GDP weighted index ETF diversification.
Does a GDP weighted index diversify a market cap index?
The MSCI Gross Domestic Product (GDP) weighted indexes reflect the size of a country’s economy (rather than the size of its stock market) by using country weights based on GDP.
GDP (country) weights might be preferable to (or, at least diversify) market value / capitalization weights because GDP figures tend to be more stable compared to stock market performance. Further, GDP weighted asset allocation tends to have higher exposure to countries with above average economic growth (i.e. Emerging markets).
A comparison of the market cap weighted MSCI (All Country World Index) ACWI and its GDP-weighted equivalent shows that some of the fastest growing economies have market value weights that are smaller than their economic weights.
MSCIBarra.com GDP v Market cap weighted indexs, relative performance.
When GDP weighted index ETF products do make it to the retail marketplace, Individual investors ought to take a look. Investors should be aware that some of the current research indicates that country returns do not necessarily correlate to country growth … because higher growth countries tend to quickly become overvalued. High expectations mean higher valuations. So rather than choose between the two, the diversified Investor might ‘complement’ a traditional market cap weighted index ETF with a GDP weighted index. Why not own both?
Proposed GDP weighted index ETFs:
- PIMCo fixed income GDP linked index
- Bank of Montreal emerging markets Bond ETF (ZEF)
This time it’s different.
Doug Cronk, CFA is Manager, Investments for a Canadian Pension fund.