A road trip to financial freedom

How to diversify your global ETF portfolio like a pro

By Lizelle Steyn

9 February 2021

how to diversify your global ETF portfolio

Photo credit: cottonbro


One of my weekly rituals is listening to the Fat Wallet Show on Mondays over lunchtime. Besides the fact that I always learn something, it’s interesting to hear what other investors have in their portfolio, and what they grapple with. A theme that comes up often is how to diversify your existing global equity ETF portfolio. It seems it’s common for investors to duplicate their exposure to specific companies when in fact the plan was to diversify. Maybe it’s time to delve into some ‘index geography’. Once you can confidently point out which part of the equity index map your global ETF covers, knowing how to further diversify becomes a breeze.

(This post covers only the equity portion of your global ETF portfolio; not your entire ETF portfolio diversification, which was covered in a previous post.)

The global equity index universe – our ‘map’

First, to give credit, my global equity index map below was inspired by the Global Equity Investing webinar of Kingsley Williams from Satrix.

global equity index universe

To understand this universe or 'map' of companies listed on the main stock exchanges of the world, let’s look at what each category means.

Developed markets

Developed markets have a higher GDP (economic output) per citizen than the rest of the world and they generally have more developed financial systems and good infrastructure in place. It doesn’t mean these countries have higher economic growth; only a bigger economy per person.The list include the likes of the US, UK, Switzerland, most of the EU, Japan, Australia and Canada. Hong Kong and Singapore are included, but China is still excluded at this stage.

Emerging markets

An emerging market economy is one that is in the process of becoming a developed economy.

Large cap

‘Cap’ is short for market capitalisation, which is the market value of all the shares listed on a stock exchange by a particular company. As the market value changes from day to day, companies can move in and out of the large, mid and small cap categories as they grow or shrink in value. Large cap refers to the biggest companies on any particular stock exchange as measured by their market value. In South Africa the top 40 companies are considered ‘large cap’; in the US the top 500 US companies are viewed by index compiler Standard&Poor’s (S&P) as large cap. The number will differ from index to index.

Mid cap

Mid cap companies are simply the next tier of companies under large caps when measured by the market value of their listed shares.

Small cap

Small cap companies are the ‘tail end’ of stocks listed on any particular exchange. They are generally not so easy to trade in and out of and are for that reason excluded from most major global indices.

Here in South Africa, in the retail investor space, you’re currently able to track global large and mid cap companies only.

Using our equity index map above as a framework, let’s take a few of the most popular global equity indices and ‘colour in’ which parts of our universe they cover.

The Nasdaq-100 Index

Nasdaq

The Nasdaq-100 is focused on the largest 100 stocks on one US stock exchange only – the Nasdaq. It excludes financial stocks and is quite tech heavy. Investing in the Nasdaq-100 is partly a geographic call (US only) and partly a thematic play, taking a bet on tech stocks.

The S&P 500 Index

S&P 500

Like the Nasdaq, the S&P 500 includes only US stocks, but at least it includes companies listed on three US exchanges. It’s also a large cap index and makes up just under two-thirds of the MSCI World, showing how dominant US large caps are in develop markets. And 72% of the earnings by these US-listed (but globally operational) companies come from sales in the US.

The MSCI World Index

MSCI World

Like S&P, MSCI is a large and established index provider. The MSCI World Index is wider than the US and includes all developed markets. Not only does the MSCI World cast its net wider than the Nasdaq-100 and the S&P 500 on a geographical basis, it also includes mid cap stocks, covering about 85% of the market cap in each of the 23 developed market countries included in the index. The likes of the US, UK, Switzerland, most of the EU, Japan, Australia and Canada are included. Hong Kong and Singapore are also in, but China is still excluded at this stage.

The MSCI Emerging Markets (EM) Index

MSCI Emerging Markets

The MSCI EM Index is the counterpart of the MSCI World Index in the emerging market (EM) universe. It also includes the large and mid caps in the countries in which it invests and covers 85% of the market cap of each country. It includes 27 countries, with Greece, the Czech Republic, Poland and the UAE among them.

The MSCI EM Investable Market Index (IMI)

MSCI EM IMI

This is not a commonly used global equity index, but I’ve included this one just to show you what the ‘IMI’ at the end of an index or ETF name means: investable market index. IMI indices include small caps on top of mid and large caps. It’s debatable whether adding the tail end of a stock exchange is worth the often extra cost of tracking these small and hard-to-trade companies.

The S&P Global 1200 Index

S&P Global 1200

The S&P Global 1200 is a popular index which covers both developed and emerging markets, but focuses on the large caps only. Only about 6% of the index is allocated to emerging markets, though.

During 2020 the S&P Global 1200 changed to a composite of seven other indices – it’s an index made up of seven other indices. This means local ETF providers tracking this index now have a fund of funds (fund of ETFs) structure to bring down the management fee (good news).

The MSCI All Country World Index (ACWI)

MSCI ACWI

The MSCI ACWI is an index with even broader coverage than the S&P 1200, as it includes mid-cap stocks too in developed and emerging markets. When tracking this index, you are invested in just under 85% of world market capitalisation (the market value of all shares listed in the world.)

A comparison between global equity indices

Now that we’ve mapped out a few of the main global equity indices, it’s time to check their fund factsheets (also called minimum disclosure documents or MDDs) and find out how many stocks they invest in and what their biggest holdings and largest country exposures are. There’s a lot of information to absorb on these factsheets. All we’re really interested in for diversification purposes are the salient characteristics as summarised in the table below.

Table: global equity index comparison

Index Nasdaq-100 S&P 500 MSCI World MSCI EM S&P Global 1200 MSCI ACWI
# of countries 1 – and only 1 stock exchange 1 – but 3 stock exchanges 23 DM countries 27 EM countries 30 50
Developed or emerging market Developed Developed Developed Emerging Developed + Emerging Developed + Emerging
Large cap Yes Yes Yes Yes Yes Yes
Mid cap No No Yes Yes No Yes
# of stocks About 100 About 500 About 1600 About 1400 About 1200 More than 3000
% of world market More than 60% About 79% About 5% About 70% About 85%
Top 5 companies Apple (12%)
Microsoft (9%)
Amazon (9%)
Alphabet (6%)
Facebook (4.5%)
Apple (7%)
Microsoft (5%)
Amazon (4%)
Alphabet (3%)
Facebook (2%)
Apple (4%)
Microsoft (3%)
Amazon (3%)
Alphabet (2%)
Facebook (1%)
Taiwan semiconductor (6%)
Tencent (6%)
Alibaba (6%)
Samsung (4%)
Meituan (2%)
Apple (7%)
Microsoft (5%)
Amazon (4%)
Alphabet (3%)
Facebook (2%)
Apple (4%)
Microsoft (3%)
Amazon (2%)
Alphabet (2%)
Facebook (1%)
Top 3 countries US (100%) US (100%) US (66%)
Japan (8%)
UK (4%)
China (40%)
Taiwan (13%)
South Korea (13%)
US (62%)
Japan (7%)
UK (4%)
US (57%)
Japan (7%)
China (5%)

Source: gofreedom.co.za

Three things struck me as I delved deeper into each index:

Examples of local ETFs that track the global equity indices mentioned above

Just a reminder of how the relationship between ETFs and indices work: An index provider like S&P or MSCI compile an index with all its underlying constituents, eg the MSCI World Index. An ETF provider like Satrix or Sygnia then pays that index provider to use their intellectual property and to track their indices through an investment fund called an exchange traded fund or ETF. That’s why often the names of the ETF provider and the index provider appear next to one another in the ETF name which you’re buying, eg the Satrix MSCI World ETF. Catering to South African investors, these ETF providers provide the returns of these global, mostly dollar-based indices in their rand equivalent, incorporating currency fluctuations between the rand and the dollar. Here are some examples of local ETFs that track the global equity indices mentioned above:

Nasdaq-100 S&P 500 MSCI World MSCI EM S&P Global 1200 MSCI ACWI
Satrix Nasdaq 100 Coreshares S&P 500 Satrix MSCI World Satrix MSCI Emerging Markets Ashburton 1200 None yet in the local retail space
Satrix S&P 500 Sygnia iTrix MSCI World Can replicate (roughly) by combining mostly Satrix MSCI World with some Satrix MSCI Emerging Markets
Sygnia iTrix S&P 500 1nvest MSCI World
1nvest S&P 500

It’s easy to make things worse when trying to diversify your ETF portfolio

What both the maps and the table comparing global equity indices brought home to me is how much these indices often overlap and how easy it is to make things worse when trying to diversify your ETF portfolio by adding another global equity index. Look for example what happens when you add the Satrix Nasdaq 100 to your Satrix MSCI World ETF. Instead of diversifying into the ‘not yet covered’ sections of our map, you’ll be making your portfolio even more concentrated in the dominant US and tech stock section.

MSCI ACWI

Example of the most pointless form of diversification

At least with the previous example, you were adding a different index. That’s better than the most pointless form of ‘diversification’: adding the exact same index, but supplied by a different ETF provider, for example adding the 1nvest MSCI World Index Feeder ETF to your Satrix MSCI World ETF. The only 'diversification' you're getting is having the exact same coverage provided by a different brand.

What does successful global equity ETF diversification look like?

What does successful global equity ETF diversification look like? Start with the global ETF you already have in your portfolio and ‘colour in’ the sections of our map which it covers. Then look for other global ETFs that don’t overlap the coloured-in area, or which only partly overlap. An example would be adding the Satrix MSCI Emerging Markets ETF to the Satrix MSCI World ETF. Thinking outside of the global equity universe, another way to diversify your global ETF portfolio would be to add a global property ETF to your global equity ETF. In other words, diversify away from the global equity asset class into the global listed property asset class.

MSCI ACWI

As soon as you’re comfortable with the key differences between the world’s main indices, you’ll be able to diversify your global ETF portfolio like a pro.




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