Construction Rules for Morningstar Emerging Markets Corporate Bond Index SM

Transcription

1 Construction Rules for Morningstar Emerging Markets Corporate Bond Index SM Morningstar Methodology Paper Version 1.1 December 22, 2011 of Morningstar, Inc. Reproduction or transcription by any means, in whole or in part, without the

2 Introduction The Morningstar Emerging Markets Corporate Bond Index (MEMCBI) provides a benchmark for emerging market corporate debt that represents the characteristics, pricing, and total return performance of the U.S. dollar-denominated emerging market corporate universe. All bonds in the MEMCBI are selected according to a fully transparent set of rule-based inclusion criteria regarding issue size, bond type, maturity, and liquidity. The index includes bonds issued by corporations in Latin America, Eastern Europe, Middle East/Africa, and Asia (excluding Japan). Individual securities have a minimum outstanding face value of $500 million or more, and eligible issuers for the index must have aggregate outstanding debt of $1 billion or more. All securities in the index are fixed rate and must have a remaining maturity of 13 months or more. The index is market capitalization weighted with a 5% capping of issuers and a pro rata distribution of any excess weight across the remaining issuers in the index. 2

3 Morningstar Emerging Markets Corporate Bond Index Construction Methodology 3

4 Morningstar Emerging Markets Corporate Bond Index Characteristics Morningstar Emerging Markets Corporate Bond Index Overview MEMCBI is a U.S. dollar-denominated index consisting of bonds issued by corporations domiciled in emerging markets. Bonds in the index are selected using a two-step process that involves country selection and security selection. Inception Dates and Base Market Values The inception date of the Morningstar Emerging Markets Corporate Bond Index is Oct. 31, Daily price and total return series are available from this date forward. *The index methodology was revised in December,

5 Scheduled Rebalancing and Reconstitution Security Rebalancing The constituents of the MEMCBI are updated once a month to ensure the index accurately reflects the available market supply of investable bonds. Updates to the bond level composition, including weightings, are made on the first business day of each month based on the previous day's closing price. The new universe of bonds is last month's composition after taking into account the new additions and exclusions triggered by the inclusion criteria and liquidity assessments for the index. All new issues must settle before the last business day of the month. Coupon Reinvestment Coupons are assumed to be received in full, not accounting for withholding taxes. Cash received intra-month due to a coupon payment is held in a cash account. Because of restrictions in local markets on short-term investments, cash is not reinvested. The cash received is reinvested in the index at the beginning of the following month. Trading, Settlement, and Transaction Cost Trading and settlement of these securities follow local market conventions. The index does not take transaction costs (bid-offer spreads) or tax withholdings into account. Bid-side prices are used for the daily bond index calculations and offered-side for adding new bonds to the index. Market Events In case of a significant market event (default, delayed payment, debt restructuring), any affected securities will not be removed until the next rebalancing date. Market prices and the index team's best estimate of the securities in question will be used to compute index returns. Ex-Dividend Rules Ex-dividend date refers to the last day an investor must hold the bond by to be eligible to receive the next coupon payment. If a security is purchased after the ex-dividend date, the bond will trade at a discount to compensate the investor for the negative accrued interest. Weight Capping The Morningstar Emerging Markets Corporate Bond Index employs a 5% issuer weight capping limit with a pro-rata distribution of excess weight across remaining constituents. 5

6 Assigning Bonds to the Morningstar Emerging Markets Corporate Bond Index At each rebalancing the country selection and security selection are defined based on the criteria described in this section. The country selection and security selection are followed in the sequence shown below. Each criterion is applied only to the "survivors" of the criteria applied previously. Country Inclusion Criteria Morningstar Indexes classifies countries as emerging for the purpose of defining the investable universe. To arrive at the initial selection of emerging market classified countries, Morningstar Indexes include only countries with GDP per capita defined by the World Bank as low income, middle income, or upper middle income. High income is excluded. Certain additional criteria are then applied to each country to identify characteristics of development and economic freedom that may exclude a country from the final selection. Exclusion from the final country selection may occur when an otherwise emerging market country exhibits characteristics that demonstrate a developed bond market or when an emerging country's bond market is deemed uninvestable. Additional criteria used to classify emerging market status include the following: Market regulatory authority Legal infrastructure & recourse Foreign ownership Treatment of minority shareholders Repatriation (full/partial) of capital Foreign exchange market Custodian services Stock lending Competitive brokerage services and trading cost 6

7 Adequate liquidity & free float Short sales Off-exchange transactions Visibility and timely trade reporting process Developed derivatives market Country Rebalancing Morningstar Indexes reviews the list of eligible countries annually in August to be announced by Aug. 31 and take effect in the end of September rebalancing that establishes the October portfolio of the same year. Country rebalancing is determined using the above-mentioned criteria. Security Selection To qualify for inclusion in the Emerging Markets Corporate Bond Index a security must meet the following criteria: Inclusion Criteria Only U.S. dollar-denominated bonds are included in the index. Bonds issued by quasi-sovereign issuers are included in the index. "Quasi-sovereign" is defined as a corporation with more than 50% government ownership. Only bonds issued by corporations based in Latin America, Eastern Europe, Middle East/Africa, and Asia (excluding Japan) are included in the index. There are no ratings restrictions on either the corporate bonds or the country of risk. Only fixed-rate coupon bonds are included in the index. Fixed to floating rate bonds will be removed at the next rebalancing subsequent to the last fixed payment. A minimum of $500 million remaining face amount outstanding is required for a bond to be included in the index. The issuer must have at least $1 billion aggregate index eligible debt outstanding. (For the purpose of aggregation bonds with less than $500 million face amount are included but will not be included in the index.) All securities must have a minimum of 13 months to maturity. Bonds with imbedded options, such as calls and puts, are included. Bonds with sinking funds are included. 7

8 Exclusion/Removal Corporate issues in default will be removed at the next rebalancing. Bonds are considered in default for failure to make scheduled coupon and/or principal payment. A company filing bankruptcy papers or the local market equivalent is considered in default. Loans and supranational and perpetual bonds are excluded. Sukuk (commonly referred to as Islamic bonds) are excluded. PIKs (payment-in-kind bonds) are excluded. Illiquid bonds are excluded or eliminated from the index. A bond is deemed illiquid when pricing on a consistent basis is unavailable or becomes unavailable. Bonds with limited liquidity may be removed at the discretion of the index committee. Private Placements If a bond issued under Regulation S and a bond issued under rule 144a both exist for the same issuer, the Regulation S version of the bond will be included in the index after a 40-day seasoning period. No seasoning is necessary for bonds issued only as 144a. 8

9 Index Calculations Overview Morningstar utilizes a third-party calculation agent for the Morningstar Bond Index calculations. This third-party agent calculates the actual change in all measured characteristics of the respective indexes on a daily basis. All of the index measures are calculated for all levels of the aggregate indexes including the individual bonds that make up the indexes. Market capitalization weighting is used for all index characteristics, excluding average price and average coupon, where "principal outstanding" is used. The weightings are fixed as of the last business day of each month. Pricing Indicative bid side prices are used for all index calculations, save new issues that are priced on the offered side. Updates to the bond-level composition are made on the first business day of each month. Transaction costs and tax consequences are ignored. Pricing is as of 3:00 p.m. Eastern Time. Index Publication Daily and monthly price and total return index values can be accessed in the following ways: (1) Morningstar's corporate website: (2) The Morningstar Indexes website: (3) Bloomberg: Page <MORN> is the directory page for all Morningstar Indexes and their closing levels. 9

10 Return Calculations There are three basic equations for calculating returns on individual bonds, and on the indexes themselves: total return, price return, and interest return. Total return is the sum of the other two returns. If daily returns are known, users can calculate returns for any given period. In what follows, a "clean price" is a quoted price that does not include accrued interest; a "dirty price" includes accrued interest. The formulas for the three types of return are as follows: Total Return The total return from date 0 to date t is defined as (1) TR (0, t) Pc ( t) Pc (0) AI Pd ( t) (0) AI (0) IC (0, t) Where Pc(0) = clean price on date 0 Pc(t) = clean price on date t Pd(0) = dirty price on date 0 AI(0) = accrued interest on date 0 AI(t) = accrued interest on date t IC(0,t) = cash received between date 0 and date t including coupon reinvestment. Then, the one-day total percentage return between dates t - 1 and date t is given by TR(0,t) 1 (2) TR( t 1,t) 1 * 100 TR(0,t 1) 1 Price Return The price return is based on the clean price appreciation over the dirty price. From equation (1), the price return (between date 0 and date t) component can be separated as (3) PR (0,t) Pc(t) Pc Pd (0) (0) 10

11 Interest Return The interest return is given by AI(t) AI(0) IC(0,t) (4) IR(0,t) Pd(0) The time between coupon payments on a bond is referred to as the coupon period. At any time during a given coupon period, the seller of the bond is entitled to that portion of the next coupon payment, known as "accrued interest," that is proportionate to the time elapsed since the prior payment. If there is no coupon payment during the period, the IC component is 0. Note: The reinvestment rate for the Morningstar Emerging Markets Corporate Bond Index is 0. 11

12 Index Weights All index-level (or portfolio-level) statistics aggregate bond level measures by each bond's market weights. For return-related statistics, the bonds' weights are fixed on the last business day of the previous month (since the indexes rebalance on the last business day of each month.) For all other statistics, a bond's weight is defined as daily market weight with monthly fixed par amounts. Thus, the market value for the ith bond is given by w ( price accruedinterest ) * paramount i i i i Then an index's total weight is calculated as W n w i i1 where n = total number of bonds in the index. Then the ith bond in the given index has a weight given by w i i W Thus, for example, a given index's modified duration is calculated as D n i1 * i m i where m i = modified duration of the ith bond. 12

13 Data Correction and Precision Index Data Corrections Commercially reasonable efforts are made to ensure the correctness of data used in index calculations. If incorrect data are detected, corrections are made as soon as feasible. Incorrect pricing and corporate action data for individual issues in the database will be corrected upon detection. Computational and Reporting Precision All calculated and adjusted data are stored in real numbers in the computer. For reporting purposes, index values are rounded to two decimal places. Morningstar publishes a Preliminary Report and a Final Monthly Adds and Drops Report on the indexes to reflect upcoming changes. Undocumented Events Any matter arising from undocumented events will be resolved at the discretion of an index committee to be established by Morningstar. 13

14 Appendix 1 Emerging Market Countries included in the index as of July 31, 2011 Afghanistan Albania Algeria American Samoa Angola Anguilla Argentina Armenia Azerbaijan Bangladesh Belarus Belize Benin Bhutan Bolivia Bonaire Bosnia & Herzegovina Botswana Bouvet Island Brazil British Virgin Islands Bulgaria Burkina Faso Burma Burundi Cambodia Cameroon Cape Verde Central African Rep. Chad Chile China Christmas Island Cocos Islands Colombia Comoros Congo Cook Islands Costa Rica Cote d'lovire Croatia Cuba Curacao Czech Republic Dem. Rep. of Congo Djibouti Dominica Dominican Republic 14

15 East Timor Ecuador Egypt El Salvador Equatorial Guinea Eritrea Estonia Ethiopia Falkland Islands Fiji French Antilles French Guiana Gabon Gambia Georgia Ghana Gibraltar Grenada Guadeloupe Guatemala Guinea Guinea-Bissau Guyana Haiti Heard & McDonald Honduras Hungary India Indonesia Iran Iraq Jamaica Jordan Kazakhstan Kenya Kiribati Kyrgyzstan Laos Latvia Lebanon Lesotho Liberia Libya Lithuania Macedonia Madagascar Malawi Malaysia Maldives Mali Marshall Islands Martinique Mauritania Mauritius Mayotte Mexico Micronesia Moldova Mongolia Montserrat Morocco Mozambique Namibia Nauru Nepal Nicaragua Niger Nigeria Niue Norfolk Island North Korea Northern Mariana Isl. Oman Pakistan Palau Panama 15

16 Papua New Guinea Paraguay Peru Philippines Pitcairn Islands Poland Reunion Island Romania Russia Rwanda Samoa Sao Tome & Principe Saudi Arabia Senegal Serbia & Montenegro Seychelles Sierra Leone Slovakia Solomon Islands Somalia South Africa Sri Lanka St. Helena St. Kitts & Nevis St. Lucia St. Vincent & the Grenadines Sudan Suriname Svalbard Swaziland Syria Tajikistan Tanzania Thailand Togo Tokelau Tonga Tunisia Turkey Turkmenistan Turks & Caicos Tuvalu Uganda Ukraine Uruguay Uzbekistan Vanuatu Vatican City Venezuela Vietnam Wallis & Futuna Isl. West Bank and Gaza Western Sahara Yemen Zambia Zimbabwe 16

17 Trinidad & Tobago 17