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How global is your global index fund?  How much of the world are you actually investing in when you buy a global index fund?

After digging into what goes into an index fund as part of writing our guide to ESG indexes article, we were inspired to find out how much of the world the Vanguard “global” fund actually covers.

​A global index fund makes it easy for you to invest your money around the world (huge diversification) and partake in the global economy.

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These funds have huge promise and we wanted to dig in to find out what you are actually buying when you purchase a global index fund.

Firstly there is some assumed knowledge in this article so if you don’t know anything about index funds start by reading the index investing series of articles before getting stuck into this article!

​Secondly you don’t need to know ANY of this to start investing.  You could just pick the Vanguard Global All Cap Index Fund and Just Start Investing.  

Let’s get into this!  Vanguard doesn’t just go away and decide in isolation which companies and countries to include in their index funds. They get this information from benchmark index providers. The two big players are FTSE (Financial Times Stock Exchange) and MSCI (Morgan Stanley Capital International).

FTSE and MSCI split the different countries in the world into different categories; developed, emerging and frontier.  Then MSCI confuses things further by adding another category; standalone.

Before we could really understand “how global is your global index fund” we had to work out how each country ends up in the index.  We went back to the data and the benchmarks to find out!

​You know how much Katie and I love data and Katie has been at it again making charts to bring financial data to life!  She created this interactive map that shows FTSE’s country classification.  Blue is developed, orange is emerging, yellow is frontier.

First thing you probably noticed is that there’s lots of countries that aren’t coloured in. There’s only 25 developed countries, 24 emerging countries and 30 frontier countries, totalling 79 countries.

FTSE and MSCI classify countries differently because they have different criteria for the different classifications.

​​How countries are classified

MSCI decides on country classification based on 3 criteria according to the MSCI website:

  • Economic development: Considers the sustainability of economic development and is only used in determining the classification of developed markets, given the wide range of development levels within emerging and frontier markets
  • Size and liquidity requirements: Determines those securities that meet the minimum investability requirements of the MSCI Global Standard Indexes
  • Market accessibility criteria: Aims to reflect international institutional investors’ experiences of investing in a given market and includes five criteria: openness to foreign ownership, ease of capital inflows / outflows, efficiency of operational framework, availability of investment instruments and stability of the institutional framework

Does that make it any clearer?  I feel like we need a whole new article just to explain the terms in those sentences.  

FTSE decides on country classification based on the following criteria according to this detailed paper that you can read if that sort of thing floats your boat:

  • How wealthy the country is (by looking at the average income per person)
  • The quality of regulation and how dealing in stocks and shares works in the country
  • A country needs to be big enough to be included
  • Any countries that are being considered for promotion or demotion between categories are added to a “Watch List” of countries and the criteria for changing them is published to keep the classification consistent and predictable
  • The cost of changing a country’s classification is considered
  • New countries are introduced in a phased approach. A new country would only join as an emerging market and promotion would only happen if the country has been globally accepted and the changes that have been made are permanent
  • International investors should be able to invest and withdraw funds easily and at a reasonable cost. ​

So there you have it!   That is how the benchmark providers decide which country makes it into the list or not.  Alan’s simple version of this is; does the country have a big enough economy and companies to invest in? How easy is it to invest and move my money in and out and how trustworthy is the economy?

Countries by classification

The map below shows how the different countries are classified by FTSE and MSCI as to whether they are Developed or Emerging. Read on below for an explanation of the map
  • ​Blue countries are Developed according to both FTSE and MSCI.
  • Orange countries are Emerging according to both FTSE and MSCI.
  • Red countries show where FTSE and MSCI have different classifications. For example, Poland and South Korea are both Developed according to FTSE but Emerging according to MSCI. You can hover over the red countries to see the different classifications. There are only 6 countries where there are differences. Poland, South Korea, Peru, Romania, Pakistan and Luxembourg (which FTSE groups in with Belgium as Developing and MSCI does not classify).

The plot thickens further, the funds available through Vanguard UK only cover developed and emerging countries. Global includes developed and emerging countries so the Vanguard global fund only covers 49 out of the 200 countries that exist in the world (Oh and by the way, the split between the developed countries account for 89% of the global index by weighting of company.)

I know what you’re thinking! What’s going on Vanguard, I thought this was a global fund meaning I’m investing in the whole world! Am I missing out because I’m not investing in the other 150 countries in the world??

The short answer: Not really.

The Longer answer: When we explain global index investing, Alan and I usually describe it as investing in all the economies in the world in proportion to how much that country contributes to the world economy. But we’ve been misleading you slightly! It’s not quite true. We’re actually investing in the different stock markets in the world in proportion to the size of the stock market in that economy. A lot of countries don’t have stock markets you can easily invest in.

Assuming that a country’s GDP (Gross domestic product which is the total products and services produced within a countries borders) is a good proxy for how much it should contribute to our index fund, let’s see how much of the world economy we’re missing out on by not investing in those 150 countries.

The following two charts show how little those 150 countries contribute to the world economy. The chart on the left shows each country represented by the same size of bubble. At the centre of the chart you can see the 25 developed countries in blue and the 24 emerging countries in orange. You can’t invest in the 30 frontier countries in yellow or the 118 non-classified grey bubbles through Vanguard UK and it looks like we’re missing out on A LOT!

But then if you change the size of each country’s bubble to reflect the size of its economy you can see that the grey and yellow bubbles are very small in comparison to the orange and blue bubbles.

This chart below that Katie created is interaction.  It works best on a big screen and hover over each of the bubles and you will be able to see more information!

In fact, the developed and emerging countries account for 93% of the world economy. The 30 frontier countries account for 3% of the world economy and the remaining 118 countries (over HALF of the world’s countries) only contribute 4% to the world economy. So from an investing standpoint you’re not missing out on a lot by only investing in 49 countries through the “global” fund

This is very similar to how your money is invested in companies as the biggest companies make up most of the index.  This is one of the best features about index funds is you don’t have to decide how much of your money to invest in a certain country or company.  The index has already worked that out for you.

They uncover all this data about the size of economies and use it to intelligently decide what percentage of the global economy is represented in the index. I love that fact that someone has already worked all this out for me and I can just pick which index I want to invest in and get on with going to the gym so I can eat more almond croisants.

Conclusion

The “global” fund only has 49 of the world’s 198 countries in it. But that doesn’t really matter since these countries account for 93% of the world economy. By number of countries the global fund is not very global; by weighting (size of the economy) the global fund is very global.  So just crack on with investing baby!

Katie and I are super happy with our money being invested in 93% of the global economy by weighting.  Talk about diversification!

As always we would LOVE to know what you think about the article.  We write these articles to help us understand the stock market and investing and to help you feel comfortable investing too. Please write a comment below or like the post to show us that we are on the right lines or not!  It means a huge amount to us!

The curse of the creator is that you put content out into the world and don’t hear from people whether it is actually helping or not!

Have fun and keep going on that journey to financial independence!

You rock

​Alan and Katie

Disclaimer: This is not financial advice.  Katie and I are not trained financial advisors, nor to we pretend to be one online.  Read our full disclaimer here

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