MSCI vs FTSE

crazychamps

Hi All,

Apologies for the long post. I am hoping that this post may come across as educational for some individuals and am hoping to have some of my questions answered.

Over the past year I have been in the process of going through an intensive learning phase before I start building my own portfolio. Essentially I am trying to cover as many areas as possible before I actually build the portfolio to minimise any key changes that would have to be made in the event that I come across some new information / knowledge (please note that I am currently invested in a global fund, but this is only temporary). The discussion also runs on the assumption that the whole portfolio is passive; which won't be the case as I want to take advantage of the positive attributes that both active and passive have to offer (these to be discussed at another time).

As such, over the past couple of days I have been trying to learn the key differences between MSCI and FTSE indices, their selection and maintenance criteria to see whether one performs better either in general or within a particular market (e.g. in size cap or developed / emerging etc...).

I came across an article recently which has a few insightful notes (as a junior member I cannot post a link) called "NBIM Discussion Note Global equity indices" and should be one of the first search results on google. I have tried to summarise my key findings below in a somewhat readable format.


.............................. .......FTSE ..............MSCI
Target Coverage........98% ..............99%
Includes Orphan Stocks...Yes ..............No
Include equity investment instruments (ICB subsector 8985) .......Yes........ No

Both use Cumulative Market Capitalisation Coverage and both review their listings quarterly (albeit with differing specifications). Because of this, MSCI holds more small cap companies than FTSE. FTSE also seems to classify some smaller companies as mid-cap which the MSCI classifies as small cap. The reason is two-fold: 1. FTSE has a lower cut-off point for medium size (86% versus 85% cumulative market cap); 2. MSCI has a global focus on striking a balance between “size integrity” and coverage, whereas FTSE aims to achieve this at a regional level. This results in MSCI holding ~1000 more companies that FTSE; majority of which (if not all) are small cap. This is shown in Figure 4 of the linked document.

Liquidity measures based on trading volume of a financial security

FTSE has a common rule that is applied to both developed and emerging market segments.

MSCI differentiates between developed and emerging markets on liquidity, lowering the bar for emerging markets

Preferred shares / secondary company share listings

FTSE --> Secondary lines of a company have to have a market cap which is 25% or more of the full market cap of the principal line in order to be included in the index.

MSCI --> will generally include preferred shares if they do not exhibit characteristics of fixed-income securities.

Other Interesting Points

Another interesting fact is that MSCI tends to have a slightly elevated allocation to America compared to FTSE. In contrast, FTSE tends to have a slightly higher allocation in Europe compared to MSCI.

Out of the top ten ICB industries, Financials and Health Care allocations are noticeably different between MSCI and FTSE, with MSCI allocating more weight to Health Care and less to Financials. The differences in allocations have diminished over the last couple of years, but the two industries still stand out with the highest differences in allocations.

It also studies overlap in companies held between the different indices whereby 6651 stocks are held by both, and an additional 2483 stocks are held by one or the other

Although a walkthrough of the methodology for the two global benchmarks shows that there are multiple differences in the rules that decide which stocks go into the index, we also see that, for a global investor,

these differences do not make much of a difference to risk/reward, especially over the last few years leading up to June 2013.

My Questions

Based on the above key points, is there any evidence to suggest that it is best to utilise FTSE trackers for developed large and mid-cap funds and using MSCI trackers for small cap companies as it holds many more companies?

[LIST=2]Is it best to use MSCI for emerging markets in order to capture more companies / reduce risk / provide a better return?[/LIST]
[LIST=3]For a sizable portfolio, despite the large amount of effort involved, is it worth splitting allocations in two; with 50% using MSCI and the other using FTSE? The overlapping companies will provide the same return (despite the minor weighting differences) as putting 100% in either, but this approach allows the investor to benefit from diversifying across an additional 2000+ companies?[/LIST]

If you made it this far down the list, thank you and I look forward to your ideas on the matter.

CC

System

Don't waste your time learning trivia! Get on with building your portfolio!
Are you doing this to put off building a portfolio?

Superscrooge

https://en.wikipedia.org/wiki/Analysis_paralysis

A_T

Sounds like overcomplication. Whether you invest in Fidelity Index World (MSCI) or HSBC FTSE All-World Index the outcome will be pretty much the same over the long term.

Prism

crazychamps wrote: »

Is it best to use MSCI for emerging markets in order to capture more companies / reduce risk / provide a better return?

Just to address this point. Having more companies in a sector or region does not especially reduce risk once you have at least 25 or so. As far as return goes it is more likely to represent the average and very unlikely to provide a better (or worse) return.

coyrls

crazychamps wrote: »

Although a walkthrough of the methodology for the two global benchmarks shows that there are multiple differences in the rules that decide which stocks go into the index, we also see that, for a global investor, these differences do not make much of a difference to risk/reward, especially over the last few years leading up to June 2013.

Is the answer to all your questions.

Linton

The difference between the indexes is minor in practical terms. If the indexes arent right for you, you need to invest in a very different allocation. Something that can most easily be achieved by looking at active funds.

What I would advocate for a new investor is to go for a global all-cap fund rather than a developed world, or large companies focused index fund.

As others have said, start investing now. You can always hone your approach later.

crazychamps

Linton wrote: »

The difference between the indexes is minor in practical terms. If the indexes arent right for you, you need to invest in a very different allocation. Something that can most easily be achieved by looking at active funds.

What I would advocate for a new investor is to go for a global all-cap fund rather than a developed world, or large companies focused index fund.

As others have said, start investing now. You can always hone your approach later.

Thank you all for commenting.

I think having a mixture of both active and passive would work for me. Thus am trying to see whether particular passive indices perform better in specific segments of the market.

Also, I am currently invested in a global all-cap fund with satellite funds to fill in the blanks, although am trying to build a whole portfolio from scratch to suit my particular needs while allowing me to control overlap / diversification.

A_T wrote: »

Sounds like overcomplication. Whether you invest in Fidelity Index World (MSCI) or HSBC FTSE All-World Index the outcome will be pretty much the same over the long term.

For a global all-cap fund I do agree that the difference will be quite minute. But one of my query is whether one of the indices performs better than the other in particular size caps and developed vs emerging.

coyrls wrote: »

Is the answer to all your questions.

This applies largely to the funds that track the global all-cap using FTSE and MSCI. But as I mentioned in the above paragraph, it may not be the same (or the different may atleast be greater than 1%) on a smaller particular segment of the market.

grey_gym_sock

there are several factors to consider when comparing tracker funds to do a particular job (e.g. world tracker, or japan tracker, or whatever). the index tracked is 1 factor, but often 2 indexes are so similar that it hardly matters which you choose. so for instance, if 1 tracker is significantly cheaper than another, that may make much more difference than which index is tracked.

other things being equal, i'd usually prefer an index that has a broader coverage of companies. though bear in mind that these differences are not always significant, when you consider the amount of money going into the extra companies. e.g. even 1000 extra companies in a global all-cap tracker may not be significant, when those 1000 are smaller small-caps, and nearly all the money is going into big-caps, mid-caps and bigger small-caps.

but i'd get down to comparing funds first, not FTSE vs MSCi in general. then you can consider number of companies covered, and whether any difference is significant.

i don't think there's any very useful general answer to FTSE vs MSCI.