SSgA CAPITAL INSIGHTS THE EXCHANGE

Part of State Street’s Vision thought leadership series

by Frédérick P. Jamet, Head of Investments, SSgA France

Is the MSCI World Still a Good Proxy for a Global Market Portfolio?

In global investing, the MSCI World Index has often been seen as

the best proxy for a global equity market portfolio. As we’ll see, this

should no longer be the case. With its significantly higher coverage

of global equity markets and superior performance during the

past decade, the MSCI All Country World Investable Market Index

(ACWI IMI) should be viewed as a better benchmark for investment

portfolios when compared with the MSCI World Index.

How to Gain Broader Coverage of Global Equity Markets – A Closer Look

While the MSCI World Index represents 85% of the market capi-

talization of listed equities in the developed world, it excludes the

following important classes of equities:

• Small-cap stocks accounting for about 15% of the total listed

equity market

• Emerging markets stocks representing around 13% of the total

• Frontier markets comprising less than 1% of the total

• Micro-cap equities accounting for less than 1% of the total

• Private equities representing a significant portion of global

equities

The MSCI All Country World Investable Market Index on the other

hand, is significantly more exposed to emerging markets and

small-cap stocks, making it a better proxy for a global market

portfolio and hence, a more suitable benchmark for global invest-

ment portfolios.

Moreover, in terms of market capitalization, the two indexes also

differ considerably. The market capitalization of the MSCI World

Index is $21.1 trillion, representing only 75% of the total global

equity universe, compared with the MSCI ACWI IMI’s market

capitalization of $28.1 trillion, thought to represent 99% of the

global universe.

The MSCI ACWI IMI’s Superior Performance Record

Besides being a better proxy for a global market portfolio, the

MSCI ACWI IMI has outperformed the MSCI World Index by 1.5%

annually over the past 10 years, as shown in Chart 1.

 

Chart 1: Performance of the ACWI IMI and MSCI World Index, July 2000 to July 2010

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■ ACWI IMI■ World

Source: MSCI, as of July 31, 2010. Past performance is not a guarantee of future results.

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Exposure Differences between the MSCI World Index and MSCI ACWI IMI

As illustrated in Chart 2, the MSCI World Index covers 24 devel-

oped countries compared with the much more significant global

exposure of the MSCI ACWI IMI to 45 developed countries,

including a 13.2% exposure to emerging markets. In addition to

this greater exposure, the MSCI ACWI IMI does not differentiate

between developed and emerging countries since it includes

both segments of the global equity market. By contrast, it can

be argued that benchmarking investments against the MSCI

World Index is in fact a bet against emerging markets given their

underweight exposure in that index.

In terms of country weights, the largest difference between the

exposure of the MSCI World Index and MSCI ACWI IMI is 5.8%

for the United States. The other larger countries, such as Japan

and the United Kingdom, also have greater weight in the MSCI

World Index than in the MSCI ACWI IMI.

There are also differences between the two indices in terms of

their sector breakdown. The MSCI World Index is more concen-

trated in defensive sectors such as Consumer Staples and Health

Care than the MSCI ACWI IMI, as shown in Chart 3. By contrast,

the MSCI ACWI IMI has greater representation in cyclical sectors

such as Materials and Industrials and would likely enjoy better

performance if activity in these sectors rebounds.

Chart 3: Sector Exposures of MSCI World and MSCI ACWI IMI Indices

Sector (%) WORLD ACWIIMI Relative

Energy 10.1 10.0 0.1

Materials 7.4 8.5 -1.1

Industrials 11.1 11.5 -0.4

Consumer Discretionary 9.9 10.3 -0.4

Consumer Staples 10.3 9.2 1.1

Health Care 9.5 8.3 1.2

Financials 21.2 21.5 -0.3

Information Technology 11.8 12.2 -0.4

Telecommunication Services 4.3 4.3 0.0

Utilities 4.3 4.2 0.1

Source: MSCI, as of July 31, 2010.

Chart 2: Country Exposures of MSCI World and MSCI ACWI IMI Indices Equity Exposure (%)

Country World ACWIIMI Relative

United States 49.0 43.2 5.8

Japan 10.1 8.8 1.3

United Kingdom 9.9 8.4 1.5

Canada 5.1 4.4 0.7

France 4.6 3.7 0.9

Australia 3.8 3.3 0.5

Germany 3.6 3.0 0.6

Switzerland 3.5 2.9 0.6

Spain 1.8 1.4 0.4

Italy 1.4 1.2 0.2

Sweden 1.4 1.2 0.2

Netherlands 1.2 1.0 0.2

Hong Kong 1.1 1.0 0.1

Singapore 0.8 0.7 0.1

Finland 0.5 0.4 0.1

Denmark 0.5 0.4 0.1

Belgium 0.4 0.4 0.0

Norway 0.4 0.4 0.0

Israel 0.4 0.3 0.1

Greece 0.2 0.2 0.0

Austria 0.1 0.2 -0.1

Ireland 0.1 0.1 0.0

Portugal 0.1 0.1 0.0Source: MSCI, as of July 31, 2010.

Country World ACWIIMI Relative

New Zealand 0.1 0.1 0.0

China 0.0 2.4 -2.4

Brazil 0.0 2.0 -2.0

Korea 0.0 1.8 -1.8

Taiwan 0.0 1.6 -1.6

India 0.0 1.1 -1.1

South Africa 0.0 1.0 -1.0

Russia 0.0 0.8 -0.8

Mexico 0.0 0.5 -0.5

Malaysia 0.0 0.4 -0.4

Indonesia 0.0 0.3 -0.3

Turkey 0.0 0.3 -0.3

Thailand 0.0 0.2 -0.2

Chile 0.0 0.2 -0.2

Poland 0.0 0.2 -0.2

Colombia 0.0 0.1 -0.1

Peru 0.0 0.1 -0.1

Egypt 0.0 0.1 -0.1

Philippines 0.0 0.1 -0.1

Czech Republic 0.0 0.1 -0.1

Hungary 0.0 0.1 -0.1

Morocco 0.0 0.0 0.0

SSGA CAPITAL INSIGHTS | THE MSCI WORLD

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Risk Differences between the MSCI World and MSCI ACWI IMI Indices

As illustrated in Chart 4, we’ve undertaken a BARRA risk analysis

to examine the risk traits of the MSCI World Index versus those

of the MSCI ACWI IMI, which we’ve used as a benchmark for the

total global equity market. Our key findings are:

• The total risk of the MSCI World Index is 24.9%.

Given its lower exposure to the higher volatility small-cap and

emerging-markets stocks, it is not surprising that the MSCI World

Index, with a total risk of 24.9%, appears slightly less risky in

absolute term than the MSCI ACWI IMI, with a total risk of 25.5%.

• The MSCI World Index’s active risk is 1.9%.

The tracking error between the MSCI World and MSCI ACWI

IMI is 1.9%, i.e. tracking the MSCI World Index with the aim of

obtaining a full passive exposure to global equities results in a

tracking risk of 1.9% vis-a-vis a full passive exposure to the total

global equity market as represented by the MSCI ACWI IMI. For

a passive portfolio, this tracking error of 1.9% versus the market

portfolio is significant. A passive equity investment that tracks the

MSCI World Index in fact represents an active bet and active risk

of 1.9% rather than a neutral exposure.

• The MSCI World Index’s country risk is 1.5%.

A large portion of the MSCI World Index’s risk (1.5%) results from

differences in the country and currency exposure of the MSCI

World and MSCI ACWI IMI indices. This derives mostly from the

13.2% exposure of the MSCI ACWI IMI to emerging markets.

• The MSCI World Index’s size risk is 0.5%.

Different market capitalization exposures also have an impact on

expected risk. Because of the high number of stocks needed to

attain the 15% exposure to small caps, the MSCI ACWI IMI Index

contains 8,827 stocks compared to 1,659 in the MSCI World

Index. This higher exposure to small caps significantly decreases

the average market cap in the MSCI ACWI IMI.

Chart 4: Barra Risk Analysis of the MSCI World Index versus the MSCI ACWI IMI

Conclusion

For many years, the MSCI World Index has been considered the

proxy for the global equity market portfolio. However, since the

index is biased towards large-cap equities, developed countries

and defensive sectors, it is not, in fact, an ideal benchmark. In

addition, an analysis of its performance over the last 10 years

highlights that its returns have lagged those of the broader MSCI

ACWI IMI.

Investors with global equity portfolios should continue to recog-

nize the principles of the market portfolio as set out in the Capital

Asset Pricing Model since the theory suggests that a market

portfolio is efficient – that is it maximizes return for the associ-

ated level of risk. In addition, this efficient portfolio theoretically

provides the lowest turnover and highest diversification.

In order to obtain the most comprehensive exposure to the effi-

cient ‘market portfolio’, investors should consider using the MSCI

ACWI IMI as a proxy for the global market to obtain important

exposure to emerging-markets and small-cap stocks and to

benefit from potentially higher returns than those obtainable by

tracking the narrower MSCI World Index.

(% Std Dev)

Momentum 0.4

Volatility 0.4

Value 0.1

Size risk 0.5

Size (Non-linearity) 0.1

Growth 0.0

Liquidity 0.0

Financial Leverage 0.0

Industries 0.2

Country risk 1.5

Currency 0.7

World Equity 0.5

Asset Selection 0.3

Active risk 1.9

Benchmark risk (MSCI ACWI IMI) 25.5

Total risk (MSCI World Index) 24.9

Source: MSCI, Barra, as of July 31, 2010.

SSGA CAPITAL INSIGHTS | THE MSCI WORLD

© 2010 State Street Corporation INST-1337 1010

This material is for your private information.

The views expressed in this material are the views of Frédéric Jamet through the period ended November 2, 2010 and are subject to change based on market and other condi-tions. The information provided does not constitute investment advice and it should not be relied on as such. All material has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Past performance is not a guarantee of future results.

Investing in foreign domiciled securities may involve risk of capital loss from unfavor-able fluctuation in currency values, withholding taxes, from differences in generally accepted accounting principles or from economic or political instability in other nations. Investments in emerging or developing markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.

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SSGA CAPITAL INSIGHTS | THE MSCI WORLD