the new benchmark against which institutional investors measure the performance of their active funds.

It's also used by the Sydney Futures Exchange for its Share Price Index (SPI) contract, which means investors such as banks or brokers buy a contract based on the index to hedge or speculate on what may happen in the market.

This adds to the liquidity of the stocks represented on the S&P/ASX 200.

In terms of straight buying of Telecom shares, there are a number of passive funds that track the 200 index.

One New Zealand analyst has estimated that such funds would have had to buy between 35 and 40 million shares in Telecom, but he believes that much of that buying will have been done already.

"Most of these index funds managers will have wanted to have purchased it by the start of the inclusion of the indices, and won't be waiting until next week," the analyst says.

This view is backed up by Richard Baker, the general manager of Tower Investment Products.

Although Tower doesn't have a passive fund tracking the Australian 200 index, its Tortis New Zealand fund tracks the NZSE 30 and it Tortis Ozzy follows the top 20 Australian stocks.

He says whenever there is a change in those indices, the fund moves in fairly quickly, possibly lagging the changes by just a few days.

"We want to make a change our weighting as close as possible to the index shift to minimise any tracking error," he says.

This kind of thinking probably accounted for the strength in Telecom's price just after the inclusion was made public on March 15th, when it pushed past the $6 mark for the first time in months.

But if the changes in the composition of any direct-linked funds have already been made, what are the longer-term advantages for Telecom being allowed to line up with the big boys across the Tasman?

That, as they say, is where it gets interesting.

Equity analyst with Perpetual Equities in Australian, Charlie Lanchester, agrees that in the short-term Telecom's inclusion in the Aussie indices won't have a huge impact on the stock.

"There's clearly already been index buying and that has buoyed the stock, but it's more a one-off effect.

"More difficult to gauge is the reaction of Australian institutional investors who are only allowed to hold stakes in companies that are in the ASX 200 or 300.

"Up till now Telecom has been quite easy for those investors to ignore, but because it's made the indices it's likely to get another look."

Mr Lanchester say in the medium-term Telecom begins to look even more interesting because of the likelihood that Optus will disappear from the market following the SingTel takeover.

Although SingTel says it plans to list on the ASX following its bid, Mr Lanchester says he has a feeling that any listing will be short-lived, as has happened to a number of other dual-listed stocks in similar situations.

He says that would push Telecom further into investor's sights as the second option behind Telstra for telecommunications exposure.

However the company still has to convince investors that it's worthy of their funds.

"Telecom is a well-managed company and they are doing the right thing in Australia in terms of expanding away from their domestic base, but the company has a lot to prove yet in terms of its AAPT acquisition.

"They've lost some key staff there and the purchase hasn't yet been bedded down, but if they do it well then Telecom could have a good ending."

As for the company missing out on the Optus mobile asset, Mr Lanchester believes it's positive rather than negative that Telecom didn't pay a large price for Optus.

Being included on the Australian indices also offers the possibility of increased exposure for Telecom worldwide.

Standard & Poor's announced late last year that is was reclassifying Australian companies using a new system called the Global Industry Classification Standard (GICS). The system is due to be introduced in the next few months.

Simply put, GICS separates companies into a number of defined categories so asset owners, asset managers, and investment research specialists can more easily make comparisons about where to put their investment dollars.

Telecommunications, for example, is divided into Diversified and Wireless sub-categories, and the Diversified sub-category is further divided into Alternative Carriers and Integrated Services.

So say a fund in New York decides it wants more international exposure in Integrated Telecommunications Service companies, it can search for such companies by code and Telecom New Zealand should come to light as a possible investment.

S&P index director in Australia, Jason Feldmayer, says the introduction of GICS will have two tangible benefits.

"It provides greater transparency and enables overseas investors to look at investment opportunities in Australia more easily, a real plus for attracting more investment funding to Australia.

"It also helps local market participants use a unified global investment platform when looking at the rest of the world."

Currently GICS covers over 12,000 companies around the world.

At the end of the day, though, many of the advantages of being included in the Aussie indices will come to nought if Telecom hasn't got the potential to back up its promise.

Hans Kunnen, Head of Investment, Markets Research for Colonial First State in Australia, says although inclusion means a short-term, one-off boost for the company, it has to maintain that momentum.

"Telecom is already dual-listed and would already have been considered by fund managers before its indices inclusion.

Mr Kunnen says maintaining liquidity is important, and being included in the indices might well increase the company's profile among retail investors.

While Colonial First State is an active funds manager and therefore doesn't track any specific index, Mr Kunnen admits the indices are a growing part of how the market measures success and his firm, like everyone else, does take notice of them.

But he adds that inclusion is just the first step.

"Being included in the S&P/ASX 200 is good news for Telecom, but it is not the saviour for a company's stock."

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