When investors describe the success of the US market over the past 12 months, they often refer to one fact: the S&P 500 gained 23%.
But in that same time period, the MSCI USA index and the FTSE USA, both also measuring the US market, were both up 25.1%, respectively. And while single-digit percentage differences feel minimal, they can have a significant impact on returns and on the managers who are benchmarking their funds against these indices.
How does a group of indices measuring the same market end up with a variety of values? The answer is by looking at different companies. Unsurprisingly, the S&P 500 holds around 500 positions, but other popular indices have slightly differing qualifications. The FTSE USA is made up of 544 constituents and the MSCI USA includes 589, each based on varying criteria.
The variance increases depending on the market. In 2024, the MSCI Emerging Markets index returned 7.5%, while the FTSE Emerging index ended the year up 12.8%. The indices are constructed using a different list of countries, with the FTSE including Iceland and Romania, while the MSCI opts for Korea, Peru and Poland.
They diverge even further when it comes to the number of stocks, with the FTSE holding 2,231 compared with the MSCI’s 1,251.
Alex Funk, chief investment officer at PortfolioMetrix, says: “Even if you look at MSCI Emerging Markets versus FTSE Emerging Markets, the construct is quite different. Certain countries are included, others are excluded. You need to be aware what your universe looks like depending on what benchmark you ultimately select.
“These are businesses that have optimised based on a certain view of the world. If you take a view different to that, just be aware of it. I’m not saying one is right and one is wrong, but be cognisant. If you’re buying a tracker that tracks against an MSCI index versus a FTSE index, you’re going to have different companies and different countries in there. Understand that as part of your portfolio construction.”
Wei Dai, head of investment research at Dimensional Fund Advisors, says these differences occur because each index company has a slightly different set of criteria and process when it comes to what stocks to include in the funds.
“Some of the indices, like Russell, follow the pathology to a tee. But then there are also indices like the S&P family, with the S&P 500 being the darling these days. They have a regular reconstitution event, but then they also have an index committee that makes a lot of those calls when the stocks get added. A lot of those decisions are not unlike what traditional active managers are doing,” Dai says.
To read the rest of the article, visit the February edition of Portfolio Adviser Magazine