Our Insights

About personal finance, investments and markets.
March 9, 2015

The trouble with ETFs

Index funds (ETFs) are without a doubt an excellent core building block for investors due to their low costs and easy diversification. However, as so often, the devil is in the detail. There are several key issues when using ETFs that investors need to be aware of and which we will detail below. Just because it’s an index fund doesn’t mean it’s a good choice.

If you would like to know how to best use ETFs as part of your wealth management plan, please do not hesitate to get in touch. We are offering an ETF-based wealth management solution for 0.75% p.a. starting from a minimum amount of €100,000.

Misleading label

In some cases, the name of an index is giving investors a false impression of what it is under the hood. For example:

  • MSCI World. This is one of the most popular indices. Many believe that this index invests on a worldwide basis. Nothing could be further from the truth. It only invests in the large industrialized countries, but not the emerging markets such as China, India or Brazil which account for roughtly half of global GDP.
  • MSCI Pacific ex-Japan. Many investors we speak to assume this index includes countries around the Pacific basin. Wrong again. It includes only 4 countries with a very heavy weighting towards Australia (60%). One of the major robo-advisors even includes this index to manage the Asian exposure which it evidently doesn’t as it includes neither China nor Malaysia, Thailand, Philippines, etc.

Distorted weighting

Many indices include the right countries and sectors but probably not in the weighting that investors expect. For example:

  • MSCI All Country World Index (ACWI). This index includes 46 countries and nearly 2500 companies. The ideal index, as it includes pretty much everything needed in one product? Sadly, no. The weighting of each country does not reflect the economic size of each country. The GDP of the US is roughly the size of Europe or of China. However, in the MSCI ACWI, the US has a weighting of 52%, Europe of 20% and China only of 2% (as of 31.12.2014). Since the last market peak in the US in Oct 2007, the index weight of the US has increased by 10%. In other words, the index gives a bigger weighting to countries which have gone up in value and a lower value to countries that have gotten cheaper. Surely not the right way to invest as it means you are buying more of what has gotten expensive and less of what has gotten cheaper?
  • MSCI China. Everyone is probably familiar with the China bull story. 1.3bn consumers, rising middle class, etc… But what sector weighting do we find in the index? More than 40% is in risky financials, 10% in the volatile energy sector and less than 10% is in the consumer sector. Is that really what investors want?

Index too narrow

Most investors are familiar with the Dax or the Euro Stoxx 50. However, these indices include only a small number of companies (30 in the case of the DAX) which does not offer sufficient diversification. More companies is always better and as a rule of thumb, a good index should have at least 500 companies per region.

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