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2011 Are There Merits in a Market Capitalisation Weighted Equity and Fixed Income Index ?
1. Part of State Street’s Vision thought leadership series
SSgA CAPITALINSIGHTS THE EXCHANGE
by
Frédéric Jamet,
Head of Investments SSgA France
Are There Merits in a Market
Capitalisation-Weighted Equity and
Fixed Income Index?
Capital asset pricing model (CAPM) theory implies that an equity
portfolio weighted according to market capitalisation is an efficient
portfolio. Empirically, a global market capitalisation-weighted
equity index such as the MSCI All Country World Investible
Markets Index (ACWI IMI) is considered to be a comprehensive
benchmark that captures the broad global equity opportunity set.
We can apply the same CAPM theory rationale to a fixed income
portfolio that is weighted according to market capitalisation. In
this sense, the Barclays Global Aggregate Bond Index provides a
robust simulation of the universe of global bonds in the market.
Considering the above, would an index that employed both
the global equity and global fixed income indices provide a
useful proxy for an efficient global market portfolio? This paper
considers the possibilities.
Components of the Global Market Portfolio
The CAPM theory of Markovitz and Sharpe1
introduces us to the
concept of an efficient market portfolio, subject to the following
conditions:
• Investments are limited to a universe of publicly-traded assets
• Investors pay no tax nor do they incur transaction costs
• Investors are mean-variance optimisers, that is they seek to
maximise return for given levels of volatility
• All investors analyse securities in the same way, predicting the
same distribution of returns
Under these optimum conditions, all investors should hold the
same market portfolio—that is, all publicly-listed assets weighted
according to their market capitalisation.
Equity Constituents
The MSCI ACWI IMI is a comprehensive equity benchmark of
more than 9000 securities—covering approximately 99% of
the world’s listed equities. This includes small-capitalisation
equities which make up around 15% of the total, and emerging
market equities which make up around 14%. The weightings are
calculated according to the market capitalisation of the index
constituents, with a floating adjustment.
This index can be considered a good proxy for a global equity
market portfolio.
Fixed Income Constituents
The Barclays Global Aggregate Bond Index is an extensive index
of more than 13,000 fixed income securities—accounting for the
majority of globally-traded investment grade bonds, including
government bonds, government agency bonds, mortgage-
backed and corporate bonds—all weighted according to market
capitalisation.
This index can be considered a good proxy for a global fixed
income market portfolio.
1
Markowitz, Harry M., Portfolio Selection, second edition, Blackwell (1991).
Figure 1: Breakdown of the MSCI ACWI IMI
Market Capitalisation ($ millions) 27,818,106
Number of Securities 9,026
Dividend Yield 2.97
Price/Earnings 11.3
Price/Earnings using Fiscal Year 1 Estimates 10.7
Price/Cash Flow 12.2
Price/Book 4.7
Price/Sales 7.7
Source: MSCI, as of 30 September 2011.
2. SSSSSSggAA CACAPIPITATALL ININSISIGHGHTSSTS ||| THE EXCHANGE
2
Combining Both – The Global Market Portfolio
A global market portfolio could, therefore, be created from a
merger of the MSCI ACWI IMI and Barclays Global Aggregate
Bond indices. The weighting methodology would be determined
by the market capitalisation of the equity and fixed income
components in both markets, and would evolve according to
changes in market capitalisation. The ratio of each would be
driven not only by performance in each asset class, but also by
the amount of equity and fixed income issued in the markets.
Since the ratio would be dynamic, the global market portfolio is
not quite a pure buy-and-hold portfolio.
The advantages of such a global market portfolio are comparable
to the advantages of a global equity or fixed income market
portfolio:
• It is an optimal portfolio in the context of Markowitz and
Sharpe. The portfolio can be considered to be a synthesis of
the views and constraints of global equity and bond investors
• It is diversified and therefore low risk
• It is liquid with low costs, and turnover is mainly limited to
accommodating new bond and equity issuance, and coupons
and dividends reinvestment
Conversely, it is also clear that such a portfolio contains some
inherent drawbacks:
• The sheer size of the portfolio means that it would not be easy
to practically implement
• According to the CAPM, the risk-free asset for such a portfolio
is a complex mix of international currencies
• It is not easy to define the average investor who would seek this
exact asset allocation between equity and fixed income.
It is important to consider that the market value of the MSCI
ACWI IMI index and the Barclays Global Aggregate Bond index is
driven not only by performance but also by new bond and share
issuance, dividends and coupons. At the end of each month
the investor would need to fund new additions by buying/selling
bonds/equities.
Many investors use either a fixed weight for allocating between
equity and fixed income or a dynamic approach in accordance
with liability-driven objectives. A typical weighting scheme for a
US portfolio is around 60% equity and 40% fixed income; for a
European portfolio it is around 30% equity and 70% fixed income.2
These allocations evolve according to market performance and
the portfolio weights are readjusted on a regular basis.
Performance and breakdowns
The upward direction of the market value of the Barclays
Global Aggregate Index since 2007 is readily apparent. Figure
3 demonstrates a continuous and positive expansion from
$17 billion to $40 billion between January 2003 and September
2011—driven by growth in bond issuance and falling interest
rates. On the equity side of the equation, the evolution of market
value of the ACWI IMI has been much more volatile, including
a substantial drop between 2008–2009. It is worth noting that
the rebound in equities in March 2009 has increased the equity
percentage by only a moderate figure—from 38% in February
2009 to 46% in December 2010—because of the vigorous
growth of the Barclays Global Aggregate Index during the
same period.
As a result of these movements, between 2003 and 2008 the
major proportion of the global market’s combined equity and
fixed income capitalisation was occupied by equities—with
equities accounting for between 50–60%. From 2009, following
the fall in value of the ACWI IMI, equities decline in proportion,
and fixed income occupies a greater proportion of the total
market capitalisation. Interestingly, the average equity weight
over the period is 51%, with a maximum at 61% and a minimum
at 38%, reached in February 2009.
Figure 3: Global Market Portfolio: Breakdown Equity—Fixed Income
— MSCI ACWI IMI — Barcap Global Aggregate — Global Market Portfolio
Trillions %
10
20
0
30
40
50
15
30
0
45
60
75
January
2003
March
2005
May
2007
July
2009
September
2011
Source: MSCI, as of 30 September 2011, Barclays Capital, as of 30 September 2011.
Figure 2: Breakdown of the Barclays Global Aggregate Bond Index
Market Capitalisation ($ Millions) 40,343,574
Number of Securities 13,583
Yield (%) 2.41
Coupon (%) 3.63
Duration (years) 5.9
Maturity (years) 7.67
Source: Barclays Capital, as of 30 September 2011.
2
Barclays Capital, as of 30 September 2011.