New Indexes Track Global Outsourcing Sector

Now there's an index family tracking one of the most controversial and emblematic issues of the globalization era: Outsourcing. Although the indexes do not answer the question of whether outsourcing is an economic savior or Satan, they do offer a way to quantify the performance of companies that provide outsourcing services.

Business development analytics firm Zagada Markets and Sweden-based Waagstein Research have launched a family of indexes that track information technology outsourcing [ITO] and business process outsourcing [BPO]. The benchmark ZagadaWaagstein Global Outsourcing 100 Index includes 100 components that have undergone rigorous quantitative screening and evaluation, while its subindexes cover a variety of slices of the broad index. It had an annualized return of more than 33% during its five-year backtested period.

"We think we have the best list of companies that could be considered a benchmark of the industry," says Philip Peters, chief executive officer of Zagada Markets.

The components span three regions, with the Asia-Pacific region representing 44% of the index, the Americas representing 41% and Europe representing 15%.Those proportions will likely change as the sector and the overall markets evolve. For example, China is a significant provider of outsourcing services. However, because its local stock markets restrict foreign investment, outsourcing companies listed there are not included in the indexes, says Peters. China's government has slowly been thawing its policies regarding foreign investment, so that could change. Russia, another country with a presence in the outsourcing industry, is not represented in the indexes because many of the companies are privately held. Peters says many outsourcing companies are still privately held worldwide--not just in Russia--and he believes that should change as the outsourcing sector matures and more and more companies go public. India is a major presence in the index, with more than a third of the component companies listed on an Indian exchange, and Peters believes the other BRIC countries should see a lot of growth in outsourcing.

"It's a young industry," Peters says, noting that many outsourcing operations are part of larger companies and that those operations are starting to be spun off. He adds that ideally the broad index would have more pure-play outsourcing companies and says that more will be added as the sector matures, with smaller pure-play companies finding their footing and large corporations spinning off their outsourcing operations. The index methodology requires at least 20% of a company's revenues come from outsourcing and that it derive its revenues from at least two different markets.

The indexes are equal-weighted rather than market-cap weighted. "In an emerging sector, the small companies would have a smaller impact on the index if it was a market-cap index," says Peters. Smaller companies that might be driving much of the sector's growth could be dwarfed by larger companies; an equally weighted index provides those small companies visibility, Peters says. For example, the index's largest company is IBM (IBM), with a market cap of roughly $154 billion, while the smallest component is Blue Star Infotech Ltd., an Indian company worth about $24 million.

The index‘s components have a combined market capitalization of about $674 billion. The outsourcing industry as a whole is estimated at $1.3 trillion. Peters points out that a McKinsey report published within the last couple of years indicated that of the work in the United States that could potentially be outsourced only about 5% had been. Currently, the United States represents about 60% of the outsourcing industry's "buy side," Peters says. Europe, mainly the United Kingdom, represents another 25%. Peters adds that outsourcing services have mostly been utilized by larger companies so far, calling it a "Global 1000 phenomenon."

"Mid-size companies represent a lot of pent-up growth," he notes.

Of the two outsourcing areas covered by the Zagada Waagstein indexes, ITO is the more developed, while BPO, which includes such services as call center staffing, data entry and finance and accounting services, is the faster growing, Peters says.

The index family includes three regional indexes for the Americas, Europe and India that feature the strongest performing companies from each region. The ZagadaWaagstein Global Outsourcing 50 index covers the pure-play ITO and BPO companies with the largest market caps. The best-performing small-caps from the three regions are included in the ZagadaWaagstein Growth Global Outsourcing 20 Index, and the ZagadaWaagstein Focus Global Outsourcing 20 Index comprises the best-performing large-cap stocks in the broad index, with at least six components from each of the three main regions. Those two indexes are combined to create the ZagadaWaagstein Performance Global Outsourcing 40 Index. The indexes are calculated real-time by S&P.

Peters expects that the indexes will eventually be licensed as the bases for investable products such as structured products and ETFs. He believes products based on the indexes would be useful for providing exposure to a growth sector and as hedging tools. The sector itself is an internationally diversified growth play. Surely some takers among the product issuers in the U.S. and globally will step forward to license the indexes.

Peters also says another four indexes will likely be added to the index family, including a dividend yield index and indexes covering companies serving the financial, capital markets and communications sectors. A composite index that extends beyond 100 components is also possible as the outsourcing sector matures and expands but likely would not replace the 100-component index, he adds.

The partnership between Zagada Markets and Waagstein Research seems a reasonable synergy. While Zagada specializes in BPO research and analysis, Waagstein Research is strong in the area of ITO, and the firms focus on different regions. Peters says they intend to "master the niche" and that they would like to be the Moody's of the industry, providing ratings and scores of outsourcing companies as they make their IPOs. He says the firms research and evaluate privately held companies in the outsourcing industry for that purpose.

"There's a lot of media diatribe and political and social concerns about outsourcing," Peters says, acknowledging the pain that results from the loss of jobs. He points out that while most people are happy to enjoy the lower prices that result when manufacturing jobs are outsourced to places like China, the loss of higher-paying jobs that require more skills causes more angst.

The U.S. economy is now largely a service economy and needs the support services offered by outsourcing firms, Peters notes, adding "The phenomenon of global trade is unstoppable."