A Stock Index Primer

With stock markets merging and European Monetary Union a reality, European indexes – especially the sector-specific ones like our Tornado European Technology Index – will play a role more important then ever before.

Indexes help you decide whether or not a given stock is performing well. When you are deciding whether or not to buy a particular stock, you might want to compare it to other stocks of its kind. Indexes allow you to do this, because they provide an average of how, for example, a telecommunications company is performing compared with a group of telecommunications stocks on a specialized index.

Since 1998, Europe has seen the creation of dozens of new indexes, from market leaders such as Dow Jones, FTSE and MSCI (the world’s leader in institutional benchmarks), to newcomers such as TORNADO-INVESTOR.COM. And more are on the way.

“Fabulous,” says the investor, “but would someone mind telling me what all that means, why I should care, and more important, should I buy T-online?”

T-online? Maybe – check its performance against other telecoms on the Tornado New E300 to find out.

“I think Europeans will no longer look at investment as being national, but rather as regional or global,” said Mark Makepeace, Managing Director of FTSE. “You can no longer pigeonhole a company and call it, say, `British’ – look at Vodafone’s structure and you’ll see it’s truly a multinational corporation, so saying it’s a UK company just no longer makes any sense.”

As national indexes like the FTSE 100 and the CAC 40 become increasingly irrelevant, what is needed are indexes that allow the investor to gauge performance of entire sectors, in addition to indexes that track shares on a regional level.

To quickly ascertain the performance of high-tech companies across Europe, the investor can glance at the broad Tornado European Technology Index and see whether it’s up or down. But she can also then look at specific sub-sectors, such as computer hardware or mobile telephony, and examine the performance of companies engaged solely in those activities.

For the investor seeking an indication of stocks trading on a regional level, for example “all of EMU Europe”, an index like the DJEuroStoxx 50 gives a quick indication of the performance of Europe’s 50 largest publicly traded companies.

Who Uses Indexes?

Organizationally speaking, the DJ Stoxx, MSCI and Tornado European Technology indexes work broadly in the same way: they start on a humongous scale (“Most of what’s in Europe”, “Everything in the World”, “All Pan-European Technology Stocks”) and then break out individual sectors and regions as need be.

It’s a handy capability – want to see the average performance of shares from Belgian, Luxembourgish and Hawaiian companies involved in manufacturing for the bio-medical industry? Or the top pan-European companies in data networking? Poof! It’s as easy as asking.

There are literally hundreds if not thousands of indexes, and a fair question at this point is, “Why so many?” The answer is, for the most part, to serve as a benchmark for index-tracking mutual funds.

Among other things, index tracking funds have tremendous appeal to retail investors not yet comfortable with investing all their money on individual stocks, which result in high transaction costs and require rather subtle timing.

“For the retail investor, an index-tracking fund allows you to buy a basket of stocks in a sector or a region all at once,” Carsten Hilck, Fund Manager at Union Investment Bank in charge of the €4.3 billion UniEuroStoxx50, an index-tracking fund benchmarked to the DJ EuroStoxx 50.

“Stocks in Europe are primarily retail money,” said a senior Merrill Lynch official, “when you see all these funds out there, the end user is most often the retail guy, and at this stage in Europe, the retail guy’s concerned about some pretty basic things: knowing the names of the companies on the index, and of course how this index performs against other indexes.”

How the fund managers select specialized indexes on which to base their funds comes down to investment trends and fashion. For example, when Japanese automobiles were all the rage, marketing departments of banks and brokerages had a look and said, “Hey, let’s create a Japanese Auto Mutual Fund.”

They then went looking for an index that covered automobiles and had a sub-sector of Japanese auto makers, and use that index as the fund’s benchmark, buying stocks in precisely the same proportions as the index itself – index goes up, fund goes up. And, er, vice-versa.

“What’s especially appealing,” said Hilck, “is that all these funds allow individuals to diversify and invest in companies throughout a sector, with tremendous economies of scale There are very low transaction fees because the fund gets special conditions with brokers, and because we’re always 100% invested we have a fund that’s very close to the index itself – almost exactly a 1:1 ratio.”

The index authors reap licensing fees from the use of their indexes as fund benchmarks, so the more funds there are based around an index, the better the indexing company does. And the more funds and money invested in an index, the greater the accuracy of the index as a window on the conditions of the market must be.

The EMU Factor

Before European Monetary Union, European investors and funds were generally limited to stocks within their national markets, and the indexes that followed them – such as the German DAX 30, the French Cac 40, the UK’s FTSE 100 and Spain’s IBEX 35.

EMU’s single currency, the merger of national stock exchanges and the possibility of the UK and even Switzerland joining EMU, brings up the specter of rendering irrelevant such revered benchmarks as the FTSE 100 and the DAX.

That trend, linked with the technology to trade more efficiently, means that the intermediaries being squeezed, and that is precisely what is causing not just the stock exchanges, but also the investment banks to merging as quickly they can.

In the US, the benchmark index to the average retail investor is the Dow Jones Industrial Average. In Europe, though, investment cultures change and stock exchanges pop up everywhere you turn, and the attempt to find a clear “Pan-European benchmark” is difficult even a year and a half into monetary union.

“When you look at who will be ‘the’ pan-European benchmark,” said the Merrill Lynch official, “you’ve got to discriminate between the institutional side, which tends to favor MSCI, and the retail side, which is rapidly emerging to be the EMU-based EuroStoxx 50, which has seen tremendous growth.”

The DJ EuroStoxx 50 is a part of the Dow Jones Stoxx family of indexes, which also include Stoxx, a broad, pan-European selection of 600 companies as well as smaller sector indexes. Because of its relative simplicity and the fact that it follows only blue chips, the DJ EuroStoxx 50 has become hugely popular with retail investors, and is gaining some ground with European institutional investors.

Union Investment Bank’s Hilck says that they chose the EuroStoxx because his company felt that the EuroStoxx 50 achieved better performance recently than did the MSCI Europe – “Last year the DJ EuroStoxx 50 was the index to beat, so we’re sure that the investor really gets the highest benchmark out there,” he said.

Currently Dow Jones estimates that index tracking funds, which are particularly attractive to both retail investors and fund managers, have invested Euro15 to 20 billion in funds that track DJ Stoxx indexes in Europe.

But in the institutional arena, where the money really moves, DJ Stoxx has got competition aplenty from Morgan Stanley Capital International’s family of indexes, the belles of the ball when it comes to global indexes: about US$1.5 trillion is benchmarked to MSCI indexes around the world.

For its part, FTSE, inundated with pressure from the UK and abroad to emerge dominant in the London and Frankfurt Exchange merger, denies that its beloved FTSE will soon be irrelevant. “Clearly some new index is needed, but It’s just too early to tell what shape that will take,” said FTSE’s Makepeace, who added, “We’ll be introducing a series of technology indexes soon.”

TORNADO-INVESTOR.COM’s index is the first index to specifically address the pan-European high tech market. American investors have enjoyed the convenience of the Nasdaq, an index which lists high-tech, high-growth stocks in the USA, but until the Tornado European Technology Index, no truly Pan-European index solely devoted to technology existed.

The Tornado European Technology Index follows the 300 most important high-tech companies in Europe, and then subdivides then into 15 sub-sector indexes so that investors can see the movement of software, computer, mobile telephony companies and so on. Taken together, these companies have a more even momentum than individual share prices.


Indexes proffer a benchmark for a “basket” of stocks which have something in common with one another. Weighting, or balancing the impact that companies within the list may have on the index as a whole, is the key to building an index that is useful as a benchmark.

In its humble pure form an index tracks the stock prices of a group of companies chosen because of the total value of their market capitalization. Weighting ensures that companies with high market values affect the index more than those with smaller market values. The index must account for the fact that the value of a 10% move on the price of the stock of a tiny company whose share price is €200 per share would be greater than a 10% move on an enormous company whose share price is €10, but that the effect of a 10% move on the stock of a large company would reflect market conditions far more accurately than the move on the small firm.

Put another way, a small move up or down by a listed giant such as Nokia would affect an index more than a large move up or down by a smaller company like Vaisala.

Of the major pan-European indexes, at least in Euroland (EMU Europe), the winner of the title of “pan-European benchmark index for the retail investor” has not yet emerged, but if you had to make a bet, the smart money would be on Dow Jones’ EuroStoxx50, which follows 50 Euroland “Blue Chips” – the largest companies by market capitalization.