Düsseldorf – Investors meticulously scrutinize global equity indices like the MSCI World, MSCI All Country World (ACWI), and FTSE All World, dedicating significant time to identify the optimal benchmark for their portfolios. The financial industry actively promotes an ever-evolving array of solutions designed to capture global market performance. However, a recent analysis of leading Exchange Traded Funds (ETFs) tracking these prominent indices reveals a surprising degree of convergence in their performance for the current year, suggesting that for many investors, the choice of product has had a minimal impact on returns.

The data, compiled by the investment portal ExtraETF, indicates that the performance difference between the top-performing ETFs for each of these major global indices has been remarkably narrow, with variations not exceeding 0.2 percentage points since the beginning of the year. This parity in returns challenges the notion that subtle differences in index composition necessarily translate into significant investment outcomes over shorter time horizons.

Unpacking the Performance Parity: A Closer Look at Leading ETFs

The analysis specifically compared the top-performing ETFs for each index, identified by ExtraETF as those yielding the highest returns year-to-date. These include the UBS Core MSCI World ETF (ISIN: IE00BD4TXV59), the iShares MSCI All Country World ETF (IE00B6R52259), and the Invesco FTSE All-World ETF (IE000716YHJ7).

Across these exemplary funds, returns have ranged from a robust 15.9% to 16.1% year-to-date. Intriguingly, the MSCI ACWI, which aims for broader global coverage, has emerged as the top performer, while the more historically focused MSCI World has shown slightly more modest, though still strong, gains. The close proximity of these figures, when visualized on a comparative chart, highlights the near-identical trajectory of these investment vehicles.

This phenomenon is largely attributable to the underlying methodologies of the indices themselves. At their core, both the MSCI and FTSE indices employ a market-capitalization weighting scheme. This means that the largest companies, by market value, wield the most influence within the index. Consequently, despite apparent differences in the number of constituent companies and geographical coverage, the primary drivers of performance often align.

The Weight of Market Capitalization: Unifying Index Performance

The market-capitalization weighting approach results in a significant concentration of influence from a select group of companies and regions. Across all three indices, U.S. equities command the largest weight by a considerable margin. Furthermore, the technology sector, encompassing Information Technology and Communication Services, consistently accounts for approximately 40% of the index composition. The ten largest companies, collectively, represent a substantial portion of the overall index value, often around 25%.

This shared emphasis means that the performance of these indices is heavily tethered to the fortunes of a relatively small number of mega-cap technology companies. When these dominant players perform well, the entire index tends to move in tandem. The subtle divergences in performance observed this year are primarily influenced by the varying exposure to specific regions, particularly Asia and emerging markets, and the performance of their constituent companies.

For instance, the MSCI World index includes only three Asian countries – Japan, Hong Kong, and Singapore – which collectively represent just over 7% of the index. In contrast, the FTSE All World index allocates a more substantial 18% to Asian equities, while the MSCI ACWI holds a significant 16%. This difference in regional weighting becomes particularly relevant when considering the performance of specific markets.

Regional Dynamics and Sectoral Influence: The Asian Factor

The year-to-date performance has shown a positive correlation with higher allocations to Asian markets. This is largely due to the strong performance of semiconductor stocks in South Korea and Taiwan. These two nations alone contribute approximately 6% to the weight of the FTSE All World index, whereas they are not represented in the MSCI World. Their robust growth in the current year has therefore provided a notable boost to indices with greater exposure to these regions.

Conversely, the MSCI World index tends to outperform when large-cap U.S. technology stocks experience upward momentum. Given their significant weighting within the MSCI World compared to other global indices, their strong performance in the second half of the year has helped the MSCI World recoup some of its earlier relative underperformance.

Long-Term Perspectives: Divergence and Strategy

While short-term performance may show remarkable parity, a longer-term perspective often reveals more pronounced differences. A comparison of the oldest available ETFs for each of these indices, dating back to 2019, illustrates this point. During this period, the exceptional growth of major U.S. technology stocks has led to the MSCI World index outperforming the other two. This trend highlights the impact of sustained dominance by certain sectors and regions on long-term investment returns.

However, the landscape can shift when index methodologies deviate from pure market-capitalization weighting. Recent innovations in ETF offerings have introduced alternative weighting schemes, such as Gross Domestic Product (GDP) weighting. Amundi, for example, recently launched an ETF employing this method, which aims to rebalance country allocations based on their economic output rather than their stock market valuations.

Invesco has also introduced an equal-weighted MSCI World variant. This approach deliberately reduces the overrepresentation of U.S. and technology stocks, increasing the allocation to regions like Europe and Asia, as well as sectors such as industrials, basic materials, and utilities. While this strategy showed promising results around mid-year, it has recently lagged behind the market-capitalization-weighted MSCI World by approximately one percentage point.

Factor Investing: Seeking Alpha Beyond Broad Market Exposure

Beyond broad market indices, specialized factor-based ETFs offer investors distinct strategies aimed at capturing specific market premiums. This year, several of these thematic approaches have demonstrated significantly stronger results compared to their broad-market counterparts, particularly among ETFs that reinvest dividend payments immediately.

ExtraETF data highlights three such successful strategies: the Xtrackers MSCI World Value ETF (IE00BL25JM42), the iShares MSCI World Momentum Factor ETF (IE000L5NW549), and the iShares MSCI World Quality Dividend Advanced ETF (IE00BKPSFC54). The Value approach has been the standout performer, delivering a remarkable 36% return, while the Momentum and Quality Dividend strategies have achieved gains of 19% to 21%.

These factor-based ETFs achieve their superior performance by drastically narrowing the investment universe, often from thousands of companies down to a few hundred. The U.S. equity allocation also tends to decrease, sometimes falling below 50%. This concentration, rather than broader diversification, is the driver of their outperformance. While they may reduce the dependence on a few mega-cap stocks, the overall concentration risk can remain significant, and in some cases, the technology sector’s weighting can even increase.

A closer examination of these factor ETFs reveals the underlying drivers of their success. For instance, in the Value ETF, a single company like Micron Technology can account for over 15% of the portfolio. Despite a recent period of weaker performance, Micron’s stock has surged over 200% year-to-date. However, its valuation has become attractive because its earnings growth has outpaced its stock price appreciation, fulfilling the criteria for a "value" stock.

Similarly, the other leading factor ETFs exhibit significant concentrations in prominent technology companies. Nvidia, Microsoft, and Apple are among the top holdings in the dividend ETF, while Apple, Nvidia, and Alphabet dominate the Momentum ETF. This concentration underscores the fact that even these specialized strategies are often heavily influenced by the performance of major technology players.

The Illusion of Diversification: Concentration Risk in Factor ETFs

The superior performance of these alternative global ETFs this year is demonstrably linked to specific market trends. However, the long-term viability of such outperformance is not guaranteed. The historical data, extending back to 2017 for European-traded ETFs, indicates that while the Momentum approach has outperformed the broad MSCI World index, it carries inherent risks. A market sentiment shift, leading to the sale of previous winners, could result in substantial losses within momentum-focused portfolios.

This reliance on specific trends means that while these factor-based ETFs may offer the potential for higher short-term returns, their performance is inherently cyclical and dependent on prevailing market conditions. Investors considering these strategies should be aware of the potential for increased volatility and the possibility that short-term outperformance may not be sustainable over the long term.

Implications for Investors: Informed Decision-Making in a Complex Market

The current market environment, characterized by the close performance of major global equity indices, presents a nuanced picture for investors. While the broad appeal of indices like the MSCI World, ACWI, and FTSE All World lies in their comprehensive diversification, the underlying market capitalization weighting mechanism leads to a significant concentration in U.S. equities and the technology sector. This concentration has been a primary driver of returns for these indices in recent years.

For investors seeking to diversify beyond these broad benchmarks, factor-based ETFs offer alternative pathways. However, these strategies often involve a trade-off between diversification and concentration. While they can capture specific market premiums, they also concentrate risk in particular stocks or sectors, making them susceptible to shifts in market sentiment and the performance of those concentrated holdings.

Ultimately, the choice of investment vehicle should align with an individual investor’s risk tolerance, time horizon, and financial objectives. Understanding the underlying methodologies of indices and ETFs, along with the potential drivers and risks associated with different investment strategies, is paramount for making informed decisions in the dynamic global equity market. The current year’s performance data serves as a valuable reminder that while broad diversification is a cornerstone of long-term investing, the specific composition and weighting schemes within investment products can significantly influence short-term outcomes.

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First Publication: October 25, 2023, 16:02 CET.