MSCI Factor Indices Consultation- Transition
Titi
off MSCI Europe
EF t IndicesFactor
I dit thetoth Barra
B
EUE3S ModelM d l- Launch of additional Factor IndicesNovember 2009

Overview The MSCI Europe Factor Indices will begin using the Barra Europe Equity Model,
EUE3S, as of the close of January 31, 2010. MSCI proposes a transition plan forthis change.

 MSCI also proposes to launch two additional Factor Indices :−MSCI Europe Barra Earnings Yield Index.

−MSCI USA Barra Value Index.

 MSCI is seeking feedback on these proposals. Please note, this consultation may or
may not lead to the adoption, in whole or in part, of the proposals described herein.

© 2009. All rights reserved.

2

Highlights of the Transition to the EUE3S Model MSCI Europe Factor Indices will transition to using the Europe Barra Equity Model,
EUE3S, in one phase as of the close of January 31, 2010.

 MSCI proposes turnover and trade limit constraints in connection with thetransition, with a goal to achieve a high factor exposure.

 A transition analysis for the MSCI Europe Barra Factor Indices, based on data asof August 20092009, shows that:−

All the factor indices achieved unit exposure to the target factors.

−

The realized one-off transition turnover was 20% for the Momentum, Value and Volatilityg factor.
factors and 10% for the Leverage© 2009. All rights reserved.

3

Highlights of the EUE3S Model Enhanced coverage of countries in Europe:−

16 Developed markets, 5 Emerging Markets and 8 Frontier Markets.

 29 industry factors based on GICS classification.
 Refined set of 9 style factors :−Two separate factors in the EUE2S model, namely, Market Sensitivity and Volatility, aremerged into the EUE3S Volatility factor, as they are highly collinear.

−Two distinct factors in the EUE3S model that capture Value, namely, the Value factor andthe Earnings Yield factor. The Earnings Yield factor incorporates forward looking earnings,
significantly enhancing the explanatory power.

−A new factor on Liquidity, not available in the EUE2S model.

 A redesigned specific risk model that uses daily specific returns and delivers moreaccurate forecasts than the EUE2S model.

 Calculation of daily factor returns with a robust multi-step regression scheme thatcurtails the influence of asset return outliers on factor return estimates.

 Detection and progressive trimming of outlier factor returns that improves thefforecastingti accuracy as it preventst pastt outliers
tlifromfbiasingbi i currentt forecasts.
ft© 2009. All rights reserved.

4

Contrasting EUE2S and EUE3S
Factor Comparisons : EUE3S vs. EUE2S
Factors

Interpretation

Descriptors
EUE3S
EUE2S
Halpha, 6M, 12 M Price return
Halpha, 12 M Price return

Momentum

Differentiates stocks based on relative price performance

Value

Differentiates stocks based on valuation relative to company fundamentals Book to Price, Sales to Price

Earnings Yield

Differentiates stocks based on valuation relative to company earnings

Market Sensitivity Differentiates stocks based on market beta
V l tilit
Volatility

DiffDifferentiates
ti t stocks
t k b
based
d on market
k t andd specificifi riski kLeverage

Differentiates stocks based on balance sheet leverageBook to Price, EY, Sales to Price

Pred EY, Hist EY, ROE, Cash EY

Historic Beta, Historic Beta
times Historic sigma
H Sigma, Cum Range,
Hb t C
Hbeta,
Cum R
Range, DDaily
il Std D
Dev
1,2,3 month squared returnBook Leverage, Market Leverage Debt to Assets, Debt to price

Factor Characteristics
EUE2S

EUE3S

RReturn

Ri k
Risk

RReturn

Ri k
Risk

2.13%

4.36%

2.69%

3.76%

Value

1.79%

1.50%

0.87%

2.23%

Leverage-1.05%

1.53%-0.86%

1.32%

Volatility-3.37%

2.53%-1.60%

5.24%

--

1.10%

1.99%

-0.10%

5.46%--

Momentum

Earnings Yield
Market Sensitivity

Annualized statistics from May 2003 - May 2009

© 2009. All rights reserved.

5MSCI Europe Barra Factor Indices – Summary Results
MSCI EuropeMomentum
EUE2S
EUE3S
6.24%
7.17%
15.56% 16.00%
0.40
0.45

Value
EUE2S
EUE3S
5.86%
5.25%
16.18% 16.63%
0.36
0.32

Leverage
EUE2S
EUE3S
5.31%
4.33%
15.10% 15.06%
0.35
0.29

Volatility
EUE2S
EUE3S
3.48%
4.22%
13.80% 11.26%
0.25
0.37

Active Return to Market
Active Risk to Market

1.79%
4.54%

2.71%
4.13%

1.41%
1.74%

0.80%
2.04%

0.86%
1.95%

-0.12%
1.70%-0.97%
4.72%-0.23%
6.17%

Active Return to Factor
Active Risk to Factor
Average Ex Ante Barra Tracking Error-0.58%
0 58%
2.91%
3.41%

-0.60%
0 60%
3.00%
4.01%

-0.38%
0 38%
1.42%
1.70%

-0.07%
0 07%
1.21%
1.89%

-0.19%
0 19%
1.45%
1.53%

-0.99%
0 99%
1.06%
1.34%

-3.73%
3 73%
3.75%
3.57%

-1.78%
1 78%
2.17%
5.05%

Average Factor Exposure

0.97

0.92

1.00

1.00

-1.00

-1.00

-0.82

-0.99

Average Number of Long Stocks
Average Number of Short Stocks
Average Number of Total Stocks

273
126400253146399284116
400290
110
400

302
98
400

324
76
400

259
141400247
148395

Average Gross Leverage
Average One way Monthly Turnover

1.60
5.05%

1.60
5.13%

1.51
5.00%

1.54
5.00%

1.57
5.00%

1.51
5.07%

1.99
5.05%

1.99
5.08%

ReturnRisk
Return/Risk

4.45%
15.42%
0.29

Annualized statistics from May 2003 - May 2009

© 2009. All rights reserved.

6Performance of EUE3S based Simulated MSCI
Europe Barra Factor Indices
1.40

1.40

1.30

1.30

1.20

1.20

1.10

1.10

1.00

1.00

0.90

0.90

0.80
May-030.80

May-04

May-05May-06

May-07

May-08May-03

Simulated MSCI Europe Barra Momentum Index / MSCI Europe
Index

May-05

May-06

May-07

May-08Simulated MSCI Europe Barra Value Index / MSCI Europe Index

Cum Monthly Barra EUE3S Momentum Factor Return

Cum Monthly Barra EUE3S Value Factor Return

1.40

1.40

1.30

1.30

1.20

1.20

1.10

1.10

1.00

1.00

0.90

0.90
0.80

0.80
May-03May-04

May-04

May-05

May-06

May-07

May-08May-03May-04

May-05

May-06

May-07

May-08SimulatedMSCI Europe Barra Leverage Index / MSCI Europe
Index

Simulated MSCI Europe Barra Volatility Index / MSCIEuropep Index

Cum Monthly Barra EUE3S Leverage Factor Return(inverted)

Cum Monthly Barra EUE3S Volatility FactorReturn(inverted)

Results based on MSCI Europe Index and Barra EUE3S model
Results based on simulations from May 2003 - May 2009

© 2009. All rights reserved.

7

Transition Analysis© 2009. All rights reserved.

8

Proposal for Transition to the EUE3S Model MSCI Europe Factor Indices will transition to using the Barra Europe Equity Model,
EUE3S, in one phase as of the close of January 31, 2010.

 MSCI proposes to use the following constraints, with a goal to achieve high target
factor exposure during the transition:−

Turnover constraint up to 20 % for Momentum, Value and Volatility factors and up to 10 %for Leverage factor.
factor−Trade limit for each security at 50% of the security’s Average Daily Traded Value.

−

Other constraints as per the existing MSCI Factor Indices methodology.

 MSCI also proposes to change the monthly rebalancing timeline of the MSCI Europe
Factor Indices as below :−Target Model release date is the first calendar day after the last business day of the previousmonth.

−The rebalancing date would be the second business day of the rebalancing month.

−The announcement date, implementation date and the effective date would be the third,
fourth and fifth business day of the rebalancing month respectively.

© 2009. All rights reserved.

9

Simulated Transition Analysis
MSCI Europe Barra Factor IndicesMomentum Value Leverage* Volatility
278282
291
248
122
118
109
152
400
400
400
400
1.6
1.6
1.6
2.0

Number of Stocks - Long
Number of Stocks - Short
Number of Stocks - Total
Gross Leverage
ActiveAti FFactor
t EExposure
Turnover
Ex-Ante Tracking Error

120%
5.79%

120%
3.94%

-1
110%
3.40%

-1
120%
10.72%

Analysis as of August 2009
20% Turnover constraint and Trade limit at 50% of Average Daily Traded Value*10% Turnover constraint applied for Leverage factor

MSCI Europe Factor Tilt Indices

Number of Stocks - Long
Active Factor Exposure

Momentum
152
0.52

Value
123
0.91

Turnover
Ex-Ante Tracking Error

20%
3.50%

20%
4.14%

Analysis as of August 2009
20% Turnover constraint and Trade limit at 50% of Average Daily Traded Value© 2009. All rights reserved.

10

Launch of additional Factor Indices© 2009. All rights reserved.

11Additional Factor Indices

The Value factor in the EUE2S model is a composite of the Earnings Yield, Book Value/Priceand Sales/Price descriptors.

With the transition to the EUE3S model, there are two factors that capture Value :−Value factor - uses Book/Price and Sales/Price and represents a company’s valuation with respect to its
book value and historic revenues.

−Earnings Yield factor - uses historic and forward Price / Earnings and represents a company’s
company s valuation
with respect to its ability to generate positive earnings and cash flows.

To better represent these two related yet distinct style factors, MSCI proposes to launch theMSCI Europe Barra Earnings Yield Index in addition to the existing MSCI Europe Barra ValueIndex.
Index

Furthermore, to retain consistency across Europe and USA, MSCI proposes to additionallylaunch the MSCI US Barra Value Factor index.

In summary, MSCI proposes to launch two additional Factor Indices :−MSCI Europe Barra Earnings Yield Index.

−MSCI USA Barra Value Index.

These two indices would be constructed using the existing MSCI Factor Index methodology.

© 2009. All rights reserved.

12Performance of Simulated MSCI Europe Barra
Earnings Yield Index
MSCIEuropeIndex
4.45%
15.42%
0.29

ReturnRisk
Return/Risk

Simulated
MSCI Europe
Barra Earnings
Yield Index
3.80%
16.47%
0.23

Active Return to Factor
Active Risk to Factor
Average Ex Ante Barra Tracking Error-1.73%
2.05%
2.33%

Average Factor Exposure

0.98

1.40
1.30
1.20
1.10
1.00
0.90
0.80
May-03May-04

May-05

May-06

May-07

May-08Simulated MSCI Europe Barra Earnings Yield Index / MSCIEurope Index
Cum Monthly Barra EUE3S Earnings Yield Factor ReturnAverage Number of Long Stocks
AAverage
NumberN b off Short
Sh SStocks
kAverage Number of Total Stocks

287
113400

Average Gross Leverage
Average One way Monthly Turnover

1.60
5.01%

Results based on MSCI Europe Index and Barra EUE3S model
Results based on simulations from May 2003 - May 2009

Annualized statistics from May 2003- May 2009

© 2009. All rights reserved.

13

Performance of Simulated MSCI USA Barra Value
Index
MSCI USA
Index
1.57%
14.59%
0.11

ReturnRisk
Return/Risk

Simulated
MSCI USA
Barra Value
Index
0.72%
15.23%
0.05

1.40
1.30
1.20
1.101.00
0.90

Active Return to Factor
Active Risk to Factor
Average Ex Ante Barra Tracking Error

0.32%
1.20%
1.93%

Average Factor Exposure

1.00

0.80
May 03May-03

May 04
May-04

May 05
May-05

May 06
May-06

May 07
May-07

May 08May-08Simulated MSCI USA Barra Value Index / MSCI USA
Cum Monthly Barra USE3 Value Factor Return

Average Number of Long Stocks
Average Number of Short Stocks
Average Number of Total Stocks

311
89
400

Average Gross Value
Average One way Monthly Turnover

1.47
5.00%

Results based on MSCI USA Index and Barra USE3 model
Results based on simulations from May 2003 - May 2009

Annualized statistics from May 2003- May 2009

© 2009. All rights reserved.

14

Discussion Points
 Is the proposed approach of transitioning the MSCI Europe Factor Indices to theEUE3S model appropriate ?

−Is the application of the turnover constraint appropriate ?

−Is the application of a trade limit of 50% of the security’s Average Daily Traded value
appropriate ?

−Is the proposed change to the monthly rebalancing timeline acceptable ?

Are the US Value factor and the Europe Earnings Yield factor relevant factors tobe replicated through MSCI Factor Indices ?

© 2009. All rights reserved.

15

Appendix© 2009. All rights reserved.

16

Transition Analysis – Summary
MSCI Europe Barra Factor IndicesTurnover Constraint
Trade Limit- % ADV

Momentum
10%
20%
50%
50%

10%
50%

Value
20%
50%

Volatility
10%
20%
50%
50%

Leverage
10%
50%

Number of Stocks - Long
Number of Stocks - Short
Number of Stocks - Total
Gross Leverage

256
115
371
1.6

278
122
400
1.6

289
111
400
1.6

282
118
400
1.6

239
161
400
2248
152
400
2291
109
400
1.6

Active Factor Exposure
Turnover
Ex-Ante Tracking Error

0.96
10.0%7.52%

120.0%
5.79%

0.92
10.0%
4.71%

120.0%
3.94%

-0.84
12.8%
10.15%-1
20.0%
10.72%

-1
10.0%
3.40%

Analysis as of August 2009MSCI Europe Factor Tilt IndicesTurnover Constraint
Trade Limit- % ADV

Momentum
10%
20%
50%
50%

Value
10%
20%
50%
50%

Number of Stocks - Long
Active Factor Exposure

168
0.45

152
0.52

131
0.78

123
0.91

Turnover
Ex-Ante Tracking Error

10%
3.30%

20%
3.50%

10%
4.08%

20%
4.14%

Analysis as of August 2009

© 2009. All rights reserved.

17Performance of Simulated MSCI Europe BarraEarnings Yield Index ( 10% Turnover )MSCI Europe
pIndex4.45%
15.42%
0.29

ReturnRisk
Return/Risk

Simulated
MSCI Europe
Barra Earnings
gYield Index
4.54%
16.67%
0.27

Active Return to Factor
Active Risk to Factor
Average Ex Ante Barra Tracking Error-1.01%
1 88%
1.88%
2.29%

Average Factor Exposure

1.00

Average Number of Long Stocks
Average Number of Short Stocks
Average Numberb off Totall Stocks
k287
112
399

Average Gross Leverage
Average One way Monthly Turnover

1.60
9.99%

1.40
1.30
1.20
1.10
1.00
0.90
0.80
May-03May-04May-05

May-06

May-07

May-08Simulated MSCI Europe Barra Earnings Yield Index / MSCIEurope Index
Cum Monthly Barra EUE3S Earnings Yield Factor Return

Results based on MSCI Europe Index and Barra EUE3S model
Results based on simulations from May 2003 - May 2009

Annualized statistics from May 2003- May 2009

© 2009. All rights reserved.

18

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The Information may not be used to verify or correct other data, to create indices, risk models or analytics, or in connection with issuing, offering,sponsoring, managing or marketing any securities, portfolios, financial products or other investment vehicles based on, linked to, tracking or otherwise
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pp
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© 2009 MSCI Barra. All rights reserved.

© 2009. All rights reserved.

20