How Global Are Global ETFs?

by on April 20, 2010 | ETFs Mentioned:

When mutual funds broke on to the investing scene, they won praise for their ability to pool assets and efficiently deliver exposure to a large basket of underlying securities. ETFs, while different from mutual funds in many ways (see five of them here), generally share this appeal; they offer an even more cost efficient way to access a pool of assets through the purchase of a single security. Besides the obvious cost benefits of an all ETF-portfolio, the idea of monitoring only a handful of holdings is a welcome and simplifying development for many investors. 

So the thought of constructing a well-diversified portfolio with only a handful securities isn’t as ludicrous as it may sound, and is in fact put into practice by all types of investors. ETFdb Pro members can access our line of all-ETF model portfolios, all of which maintain between seven and 12 ETFs (if you’re not a Pro member yet, sign up for a free trial or read more here).

All cap domestic equity ETFs have become popular as a means of accessing the broad U.S. market. But some investors take simplicity in portfolio construction one step further, achieving the entirety of their equity exposure through a single ETF that tracks the performance of global equity markets. In total, there are 17 ETFs in the Global Equities ETFdb Category, with aggregate assets of more than $10 billion. Two of the largest are the iShares MSCI ACWI Index Fund (ACWI) and Vanguard Total World Stock Index (VT), both of which offer exposure to both emerging and developed markets around the world.

Global ETFs
Country/Region % GDP* % ACWI % VT
U.S. 20% 42% 42%
China 13% 2% 2%
Japan 6% 9% 9%
India 5% 1% 1%
Germany 4% 3% 3%
U.K. 3% 9% 8%
Russia 3% 1% 1%
France 3% 4% 5%
Brazil 3% 2% 2%
Italy 3% 1% 1%
Other 38%
26% 25%
*2009 nominal GDP from CIA World Factbook

For investors looking to keep their portfolios simple, these ETFs offer a way to access the global economy through a single security. In general, the larger economies receive larger allocations in global equity ETFs. But a closer look at the composition of these funds shows that they’re not as reflective of the global economy as some investors might imagine. A comparison of the country weightings against the percentage of global GDP generated by that economy shows some relatively large gaps and pretty consistent trend.

Both ACWI and VT give a handful of countries significantly larger weightings than they would receive on a strict GDP-based weighting system (which admittedly isn’t practical for a number of reasons). The largest overweighting is the U.S., which accounts for more than twice as much of ACWI and VT as it does of global GDP. The UK and Japan also receive significantly more weight in global ETFs than they would from a strict GDP-based allocation.

On the other side of the coin, China’s weighting in global ETFs is extremely light compared to its contributions to the world economy, as are those of Brazil, India, and Russia. So there’s clearly a trend emerging here: developed markets are generally overweighted while emerging economies are generally underweighted. In aggregate, the BRIC bloc accounts for about a quarter of global GDP, but just about 5% of global ETFs.

Emerging Market ETFs

That isn’t to say these funds are flawed. ACWI and VT track their underlying indexes with impressive efficiency, and offer exposure to a well-diversified basket of securities at bargain basement rates (ACWI charges 0.35% while VT charges 0.30%). But if you’re using one of these ETFs as a “one stop shop” for equity exposure, be aware that you’re getting a heavy helping of advanced economy exposure with just a side of emerging markets.

The simplest way to fix this imbalance is to complement global equity ETFs with an allocation to an emerging markets ETF. U.S. investors have dozens of options for accessing emerging markets through ETFs (see all the ETFs in the Emerging Markets ETFdb Category). Three interesting options include:

  • iShares MSCI Emerging Markets Index Fund (EEM): The most popular emerging markets ETF, EEM offers exposure to more than 600 securities in nearly two dozen different countries. With an average daily volume of nearly 70 million shares, EEM is one of the most liquid ETFs available to U.S. investors.
  • Dow Jones Emerging Markets Composite Titans Index Fund (EEG): This ETF is unique from other emerging markets ETFs because of the methodology behind the underlying index. EEG doesn’t maintain any exposure to Taiwan, South Korea, or Israel, three economies afforded significant weight in many other emerging markets ETF. Although some index providers classify these economies as developed, they are in many ways developed markets (see some of the figures here)
  • SPDR S&P BRIC 40 (BIK): This ETF tracks the S&P BRIC 40 Index, a benchmark that includes stocks listed in four of the largest emerging markets: Brazil, Russia, India, and China. Unlike some other emerging markets and BRIC ETFs, BIK makes a significant allocation to Russia–about 22% of assets. India is given the smallest weighting of the four economies, coming in at just under 8%.

Disclosure: No positions at time of writing.