The US stock market now accounts for almost three quarters of global indices, representing an unprecedented level of dominance.
This reflects the fact that US markets have outperformed, but it also means global indices have become increasingly lopsided.
One of the key benefits of using global indices is they invest across thousands of companies. This usually means no single company, sector or country has an outsized influence on the performance of the index.
Today, just a handful of large US technology companies dominate global indices.
How concentrated is the MSCI World index today?
Chip designer Nvidia and Apple represent more than a tenth of the global MSCI World index while the top 10 holdings are 28% and the technology sector is around 38% of the index when Alphabet and Meta are classified as technology stocks.
This means that anyone holding a global tracker ETF as well as a US fund and technology fund may be unnecessarily doubling up on US and technology exposures.
It is therefore important to consider whether you intentionally want to have a large exposure to the US. A large US weighting may well be justified as US earnings continue to grow, driven by the AI boom, but it worth being aware of the concentration risks.
There is nothing intrinsically good or bad about indices weighted by market capitalisation, which are simply shares prices multiplied by the number of shares outstanding.
Market capitalisation indices are inherently influenced by price momentum because fund inflows concentrate disproportionately in the largest constituents by default regardless of fundamental factors like profitability.
This behaviour can become a self-fulfilling prophecy where price momentum invites further price momentum, leading to possible overvaluation.
Are there historical precedents of index domination?
In 1989 Japan reached an historic peak when the Tokyo stock exchange accounted for nearly half of global market capitalisation, and eight of the world’s largest companies by market value were Japanese.
The benchmark Nikkei 225 index subsequently plummeted by over 60% and property values which had been used as collateral for loans, fell by up to 80%, leading to Japan’s ‘lost decade’ in the 1990s.
How can I reduce US concentration risk?
One way to reduce the large US weighting in global indices is to track a global index which excludes the US and, if required, buy a US tracker separately, applying a weighting you feel comfortable with.
The MSCI World ex US index is less concentrated with the top 10 holdings accounting for just 13% of the benchmark, compared with 28% for the market-cap weighted version.
Top holdings include Dutch semiconductor equipment maker ASML at just under 3%, HSBC, and Swiss firms Roche and Nestle. Financials represent the largest sector at 28%, followed by industrials at 18%.
What are the advantages of an equal weighted global index?
The equal weighted MSCI World index includes the same constituents as the parent index. However, at each quarterly rebalancing, all constituents are weighted equally, removing the influence of recent price moves.
The US remains the largest constituent, but its size is reduced to around 41% of the total index, with Japan the next largest at 14% followed by Canada and the UK at 6% and 5%, respectively.
Industrials are the largest sector weighting at 20% with financials at 18% and information technology at 11%.
Is there any downside to equal weighting?
Equal weighted indices make more changes during quarterly rebalancing which results in higher transaction costs, impacting performance.
Rebalancing requires selling winners and buying laggards, which may be beneficial but can be a performance drag during trending markets.
Because equal weighting gives small and medium sized companies equal footing with their larger brethren, it exposes the portfolio to larger drawdowns during recessions and elevated market volatility.
The approach tends to overweight cyclical sectors like industrials and financials compared with the market-capitalisation version.
How do MSCI and FTSE global indices compare?
There are some differences between the two main global index providers, MSCI and FTSE, so it is worth noting being aware of them before building portfolios.
The MSCI World index excludes emerging markets like China, India and Brazil.
MSCI ACWI (All cap world index) is closer to the FTSE World index in that it includes emerging markets and targets around 85% of total market value, excluding the smallest companies, while the FTSE All World targets 90% of total market value, capturing more of the world’s smallest companies.
South Korea is classified as developed by FTSE, but MSCI defines it as an emerging market. It is worth mentioning that technology firms Alphabet and Meta are classified as communications services by MSCI while FTSE puts them into the technology sector.
None of these differences matter too much given the current dominance of US stocks in that it doesn’t change the weighting that much, but they are nuances worth bearing in mind.
Martin Gamble: Shares and Markets Writer
Martin Gamble is Shares and Markets writer at AJ Bell. He was previously the Education Editor of Shares Magazine. He has been with the business since 2019.
Martin graduated from the University of Kent in...