- 2001: Volume 10, No. 2 Ask Cr. Index: I Just LOVE Birthdays!

Remember the delicious anticipation preceding childhood birthday celebrations? Okay, forget about the prospect of Aunt Minnie’s Lemon Chiffon Souflée Cake becoming a natal Hindenburg. Otherwise, birthdays were preceded by a sense of happy expectancy, right?

Well, there’s a birthday in indexland a-comin’. As Barclays Global Investors’ Steven Schoenfeld quips, the ‘iShares formally known as WEBS’ will be turning five years old on March 18. WEBS you say? What are they? Why, World Equity Benchmark Shares, of course—seventeen single-country exchange traded funds (ETFs) managed by Barclays Global Fund Advisors. These funds were renamed the MSCI series of iShares during the May 2000 rollout of the world’s broadest franchise of branded ETFs.

While we can’t share Aunt Minnie’s cake here, we can at least answer a couple of oft-asked questions from the doctor’s mailbag on MSCI iShares... er... "the iShares formally known as WEBS."

Dr. Index—

What are the expense ratios of the iShares country index funds? Do the returns of these funds vary much from their underlying MSCI indexes? If so, why?

Most of the MSCI iShares series single-country ETFs are based upon slices of Morgan Stanley Capital International’s EAFE index. EAFE (Europe, Australasia, and Far East), devised in 1969, was originally comprised of 20 developed equity markets outside of the Americas. In 1987, MSCI started tracking nearly 30 emerging equity markets, too. WEBS, launched in 1996, were based on 15 EAFE components, plus indexes tracking Canadian and Mexican equity markets. According to MSCI estimates, over 90 percent of institutional international equity assets in North America and Asia are benchmarked to MSCI indexes. In Europe, MSCI indexes are used by two thirds of Continental European fund managers, according to Merrill Lynch/Gallup and Primark Extel surveys.

The original cadre of 17 WEBS funds, renamed iShares, were augmented in May 2000 with ETFs based upon four additional MSCI indexes. The MSCI iShares complement of developed markets carries an estimated .84 percent annual expense ratio while those tracking MSCI emerging markets indexes are priced at an estimated .99 percent annual expense ratio. All tolled, iShares MSCI funds’ weighted average estimated expense ratio is .86 percent, compared with an average international equity mutual fund expense ratio of 1.86 percent in the Morningstar database.

Some MSCI indexes are so heavily concentrated in one or more component stocks that cloning them into fund portfolios would put the funds’ tax status in jeopardy. To preserve their regulatory tax status, iShares portfolios aren’t built as exact replicas of their underlying MSCI indexes. For that reason, not surprisingly, MSCI iShares returns can vary from those of their benchmarks. According to a study conducted by Salomon Smith Barney in October 2000, 11 of the original 17 WEBS fund shares outperformed, while six underperformed, their underlying MSCI indexes on a 12-month total return basis. (The Week in ETFs, October 18, 2000.) Variances in returns such as these, however, don’t mean fund and index returns weren’t highly correlated—they were. Salomon Smith Barney’s analysis showed an average 98 to 99 percent correlation between iShares net asset values and their underlying MSCI benchmarks over one- and four-year periods. These relationships were maintained by fund manager "optimization" programs—using subsets of index components or similar securities to capture index characteristics without necessarily replicating the index’s original component weightings. Of course, even full replication portfolios can yield returns different from their benchmarks. If nothing else, fund returns are going to vary from index returns by the amount of their expense ratios.

Jawboning like this sure stirs up an appetite. Where’s the cake cutter?

In addition to the normal risks associated with equity investing, international investments may involve risk of capital loss from unfavorable fluctuations in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors, in addition to those associated with their relatively small size and lesser liquidity Securities focusing on a single country may be subject to higher volatility.

For complete information, including charges and expenses, request a prospectus by calling 1-800-iSHARES (1-800-474-2737). Read it carefully before investing.

• iShares are Not FDIC Insured 
• Have No Bank Guarantee 
• May Lose Value.

Index performance returns do not reflect any management fees, brokerage commissions, other transaction costs or expenses. One cannot invest directly in an index. Investors buy iShares at market price plus a brokerage commission-not at NAV; brokerage commissions would diminish the performance shown.

Past performance does not guarantee future results.

Brad Zigler is head of investor education at Barclays Global Investors Services. Questions can be directed to Dr. Index at http://www.ishares.com/dr_index/.