Article: What lies beneath

Understanding the index that underpins your chosen exchange-traded fund (ETF) is of paramount importance. The vast majority of ETFs available to UK investors track either a benchmark from MSCI, one of the world’s leading indices providers, or one provided by FTSE, STOXX or S&P. It is very important that you understand what is in the index and how that index works, since its performance will drive returns from the ETF.

Buy an ETF that tracks the MSCI ACWI (All-Country World Index), an index tracking stocks from 23 developed and 23 emerging markets countries, boasting 2,476 constituents and covering roughly 85% of the global investable equity universe, and you’d own a diversified portfolio at a stroke. This global index consists of the MSCI World, a global index for developed countries, and the MSCI Emerging Markets, a global index for emerging markets countries. Yet the share of emerging markets in the ACWI is actually modest in comparison to developed markets. The top 10 is dominated by US giants including Apple (AAPL:NDQ), Microsoft (MSFT:NDQ) and General Electric (GE:NYSE).

It is important to note the MSCI World Index covers the developed world’s stocks from countries including the US, UK, Germany and Australia, yet excludes Brazil, China and India. Investors seeking exposure to emerging markets would be better to use the MSCI’s smaller indices.

Also bear in mind that an ETF doesn’t have to hold exactly the same stocks as its index – where an index features a huge number of stocks, this would be too complicated and expensive. Indices like the MSCI ACWI IMI are usually replicated by sampling, which means the provider selects the most important and liquid stocks in the index.

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iShares Core MSCI World UCITS ETF (SWDA)

iShares Core MSCI World UCITS ETF (SWDA) mirrors the performance of the MSCI World Index through physical replication of the MSCI World Index, a broad global equity benchmark representing around 89% of the MSCI ACWI Index. It represents the performance of large and mid cap shares across 23 developed market countries, covering roughly 85% of the free float-adjusted market cap in each nation, though it does not offer any emerging markets exposure. The US speaks for 59.06% of the portfolio, so investors are buying material exposure to American corporate heavyweights, such as Apple, and energy giant Exxon Mobil (XOM:NYSE). The ETF has a 0.2% ongoing charges figure.

ETFS-E Fund MSCI CHINA A GO UCITS ETF (cash)

This ETF is designed to provide exposure to China’s ‘A-share’ equity markets by tracking the performance of the MSCI China A Index, which captures large and mid cap representation across A-Share listings on the Shanghai and Shenzhen exchanges. With a total expense ratio (TER) of 0.88%, this ETF aims to replicate the performance by physically investing in A-shares, while its chosen index offers diversified exposure to more than 800 large and mid cap stocks, giving an opportunity to benefit from the growth potential of China’s small and medium-sized firms. Furthermore, the MSCI China A Index has a lower concentration of exposure to financials and large cap state-owned enterprises than other major China A-share indices and a higher exposure to the consumer, industrial and health care sectors. Leading index constituents include the likes of Ping An Insurance (601318:SHA), its highest weighting stock, as well as China Merchants Bank (600036:SHA).

Db x-trackers MSCI EM Eastern Europe Index UCITS ETF (XMEE)

A play on the potential of Eastern Europe, Db x-trackers MSCI EM Eastern Europe Index UCITS ETF (XMEE), with a low all-in-fee of 0.65%, seeks to indirectly replicate the performance of the MSCI EM Eastern Europe Index. Reflecting the impact of geopolitical uncertainties and the weak oil price on Russia, this index trades on a single-digit PE ratio of 8.5 and 4.68% dividend yield that might interest value and income seekers alike. Investors are purchasing exposure to an index with only 49 constituents spanning the Russian Federation, Poland, Hungary and the Czech Republic and with heavy weightings towards the energy and financials sectors through Rosneft (ROSN: MCX) and VTB Bank (VTBR: MCX).