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Goldman Sachs

Equity Index Research

Global

The New MSCI Indexes:

Highlights and implications of the rebalance.

MSCI announces revised composition of indexes after float adjustment & additions

• On May 19, MSCI announced the revised composition of their indexes under their "enhanced methodology."

• The changes create turnover (buys plus sells) of 25.8% in MSCI World, 30.9% in MSCI EAFE and 26.8% in MSCI Europe.

• The changes will be implemented in the standard MSCI indexes in two phases – November 2001 and May 2002. MSCI will also create a "preliminary index" as of May 31, 2001, which will reflect all the changes and allow fund managers to immediately start to track the new index.

The greatest impact is at the stock level

• Largest EAFE weight increases: Shell T&T, NTT DoCoMo, BP, Vodafone and GlaxoSmithkline.

• Largest EAFE weight decreases: NTT, France Telecom, Toyota, and Deutsche Telekom.

• At the stock level, the composition of the new indexes contained relatively few surprises. There are still many large stocks that the new MSCI will not include. These include: Schering Plough, Texaco and Colgate-Palmolive in the U.S.; Orange, Telefonica Moviles and BMW in Europe; and KDDI and Japan Telecom in Asia.

• The excluded stocks may see selling pressure over the coming days if speculators unwind positions that they may have put on in anticipation of their inclusion.

Country and sector weights are changing: Japan down less than expected

• The U.K. and the U.S. were the greatest beneficiaries and France, Germany and Italy the biggest losers. In total, the eurozone countries will fall in weighting by 4.17% in EAFE.

• The greatest surprise is that MSCI made only a small adjustment to the weighting of Japan, decreasing its weight by 0.71% within EAFE.

• At the sector level, Energy is the greatest beneficiary and Telecommunications and Equipment the biggest loser within the MSCI EAFE index in the global index Technology Hardware increases most, due to the high number of additions in the sector in MSCI US.

There will be performance implications

• We expect that the additions and weight increases will outperform the weight decreases by 10 - 20% over the next 12 months on a sector-adjusted basis. This implies new EAFE outperforms old EAFE by approximately 1 - 2%.

• We have developed the GS-METR, an activity monitor to indicate when portfolio rebalancings are traded in the global stock markets.

Emerging markets are affected even more than developed markets

• Within the emerging markets turnover is even higher than developed markets - 45.3% across MSCI EMF.

Summary of new rules and methodology enhancements

On December 9, 2000 MSCI announced that it would make two major changes to its rules. These are:

1. Adjust all constituents for free float, rounded up to nearest 5%.

2. increase market coverage from 60% (on a non-float adjusted basis) to 85% on a float-adjusted basis. Coverage is calculated within each industry of each country.

The new rules will be implemented in two stages: the first half of the adjustment will take place on November 30, 2001 and the second half will take place on May 31, 2002. Deletions will be made in one phase on November 30, 2001. So, for example, MSCI's addition of Shell T&T with 100% of its shares will be phased - initially 50% of the shares will be included in November, and then in May the full 100% of shares will be included. MSCI will also create a "preliminary index," which will reflect all the changes on May 31, 2001. The preliminary index allows managers to move immediately to the new methodology, or to implement it on a different schedule to the November 2001/May 2002 timetable that the official index uses.

On May 19, 2001 MSCI announced the additions, deletions, weight increases and weight decreases to the index as a result of the new rules. We estimate the total turnover (buys + sells) at 25.8% in MSCI World and 30.9% in MSCI EAFE. This means that index trackers and low risk active managers will need to make changes over the next 12 months of about this size in order to adjust to the new index.

MSCI also provided detailed rules for their new "enhanced methodology." Within this document, there are three significant changes that will affect the index looking forward:

1. MSCI will provide greater predictability in its index rules, and is aiming to increase the stability of the index going forward. They acknowledge a need for transparency in rules.

2. MSCI has given better guidance on the criteria for including new stocks.

3. MSCI has announced that, in significant cases, the free float factors will change continuously. This may lead to more changes to the index on a daily basis.

Summary of additions, deletions and applied free float factors by country

Exhibit 1 summarizes the changes by market to MSCI. A total of 357 additions and 130 deletions were made to the MSCI World index. The greatest number of additions and deletions were made to MSCI US and MSCI Japan indexes. In general, MSCI has added many more names in large countries than in small countries.

A total of 979 stocks, or 63% of stocks in the new index have free float adjustment factors applied to them. In Japan, the most tightly-held market, every stock of the new 325 member index has a free float adjustment factor of less than 100%.

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