What it means
The product was created by Morgan Stanley in 1994 for investors who wanted exposure to overseas markets without the cost and complexity of buying shares one by one. Each OPALS security followed one country's equity market.
Many were listed on the Luxembourg Stock Exchange, which let international investors trade them like any other listed security. The design feature was optimisation.
Rather than holding every company in the index, the portfolio held a smaller selection chosen to move closely with the index. This kept costs down and made management easier, while aiming to deliver a return similar to the market.
For institutions, the product solved practical problems. Investing directly in a foreign market can require local accounts, local tax arrangements and settlement systems.
Futures contracts can also be restricted or unattractive for regulatory reasons, so a listed security that tracks the market was a convenient alternative. The main risk is tracking difference.
Because the portfolio holds fewer companies than the index, its return can drift above or below the benchmark, and the gap can be large when a few shares behave differently. Investors also need to consider currency movements, fees and whether the security can be sold easily.
OPALS were aimed mainly at large institutions and sophisticated investors, and the structure is not widely used today. Exchange-traded funds with transparent holdings, daily pricing and low fees have taken over most of the same role.
The term is still useful in financial history as an example of how index-style investing developed. A modern finance reader will recognise the same questions in today's exchange-traded products.
What does the vehicle hold, how closely does it follow its benchmark, what does it cost and how easily can it be sold? Asking these four questions of any pooled product is still the best way to judge whether the convenience is worth the price.
In practice
Real-world examples.
Example
A European pension fund wants exposure to an Asian equity market but has no local custody arrangements. It buys a listed security that tracks the market through a reduced basket of shares. The fund avoids opening local accounts and uses its existing settlement system.
Example
An investment bank designs a structure for institutional clients who cannot use futures because of internal restrictions. The structure packages a selected group of shares into a single listed instrument. Clients can sell it at any time in the market.
Example
A fund manager reviews a position in a country-tracking security and finds that it has lagged the index by 1.2% over a year. She investigates whether the cause is fees, currency or the choice of shares. The result guides her decision to switch to a broader fund.
Formula
Calculation
Tracking difference = return of the OPALS portfolio - return of the benchmark index
Suppose a country index returns 8.0% over a year, while an OPALS security that tracks it returns 7.4%.
Tracking difference = 7.4% - 8.0% = -0.6%.
On an investment of $20,000,000, the shortfall is 20,000,000 x 0.006 = $120,000.
If the security's fees are 0.4% a year, they account for 20,000,000 x 0.004 = $80,000 of that gap, and the remaining $40,000 comes from holding a smaller basket of shares than the index.Case study
Seen in the real world.
Westbridge Pension Trust is an illustrative, fictional fund that wanted to invest $30 million in a single emerging market in the mid-1990s. Buying the shares directly would have required local brokers, custody and tax filings.
The trustees chose a listed security that tracked the country using about 40 of the largest companies. It cost 0.5% a year to hold, which was $150,000, but saved an estimated $250,000 in set-up and administration costs in the first year.
After three years, the security trailed the index by 0.8% a year because several shares outside the basket had rallied. The trustees accepted the gap as the price of convenience, and later moved to a wider fund. The illustrative lesson is that a convenient wrapper can be worth its cost, but tracking difference should be measured.
Watch out
Common mistakes.
- Assuming the security holds every company in the index, when it holds a smaller selection intended to follow the index.
- Ignoring tracking difference, which can be large when the chosen shares diverge from the market.
- Treating it as the same as a modern exchange-traded fund, when it was less transparent and mainly available to large investors.
Questions
People also ask.
What does OPALS stand for?
It stands for Optimized Portfolios as Listed Securities, and the word optimised refers to the selected basket of shares.
Who created OPALS?
Morgan Stanley introduced them in 1994 as a way to give investors access to single-country equity markets.
Are OPALS still important?
They are mostly of historical interest, because exchange-traded funds now provide similar exposure with more transparency and lower costs.
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