MSCI Consultation on the Design ofa Family of China A Style Indices
January 2006

Table of Content• Introduction• Investment Needs and Rationale for Style in China• Summary of Proposals• Issues in Style Segmentation and MSCI Value and Growth StyleSpace• Family of China A Style Indices Index Design• Discussion© 2006 MSCIBarra
All rights reserved.

2

Introduction• Early in 2005, MSCIBarra launched the China A Index series toserve the needs of China domestic investors• MSCIBarra is committed to the China A Market and intends tofurther develop its family of indices in China to cover the needsof domestic investors• MSCIBarra is now considering the creation of a family of Style
Indices for the China A share market that:• Provides benchmark indices that are reflective of the styleinvestment processes of China A share investors• Provide an appropriate framework to serve as the basis forinvestment vehicles© 2006 MSCIBarra
All rights reserved.

3

Investment Needs and Rationale for Style in
China• Based on MSCIBarra research, there are strong style effects in the
China A Market• As illustrated by the simulations on the next page value securities andgrowth securities, as a group, have distinct performance
characteristics• Similar conclusions were drawn while building the CHE2 risk model usedin Aegis for China in which value and growth are two risk indices• This leads to performance differentials under different economic andmarket conditions, thus providing an opportunity to influence theoverall performance of an equity portfolio by allocating to, and varying
the allocation to, these styles© 2006 MSCIBarra
All rights reserved.

4Investment Needs and Rationale for Style in
China (Continued…)
Meaningful Style Effect in the China A Share Market
Simulated Value Index and Growth Index - Relative Performance to MSCI China A Index - T otal Return
124.0
122.0
120.0
118.0
116.0
114.0
112.0
110.0
108.0
106.0
104.0
102.0
100.0

04
/20

/3 0
11

9 /3

0 /2

00

4

04

4

/2 0

00

30
7/

0/

0 /2
5 /3

20

04

04
/2 0

03
30

3 /3

11

1/

3

/20

00
0 /2

/3 0

00
9 /3

0 /2

3

3
00
0 /2

7 /3

00
5 /3

0 /2

Simulated Grow th (3Y EPS G, 3Y SPS G and g) / MSCI China A Index© 2006 MSCIBarra
All rights reserved.

3

3
00
3 /3

0 /2
1 /3

/20

02

2
00
11

/3 0

0 /2
9 /3

00

2

02

0 /2
7 /3

/2 0

00

5/

30

0 /2

2

2
00
3 /3

0 /2

01
1 /3

/20

00
11

/3 0

0 /2

1

1
00
9 /3

0 /2

20
0/

00

5 /3

7 /3

1

1
00

0 /2
3 /3

0 /2

00
0
1 /3

/2
/3 0
11

01

98.0

Simulated Value (BV/P and DY) / MSCI China A Index

5Investment Needs and Rationale for Style in
China (Continued…)• In order to exploit these performance differential, value and growthinvesting requires a degree of manager specialization• Successful value investing requires investment managers to acquire
above-average skills in valuing existing assets while successful growthinvesting demands above-average future sales and earnings forecastingskills• The features of value and growth securities as well as the differencesin the value and growth investment processes provide the rationale fordividing the market in value and growth investment styles• The evaluation of these specialized managers requires appropriate
style benchmarks that can also serve as the basis for style mandates
attribution© 2006 MSCIBarra
All rights reserved.

6

Summary of Proposal
MSCIBarra proposes:• To build a family of style indices from the existing MSCI China A Index•

To apply a two-dimensional, multi-factor style framework which uses a
different set of variables to define value and growth companies• To define value using the following descriptors:•

Book Value to Price and Dividend Yield as the measure of value• To define growth using the following descriptors:•

Current Internal Growth Rate (g= ROE(1-Pay Out))•Long-term historical EPS growth trend (using 3-years of historical data)•

Long-term historical sales per share growth trend (using 3-years of historical data)© 2006 MSCIBarra
All rights reserved.

7

Summary of Proposal (Continued...)MSCIBarra proposes:• To have style indices built independently from each other thatclosely capture the underlying investment style:• A Value Index including all securities with a value characteristic• A Growth Index including all securities with a growth characteristic• To rebalance the style indices on a semi annual basis with two
additional quarterly index reviews• To use “buffer zones” for the various indices to reflect the investment
process of style managers and limit the turnover caused bytemporary migration of companies from one style index to the other© 2006 MSCIBarra
All rights reserved.

8

Summary of Proposal (Continued...)Value Index

Growth Index
Value

Value

Growth
Value

Index

Non

GrowthGrowthNon Value

The Value Index includes all
securities with a value characteristic© 2006 MSCIBarra
All rights reserved.

NonGrowthGrowthIndex

GrowthNon Value

The Growth Index includes all
securities with a growth characteristic9Issues in Style Segmentation
One or Two Dimensions?
• Can Value and Growth characteristics be determined along a single
dimension or is a two-dimensional framework preferable?
• Value securities are securities of companies with lower than averagevaluation• Growth securities are securities of companies with higher than average
future growth prospects• A two-dimensional approach recognizes that a perfect link does notexist in practice and that value and growth need to be specified
independently• In the two-dimensional framework, Non-Value does not necessarily equal
Growth• Some companies can exhibit both Value and Growth characteristics, whileothers exhibit neither© 2006 MSCIBarra
All rights reserved.

10Issues in Style Segmentation (continued)
Single or Multiple Factors?
• On the Value side multiple factors are needed:• To capture the multiple dimensions of company valuation• To offset potential measurement errors in accounting variables• To improve the comparability of company valuation within and acrosscountries• On the Growth side, future growth prospects:• Are not directly observable, and• Need to be estimated using statistics related to a set of historical and / orforward-looking accounting variables when available© 2006 MSCIBarra
All rights reserved.

11

MSCI Value and Growth Style Space• MSCIBarra proposes to uses a two-dimensional multi-factor
approach to segment the MSCI China A Index into various styleindices•This framework has the following features:• Style is defined relative to other companies within the MSCI China A
Index• Value and growth are specified independently using a different set ofvariables and using a multi-factor approach• Z-scores are used to combine the various variables for value and also
for growth so that each security has a value z-score and a growth zscore• Securities can be positioned in the two-dimensional style space basedon their value z-score and their growth z-score© 2006 MSCIBarra
All rights reserved.

12

MSCI Value and Growth Style Space (Continued)
Selection of Value and Growth variables• Value will be defined using the following descriptors:• Book value to price ratio• Dividend yield• Growth will be defined using the following descriptors:• Current Internal Growth Rate (g= ROE(1-Pay Out))• Long-term historical EPS growth trend (using 3-years of historical data)• Long-term historical sales per share growth trend (using 3-years of historicaldata)© 2006 MSCIBarra
All rights reserved.

13

MSCI Value and Growth Style Space (Continued)
MSCI China A Index in the Value and Growth Style Space
Value
2.6
2.4
2.2
2.0
1.8
1.6
1.4
1.2
1.0
0.8
0.6
0.4
0.2
Non Growth

Growth0.0-2.6 -2.4 -2.2 -2.0 -1.8 -1.6 -1.4 -1.2 -1.0 -0.8 -0.6 -0.4 -0.2 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 2.2 2.4 2.6
-0.2
-0.4
-0.6
-0.8
-1.0
-1.2
-1.4
-1.6
-1.8
-2.0
-2.2
-2.4
-2.6
Non Value© 2006 MSCIBarra
All rights reserved.

14

Family of China A Style Indices
Index Design© 2006 MSCIBarra
All rights reserved.

15

Investment Needs and Index Objectives•

A family of style indices should be developed keeping in mind the following
objectives:•

To serve as a tool for allocating across investment styles for the whole portfolio•

To measure and analyze the performance of the various segments of the market orunderlying universe•

To serve as a basis for evaluating and attributing the performance of individual
style managers•

To provide an appropriate framework to serve as the basis for investment vehicles•

However some of the these objectives may have conflicting implications forthe design of a family of style indices•Finding a good balance in the index construction to achieve all of theseneeds might not be possible•

Either some of the needs are viewed as more important and should drive most of
the index construction•

Or multiple series are required© 2006 MSCIBarra
All rights reserved.

16

Investment Needs and Index Objectives(Continued...)Asset Allocation
Role

Performance
Benchmarking Role

More Granular Style& Strategies

This index design would becharacterized by:This index design would becharacterized by:This index design could becharacterized by:

 No overlap of market capitalization

 Independent index construction

across sub-indicesfor indices Narrow opportunity sets depicting a
specific investment strategy or a subset of a broader style index

 All sub-indices being contiguous Potential overlap of market

 Market capitalization of sub-indicesto add up to the underlying universe(exhaustive).
© 2006 MSCIBarra
All rights reserved.

capitalization between sub-indices Potential non-exhaustive
representation of the underlying
universe.

Independent index construction
 Potential non-exhaustive
representation of the underlying
universe.
17

Investment Needs and Index Objectives(Continued...)• Given the existence of strong style effects in the China A market,
many asset managers appear to be following investment strategies
which are based on style, even though they might not always
explicitly publicize it• However, in China, the institutional investment process is generally
not organized around size and style allocation as it is the case inmany other major markets• Therefore, the need for style indices is not predominantly for asset
allocation and mandate attribution to style but rather for meaningfulperformance measurement• In addition, there are important needs coming from retail investingfor efficient indexation of active investment strategies around style© 2006 MSCIBarra
All rights reserved.

18

Investment Needs and Index Objectives(Continued...)• Style indices that are built to be good performance benchmarks
should portray the “unmanaged representation” of style investment
processes• As such, they can support the efficient indexation of active investment
strategies• As a result, in order to be fully representative of the opportunity set
available to value and to growth managers, style indices should:• Exclude the non-value and non-growth segment which is essentiallycomprised of high valuation and low growth securities that none of thevalue and the growth managers would consider as being part of theiropportunity set• Fully allocate in the value index securities that exhibit value and growth
characteristics and also fully allocate in the growth index securities thatexhibit value and growth characteristics as each of the value and thegrowth managers would consider these securities as being fully part oftheir opportunity set© 2006 MSCIBarra
All rights reserved.

19

Proposal for Value and Growth Indices••

Therefore, MSCIBarra proposes to have a series of value and growth indicesbuilt independently from each other•

The Value Index would include only securities which have a positive value z-score•

The Growth Index would include only securities which have a positive growth zscore

Although this index design leads to an overlap between value and growthindices, it produces style indices which more accurately portray theunmanaged representation of the value and growth investment processes,
and hence serve as better performance benchmarks for style investing
Value
Value
Growth
Value

Index

Non

GrowthGrowth© 2006 MSCIBarra
All rights reserved.

Non ValueNon

GrowthGrowthIndex

Non Value

Growth20

Proposal for Value and Growth Indices –MaintenanceIndex Rebalancing and Buffer Zones•

The indices would be fully reviewed on a semi annual basis in May and November
and partially reviewed in February and August••

Buffer zones will be used to manage the temporary migration of companies fromone style index to the other. They will apply around the origin••

This rebalancing frequency provides a good trade-off between capturing style andcontrolling turnoverCompanies falling within the buffer zones will not change their current style classification
at the time of rebalancing

Outside of rebalancing, only securities which are added to the MSCI China A
Index will be considered for inclusion in the style Indices© 2006 MSCIBarra
All rights reserved.

21

Discussion
Investment Process Needs•

Do you consider value and growth styles in your investment process?
•••If yes, how?

Currently, what are the most important needs that a family of styleindices should serve?
•

Do these needs include performance benchmarking and indices that canalso serve as the basis for efficient indexation of active investment
strategies around style?

•

The need for asset allocation across various style segments?

Do you currently use any existing value and growth indices?

© 2006 MSCIBarra
All rights reserved.

22

Discussion (Continued…)
Proposal•

How do you define value and growth for China?
•

What are the qualitative or quantitative characteristics that you look for?

•Are you comfortable with the proposed design of the Value and theGrowth Indices which are built independently from each other?

•

What is your view on the two-dimensional approach?

•

Would you recommend to add or delete any variables?

© 2006 MSCIBarra
All rights reserved.

23

Discussion (Continued…)
Style Investing in China and Variables Selection••

In China, broad consensus forecast data has become available recently•

Do you use consensus forecast data? If yes which ones, from which provider?

•

What do you think of the accuracy of the data, the quality of the updates?

•

How common is the use of consensus data in China?

For the historical growth rates, a balance needs to be found between:•

Computing a meaningful growth rate (enough data points) while ensuring that
historical data is available for the majority companies (many IPOs without any
historical data)•

Having growth rates which are not too lagged, especially if no forward looking growth
rates are used•

In this context, do you think that 3 years of historical data is sufficient?

•Do you use some other considerations when determining value and growth?
•

If yes, what are the variables you are looking at?
© 2006 MSCIBarra
All rights reserved.

24

Discussion (Continued…)• As illustrated on the next page, the distribution of the securities in the
MSCI China A Index in the Value and Growth Style Space is very different
from that of the MSCI USA Index, for example:•

In China, there is not a strong link between value and growth and, as a result, there
are many non value and non growth companies and many value and growthcompanies• At the same time, some investors consider that in the China A Market:•

Many value companies have low prices because they are under financial distressand/or exhibit very low growth features•

Many growth companies are very expensive and might not have the growth potentialthat justify such valuations© 2006 MSCIBarra
All rights reserved.

25

Discussion (Continued…)
MSCI China A Index in the Valueand Growth Style SpaceMSCI USA Index in the Value and
Growth Style Space

Value
2.6

Value
2.6

2.4

2.4

2.2

2.2

2.0

2.0

1.8

1.8

1.6

1.6

1.4

1.4

1.2

1.2

1.0

1.0

0.8

0.8

0.6

0.6

0.4

0.4

0.2
Non Growth

Growth0.0-2.6 -2.4 -2.2 -2.0 -1.8 -1.6 -1.4 -1.2 -1.0 -0.8 -0.6 -0.4 -0.2 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 2.2 2.4 2.6
-0.2

0.2
Non Growth

Growth0.0-2.6 -2.4 -2.2 -2.0 -1.8 -1.6 -1.4 -1.2 -1.0 -0.8 -0.6 -0.4 -0.2 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 2.2 2.4 2.6
-0.2

-0.4

-0.4

-0.6

-0.6

-0.8

-0.8

-1.0

-1.0

-1.2

-1.2

-1.4

-1.4

-1.6

-1.6

-1.8

-1.8

-2.0

-2.0

-2.2

-2.2

-2.4

-2.4

-2.6
Non Value-2.6
Non Value© 2006 MSCIBarra
All rights reserved.

26

Discussion (Continued…)
Alternative••

The current proposal does not impose a minimum growth requirement whenbuilding the value index and vice-versa. For the construction of the value
indices and the growth indices:•

Should some minimum growth requirement (i.e. screening out the 10% most nongrowth companies) be used when building the value index•

Should some minimum value requirement (i.e. screening out the 10% mostexpensive companies) be used when building the growth index

Should these indices come in addition to or as a replacement of the proposedvalue and growth indices?
Value

Value
Strong non
growthcompanies
screened out

Growth
Value

Index

Index

Non

GrowthGrowth© 2006 MSCIBarra
All rights reserved.

GrowthNon

GrowthGrowthVery expensive
companies
screened out
Non Value

27
Non Value

Discussion (Continued…)
Other Needs•

Beside the proposed Value and Growth Indices, are there other needs
related to style investing which are not covered by this proposal?

•

Is there a need for a more granular breakdown within the value andgrowth indices that could serve as the basis for investment vehicles,
such as:••Deep value, aggressive growth, reasonable value, etc?

Are you looking at other dimensions besides value and or growth?
•

Momentum, high dividend yield?

© 2006 MSCIBarra
All rights reserved.

28

Contact Us

EuropeAmsterdam
Frankfurt
GenevaLondonMadridMilan
Paris
Zurichcs.europe@msci.com+31 20 462 1382
+49 69 2166 5325
+41 22 817 9800
+44 20 7425 6660
+34 91 700 7275
+39 02 7633 5429
+33 153 77 70 17+41 1 220 9300

AmericasAtlanta
BostonChicagoMontreal
New York
San Francisco
São Paulo
Torontocs.america@msci.com+1 404 949 4529
+1 617 856 8716
+1 312 706 4999
+1 514 847 7506
+1 212 762 5790
+1 415 5762323+55 11 30486080+1 416 943 8390

Asia Pacific cs.asia@msci.com
Hong Kong+852 2848 6740
Singapore+65 834 6777
Sydney+612 9770 1579
Tokyo
+813 5424 5470
China Netcom 10800 852 1032 (toll free)
China Telecom 10800 152 1032 (toll free)© 2006 MSCIBarra
All rights reserved.

29

Notice and Disclaimer
Copyright © 2005. All rights reserved.
This document and all of the information contained in it, including all text, data, graphs, charts and all other information(collectively, the “Information”) may not be reproduced or redisseminated in whole or in part without prior written permission
from MSCI or Barra, Inc. Any use of MSCI indices, data or other information requires a license from MSCI or Barra. The
Information is for informational purposes only and does not form a part of the terms or conditions of any agreement you haveor may enter into with MSCI or Barra. The Information may not be used to verify or correct other data, to create indices, or inconnection with offering, sponsoring, managing or marketing any securities, portfolios, financial instruments or products.
None of the Information constitutes an offer to buy or sell, or a promotion or recommendation of, any security, financial
instrument or product or trading strategy, and MSCI and Barra do not endorse, approve or otherwise express any opinion
regarding any issuer, securities, financial products or instruments or trading strategies that may be described or mentioned
herein. Further, none of the Information is intended to constitute investment advice or a recommendation to make (or refrainfrom making) any kind of investment decision and may not be relied on as such. The user of the Information assumes theentire risk of any use it may make or permit to be made of it. NEITHER MSCI, BARRA, ANY OF THEIR AFFILIATES OR ANYOTHER THIRD PARTY INVOLVED IN MAKING OR COMPILING ANY OF THE INFORMATION MAKES ANY EXPRESS OR IMPLIEDWARRANTIES OR REPRESENTATIONS WITH RESPECT TO THE INFORMATION (OR THE RESULTS TO BE OBTAINED BY THE
USE THEREOF), AND MSCI, BARRA, THEIR AFFILIATES AND EACH SUCH OTHER THIRD PARTY HEREBY EXPRESSLYDISCLAIM ALL IMPLIED WARRANTIES (INCLUDING, WITHOUT LIMITATION, ANY IMPLIED WARRANTIES OF ORIGINALITY,
ACCURACY, TIMELINESS, NON-INFRINGEMENT, COMPLETENESS, MERCHANTABILITY AND FITNESS FOR A PARTICULARPURPOSE) WITH RESPECT TO ANY OF THE INFORMATION. Without limiting any of the foregoing, in no event shall MSCI,
Barra, any of their affiliates or any other third party involved in making or compiling any of the Information have any liability
regarding any of the Information for any direct, indirect, special, punitive, consequential or any other damages (including lost
profits) even if notified of the possibility of such damages.
Morgan Stanley Capital International, MSCI®, ACWI, EAFE®, Barra and all other service marks referred to herein are theexclusive property of MSCI, Barra or their affiliates. All MSCI indices are the exclusive property of MSCI and may not be usedin any way without the express written permission of MSCI and all Barra risk models are the exclusive property of Barra andmay not be used in any way without the express written permission of Barra.

© 2006 MSCIBarra
All rights reserved.

30