Index funds might have to divest Russian securities under new sanctions imposed by the Department of Treasury's Office of Foreign Assets Control under a directive of President Obama to tighten pressure on the country in connection with separatist violence in Ukraine and the July downing of the Malaysian Boeing 777 jetliner killing 298 people on board.
S&P Dow Jones Indices July 31 reached out to all index fund managers licensing its indexes to discuss the implications of sanctions on some Russian securities, imposed earlier in the month.
“The most recent announcement (by OFAC) was the first time that (any) stock that is actually in some of our indexes was included,” said David M. Blitzer, managing director and chairman of the index committee at S&P Dow Jones Indices.
“Since we've gotten questions and comments from clients — clients are also trying to figure out what they're going to do and what they want us to do, we thought this (engagement of discussion) was the appropriate step,” Mr. Blitzer said.
“Hopefully over the next two or three weeks we'll have a much better sense of how the clients feel,” Mr. Blitzer said. “We'd like to have more clarity … of the Treasury regulations.”
“As a result of all this analysis, we may drop some stocks from some indices,” Mr. Blitzer said. “It will depend on who is using the index, how it is being used, and what their situation is. Once we get the information, we will be in a better position to analyze it.”
“If companies are removed from indices, investors would most likely sell to minimize any tracking error,” Mr. Blitzer said.
The sanctions have no immediate impact on index funds.
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John Tucker, Boston-based senior managing director at State Street Global Advisors and co-head of passive equity strategies in North America, said: “There is still a lot of uncertainty about the sanctions.”
“Right now, secondary market trading is allowed” for equity and debt of the Russian securities under sanctions, Mr. Tucker said. The sanctions prohibit trading in new equity and new debt of some of the companies under sanction, but not all of them under sanction, Mr. Tucker said.
“That's where it gets tricky,” Mr. Tucker said. “There is not a way to identify new equity from old equity” in trading of those companies under sanctions. With debt, investors can identify new from existing issues, he pointed out, enabling segregation in buying and selling.
SSgA is studying the implications of the sanctions, Mr. Tucker said.
Sanctions affect only a few Russian companies right now, but there is talk of adding more names, Mr. Tucker said.
At New York-based MSCI Inc., which licenses its series of indexes to index fund managers, spokeswoman Michele Clarke said, “We haven't said anything to clients” about the sanctions. MSCI executives are considering whether to do so, she said. Until then, “we are not commenting.”
The sanctions could affect 88 S&P Dow Jones indexes.
S&P Dow Jones identified two sets of indexes. One set of 77 indexes contain Russian and non-Russian stocks, including the Dow Jones Global total Stock Mark Index. The other set of 11 indexes contains only Russian stocks.
“Russia is not a huge portion of that” Dow Jones Global Emerging Markets Total Stock Market Index, Mr. Blitzer said.
Russian equities represents 4.5% of the total $5 trillion market capitalization of the Dow Jones emerging markets index on the basis of float, or the shares available for trading, and 5.9% of the full total $10.6 trillion market capitalization of the index.
“We have had one or two clients … say get rid of all the (Russian) stock, period,” Mr. Blitzer said. “There is that opinion floating around.”
Mr. Blitzer doesn't know if the perspective motivating the comment was political or financial.
“It may have been from the point of view of an institutional investor tracking an index (in which) Russian stocks represent a very portion small (thinking) 'life is a lot simpler if you take the Russian stocks out and reallocate the fund to the rest of the countries.'”
Then “you don't have to worry about sanctions,” Mr. Blitzer said.
Russian companies the OFAC sanctioned include Gazprombank OAO, Novatek OAO, OAO Rosneft Oil Co., Vnesheconombank, Almaz-Antey Corp., and Feodosia Enterprises.
Dow Jones Standard & Poor's isn't directly affected by the sanctions, because they apply only to buyers and sellers of securities, not companies that maintain indexes, Mr. Blitzer said.
“We don't actually invest any money,” Mr. Blitzer said. “Obviously we have to be responsive to the whole issue.”
Soogyung Cho, Dow Jones S&P spokeswoman, said: “For indices to remain relevant, they must meet the need of the market”, noting the company's outreach to investors.
In its July 31 outreach to index managers that are clients of its indexes, S&P Dow Jones raised questions about the sanctions, including:
• “Where you have funds tracking (the 88 indexes S&P identified as containing Russian stocks) would you be disadvantaged if all sanctions securities are removed?”
• “If S&P DJI were to remove sanctions securities from its indices, how much notice should be given before sanctions securities are removed?”
• “If the U.S. and various European countries issue different sanction lists, should a security appearing (on) one list be treated as if appeared on all lists?” and
• “(A)re there countries where you do not have clients or investors and where specific sanctions would not apply?”
S&P DJI asks index fund managers to respond by Aug. 15.
Barry B. Burr is editorial page editor at sister publication Pensions & Investments