MSCI Quality Indices Methodology

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1 Index Methodology MSCI Quality Indices Methodology May 2013 msci.com

2 Index Methodology MSCI Quality Indices May 2013 Contents ... 2 Contents ... ... 3 Section 1: Introduction ... ... 4 Section 2: Index Construction Methodology ... Section 2.1: Applicable Universe ... ... ... 4 Section 2.2: Determination of Quality Score ... ... .. 4 ... Section 2.3: Security Selection ... ... 7 Section 2.4: Weighting Scheme ... ... ... 7 ... 7 Section 3: Maintaining MSCI Quality Indices ... Section 3.1: Semi-Annual Index Reviews ... ... 7 ... Section 3.2: Ongoing Event Related changes ... 8 ... Appendix I: Calculation of Fundamental Variables .. ... 9 Appendix II: Quality Z Score Computation ... ... 10 Appendix III: Rules To Determine Fixed Number of Se curities at Initial Construction and in Ongoing Rebalancing ... 11 ... 14 Appendix IV: Issuer Weight Capping ... Appendix V: Corporate Events Treatment... ... 15 Client Service Information is Available 24 Hours a Day ... 17 ... ... 17 Notice and Disclaimer ... ... 17 ... About MSCI ... msci.com MSCI Research © 2013 MSCI Inc. All rights reserved. 17 of 2 ocument Please refer to the disclaimer at the end of this d

3 Index Methodology MSCI Quality Indices May 2013 Section 1: Introduction The MSCI Quality Indices aim to reflect the perform ance of a Quality growth strategy. Quality growth mpanies with durable business models and companies are characterized in the literature as co companies tend to have high ROE, stable earnings sustainable competitive advantages. Quality growth that are uncorrelated with the broad business cycle , and strong balance sheets with low financial growth as an important factor in their security leverage. Many active strategies emphasize Quality selection and portfolio construction. MSCI categorizes the MSCI Quality Indices as Risk P remia Indices, which reflect the systematic element s e capitalization weighted indices represent the bro ad of particular investment styles or strategies. Whil market beta, investors increasingly recognize that there are additional sources of systematic return associated with particular investment styles and st rategies, such as value, momentum, volatility, etc, ghted indices. The Quality factor is complementary that could be represented through alternatively wei a , Low Volatility and may provide diversification to to other systematic risk premia such as Size, Value portfolio of risk premia. The MSCI Quality Indices aim to capture the Quality factor with a simple and transparent methodology while ensuring reasonably high trading liquidity an d investment capacity of constituent companies, as s well as moderate Index turnover. Quality is an obje ctive measure of certain historical variables and i not an endorsement or recommendation by MSCI as to the future performance of any constituents or the index. vestors of the MSCI Quality Indices include: The main potential applications by institutional in • Strategic asset allocation: seeking equity market e xposure to the Quality factor ematic risk premia • Portfolio diversification: combined with other syst • tics of Quality strategies Investment research: tools to study the characteris msci.com MSCI Research © 2013 MSCI Inc. All rights reserved. 17 of 3 ocument Please refer to the disclaimer at the end of this d

4 Index Methodology MSCI Quality Indices May 2013 Section 2: Index Construction Methodology Section 2.1: Applicable Universe ein, onstituents of an underlying MSCI Parent Index (her The applicable universe includes all the existing c opportunity set with sufficient liquidity and a “Parent Index”). This approach aims to provide an ny country or regional Index. capacity. The relevant MSCI Parent Index would be a Section 2.2: Determination of Quality Score y combining Z scores of three winsorized fundamental The Quality score for each security is calculated b ation and Earnings Variability. The details of the calcul variables, namely Return on Equity, Debt to Equity of the fundamental variables are provided in Append ix I. 2.2.1: Winsorizing the variable damental variable values are winsorized to ensure t hat As part of the standardization process, outlier fun for s are less affected by extreme values. To do this, the average values used to standardize the variable a given variable, the values for all securities are first ranked in ascending order within each MSCI P arent . Then, for securities that lie below the 5th Index. Missing values are excluded from the ranking their value is set equal to the value of the 5th percentile rank or above the 95th percentile rank, percentile ranked or 95th percentile ranked securit of y, as applicable. This process is repeated for each the three fundamental variables. Example: Winsorization th in ascending order of the variable value. The 5 For example, assume there are 200 securities ranked th th st percentile security is the 10 ranked security. ranked security and the 95 percentile security is the 191 ir values become equal to the value of the 10th ran For all the securities ranked from 1 through 9, the ked security. Meanwhile, for all securities ranked from 192 through 200, their values become equal to the value of the 191st ranked security. 2.2.2: Calculating the Z-Scores hree After winsorizing all the three variables within ea ch MSCI Parent Index, the Z-Score for each of the t the mean and standard deviation of the relevant variables for each security can be calculated using variable within each MSCI Parent Index. Computing a Z-Score is a widely used method of standardizing a s that may have a different unit of measurement or variable in order to combine it with other variable a core o and a standard deviation of 1, the value of a z-s different scale. Because it has a mean value of zer shows how many standard deviations a given value li es from the mean. ROE (Return on Equity): The Z-Score is defined as follows for (け⡹⥲) ᡸ = ゗ Where: is the winsorized variable for a given security ᡶ • msci.com MSCI Research © 2013 MSCI Inc. All rights reserved. 17 of 4 ocument Please refer to the disclaimer at the end of this d

5 Index Methodology MSCI Quality Indices May 2013 Parent Index Universe, excluding missing is the mean of the winsorized variable in the MSCI • μ values e in the MSCI Parent Index Universe, is the standard deviation of the winsorized variabl ... • excluding missing values Debt to Equity and Earnings Variability: The Z-Score is defined as follows for the (け⡹⥲) ᡸ = − ゗ ngs curity having higher Debt to Equity or higher Earni A negative Z score is calculated to ensure that a se Variability gets a lower respective Z-Score. msci.com MSCI Research © 2013 MSCI Inc. All rights reserved. 17 of 5 ocument Please refer to the disclaimer at the end of this d

6 Index Methodology MSCI Quality Indices May 2013 2.2.3: Calculating the Quality Score After standardizing each of the three variable valu es for each security, MSCI calculates a composite Quality Z-Score for each security. The Quality Z-Scor es are computed by averaging the Z scores of all the three fundamental descriptor as calculated in secti on 2.2.2. Computation of the Quality Z Score also depends on the availability of fundamental variable s as described in Appendix II. The Quality Score is then computed from the composi te Quality Z Score as follows: , Z 0 > ᡒ + 1 " = Score Quality 㐠 − 1 ) ( ᡒ < 0 , − 1 Z in the previous step. Where Z is the composite Quality Z Score determined MSCI Research msci.com © 2013 MSCI Inc. All rights reserved. 17 6 of ocument Please refer to the disclaimer at the end of this d

7 Index Methodology MSCI Quality Indices May 2013 Section 2.3: Security Selection The MSCI Quality Indices are constructed with a fix ed number of securities approach. All the existing ranked based on their Quality Scores. If multiple constituents of the relevant MSCI Parent Index are securities have the same Quality Score, then the se s curity having a higher weight in the Parent Index i given a higher rank. A fixed number of securities w ith the highest positive Quality Scores are al construction with an aim to attain a high exposu predetermined for every MSCI Quality Index at initi re to the Quality factor while maintaining sufficient s index market capitalization and number of securitie coverage. Rules for arriving at a fixed number of c n onstituents at initial construction are explained i Appendix III. The fixed number for security selecti on determined at initial construction is evaluated at every Semi-Annual Index Review(SAIR) to ensure that the Quality universe has sufficient index market ixed number of constituents at every SAIR are capitalization coverage. Rules for evaluating the f explained in Appendix III Section 2.4: Weighting Scheme Indices urities eligible for inclusion in the MSCI Quality For a given rebalancing effective date, all the sec ization weight in the Parent Index and the Quality are weighted by the product of their market capital Score. Quality Weight = Quality Score * Market Capitalization Weight in the Parent Index The above weights are then normalized to 100%. The final security level inclusion factor is determined as the ratio of the final security level weight and the security level pro forma market capitalization ight te the impact of stock-specific risk, the issuer we weight in the relevant MSCI Parent Index. To mitiga Appendix IV. will be capped at a specific level as described in Section 3: Maintaining MSCI Quality Indices Section 3.1: Semi-Annual Index Reviews nnual basis, usually as of the close of the last The MSCI Quality Indices are rebalanced on a semi-a business day of May and November, coinciding with t he May and November Semi-Annual Index Review of the MSCI Global Investable Market Indices. Funda mental variables as of the end of April and October are used respectively. This approach aims to captur e timely updates to Quality characteristics of the ncy of the relevant MSCI Parent Indices. The pro companies and coincides with the rebalancing freque nine business days before the effective date. forma MSCI Quality Indices are in general announced Section 3.1.1: Buffer Rules: y, buffer rules are applied at 20% of the fixed To reduce Index turnover and enhance Index stabilit number of securities in the MSCI Quality Indices. msci.com MSCI Research © 2013 MSCI Inc. All rights reserved. 17 of 7 ocument Please refer to the disclaimer at the end of this d

8 Index Methodology MSCI Quality Indices May 2013 00 securities and the buffers are applied between For example, the MSCI World Quality Index targets 3 rank 241 and 360. The securities in the MSCI Parent Index with a Quality rank at or above 240 will be added to the MSCI World Quality Index on a priority ty basis. The existing constituents that have a Quali d until the number of securities in the MSCI World rank between 241 and 360 are then successively adde Quality Index reaches 300. If the number of securit ies is below 300 after this step, the remaining lity Score rank are added until the number of securities in the Parent Index with the highest Qua securities in the MSCI World Quality Index reaches 300. Section 3.2: Ongoing Event Related changes In general, the MSCI Quality Indices follow the eve nt maintenance of the MSCI Parent Index. Section 3.2.1: IPOs and other early inclusions considered for inclusion at the next semi-annual I ndex IPOs and other newly listed securities will only be review in the MSCI Quality Index, even if they qual ify for early inclusion in the MSCI Parent Index. rate events Section 3.2.2: Additions and Deletions due to corpo e to corporate events aims at minimizing the The general treatment of additions and deletions du turnover in the MSCI Quality Indices. A constituent deleted from the MSCI Parent Index following a d w of the Parent Index will be simultaneously delete corporate event or during the Quarterly Index Revie from the MSCI Quality Index. treatment of corporate events. Please refer to Appendix V for more details on the msci.com MSCI Research © 2013 MSCI Inc. All rights reserved. 17 of 8 ocument Please refer to the disclaimer at the end of this d

9 Index Methodology MSCI Quality Indices May 2013 Appendix I: Calculation of Fundamental Variables Fundamental Ca lculation Details Variable nings per share figure and (ROE) is calculated using the trailing 12 month ear Return on Equity latest book value per share (ROE) = ROE Trailing 12 month earnings per share Latest Book Value Per Share calculated using th quity is and Book e latest fiscal year Total Debt E Debt to Value Debt to Equity(D/E) Total Debt D/E = Book Value Earnings Variability is defined as the standard dev iation of y-o-y earnings per Earnings Variability share growth over the last five fiscal years fer to the MSCI Fundamental Data Methodology For more details on the fundamental data, please re ). gional/all_country/methodology.html http://www.msci.com/products/indices/country_and_re ( msci.com MSCI Research © 2013 MSCI Inc. All rights reserved. 17 of 9 ocument Please refer to the disclaimer at the end of this d

10 Index Methodology MSCI Quality Indices May 2013 Appendix II: Quality Z Score Computation he availability of fundamental variables as Computation of the Quality Z Score also depends on t described below: Case Detail Action If ROE is missing, Composite Quality Z Score is not calculated and the security Case 1 ROE is missing will not be part of the MSCI Quality Index Composite Quality Z Score is calculated Debt to Equity is missing, but using ROE and Earnings Variability Z Case 2 other two variables are available Scores Earnings Variability is missing, Composite Quality Z Score is calculated but other two variables are Case 3 using ROE & Debt to Equity Z Scores available Composite Quality Z Score is not Debt to Equity and Earnings calculated and the security will not be Case 4 Variability are missing but ROE is available part of the MSCI Quality Index Security will not be part of the MSCI Case 5 All three variables are missing Quality Index msci.com MSCI Research © 2013 MSCI Inc. All rights reserved. 17 of 10 ocument Please refer to the disclaimer at the end of this d

11 Index Methodology MSCI Quality Indices May 2013 Appendix III: Rules To Determine Fixed Number of Securities at Initial Construction and in Ongoing Rebalancing t Initial Construction Algorithm to Determine Fixed Number of Securities a MSCI Research msci.com © 2013 MSCI Inc. All rights reserved. 17 11 of Please refer to the disclaimer at the end of this d ocument

12 Index Methodology MSCI Quality Indices May 2013 Rounding Off Rules: us Box Step is done depending on NumSec Obtained in the Previo Upward rounding off = 10 Securities If NumSec in Previous Step < 100, Nearest Rounding • • est Rounding = 25 Securities If NumSec in Previous Step > = 100 but < 300, Near If NumSec in Previous Step >= 300, Nearest Rounding = 50 Securities • s as of May 2012 Examples: Initial Construction, major Region msci.com MSCI Research © 2013 MSCI Inc. All rights reserved. 17 of 12 ocument Please refer to the disclaimer at the end of this d

13 Index Methodology MSCI Quality Indices May 2013 at Semi Annual Rebalancing Algorithm to reevaluate Fixed Number of Securities MSCI Research msci.com © 2013 MSCI Inc. All rights reserved. of 17 13 Please refer to the disclaimer at the end of this d ocument

14 Index Methodology MSCI Quality Indices May 2013 Appendix IV: Issuer Weight Capping For Broad Regional/Country Indices issuer weight is capped at 5%. For other narrow Country/Regional and maximum issuer weight in the Parent Index. Indices issuer weight is capped at a maximum of 10% maximum issuer weight in the parent index) Cap for narrow Country/Regional Indices = max (10%, he issuer weight is capped at 5%: For the following broad regional Quality Indices, t 1. MSCI ACWI Quality Index MSCI World Quality Index 2. MSCI EM Quality Index 3. MSCI Europe Quality Index 4. 5. MSCI USA Quality Index msci.com MSCI Research © 2013 MSCI Inc. All rights reserved. 17 of 14 ocument Please refer to the disclaimer at the end of this d

15 Index Methodology MSCI Quality Indices May 2013 Appendix V: Corporate Events Treatment This appendix describes the treatment of the most c ommon corporate events in the MSCI Indices. Details regarding the treatment of all other corpor d ate events not covered in this appendix can be foun in the MSCI Corporate Events Methodology book, avai lable at onal_equity_indices/gimi/stdIndex/methodology.html http://www.mscibarra.com/products/indices/internati Event Type Event details Action Quality Maintain acquiring company and constituent acquires Index another Quality Index constituent remove acquired company Maintain acquiring company Quality Index constituent acquires Acquisition non Quality Index constituent Remove acquired company Non Quality Index constituent without adding acquiring acquires Quality Index constituent company Index Quality constituent merges Add new company with a with Quality Index constituent constraint factor that is the weighted average of the two constituents Index constituent merges Add new company if MSCI links Quality Merger with non Quality Index constituent its price history to the Quality Index constituent. New company not added if price history is linked to the non Quality Index constituent Parent Security will be considered for Index IPO added to inclusion in the Quality IPO Index at the next Semi-Annual Index Review Quality off security to the - Add spun Index constituent spins off Quality Index with the constraint security Spin-off factor of the spinning security, if it is included in the Parent Index Security A converted to B, A B inherits constraint factors from A deleted from Parent Index, B Conversion added Domicile of company reviewed: B inherits constraint factors from Country A if it is added to the Parent Index Security A deleted from country A, Reclassification security B added to country B msci.com MSCI Research © 2013 MSCI Inc. All rights reserved. 17 of 15 Please refer to the disclaimer at the end of this d ocument

16 Index Methodology MSCI Quality Indices May 2013 Action Event details Event Type Stock exchange (price source) of B inherits constraint factors from Stock exchange company reviewed: Security A A if it is added to the Parent Index reclassification deleted, security B added Changes in number of shares No change in Constraint Factor and Other Events subsequent FIF resulting from Resulting in Changes other events such as share in Number of Shares placements and offerings, and and FIFs debt-to-equity-swaps msci.com MSCI Research © 2013 MSCI Inc. All rights reserved. of 17 16 Please refer to the disclaimer at the end of this d ocument

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