How Global Equity Indices are constructed
The make-up of the global equity markets based on MSCI rules
Clients often ask us about the make-up of the global equity markets—questions about size, the definition of developed and emerging markets, and changes to equity market composition over time.
There are a number of providers of global equity indices. Each has different index construction rules although there are many similarities. For simplicity, in this article we review the composition of the global equity indices based on MSCI’s rules. MSCI’s global equity indices are among the most popular benchmarks for non-U.S. and global equity portfolios.
MSCI divides the global equity markets into three categories: developed markets, emerging markets and frontier markets. Institutional investors invest in developed and emerging markets, but rarely invest in frontier markets because of size, concentration, and liquidity constraints (see Figure A).
A comparison of the various indices’ key characteristics as of May 2015 is shown in Figure B. Of note are the differences in size and number of securities. The emerging markets index, however, has grown considerably in terms of market capitalization, number of countries, and improved diversification.
MSCI employs a series of rules to create these indices. The rules are described in the Appendix. Composition of the global equity indices changes is based on: the index creators’ decisions to add or remove countries and companies; market value changes of the individual stocks making up the index; and corporate events such as mergers, acquisitions and bankruptcies.
In total, the global equity markets had a market capitalization of $44.5 trillion at May 31, 2015 based on the MSCI IMI indices, which includes the developed foreign markets plus the U.S. and Canada. As the Figure C illustrates, the U.S. allocation of the global equity markets has increased from 43% in 2007 to 53% at the end of 2014, largely as a result of the much stronger performance of U.S. stocks during this period. The allocations to emerging markets and Canada remained relatively steady, while the allocation to developed foreign markets (EAFE) declined by about 10 percentage points. The frontier markets represent less than 0.5% of the global equity markets.
Annually, MSCI assesses those markets it has placed under review for potential reclassification. MSCI considers markets for reclassification only if the classification status can be viewed as irreversible. Changes to classifications over the past several years are included in Figure D.
MSCI will include the MSCI Pakistan Index in its 2016 annual Market Classification Review for a potential reclassification to emerging markets. On June 9, 2015, MSCI Inc. announced that it expects to include China A-shares in its global benchmarks after a few important remaining issues related to market accessibility have been resolved. On June 19, 2015, MSCI Inc. announced that the introduction of any restrictive measures, which may result in a material deterioration of the accessibility of the Greek equity market, may lead to the reclassification of the MSCI Greece Index to Standalone Market status from Emerging Markets status.
* As of the close of the last business day of the month.
** Trinidad and Tobago was added to the MSCI Frontier Markets Index in May 2009
*** Pakistan was removed from the MSCI Emerging Market Index in December 2008 and maintained as a standalone country index
**** Sri Lanka was removed from the MSCI Emerging Market Index in June 2001 and maintained as a standalone country index
***** Index was discontinued on January 2, 2008