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Beating the index is tough, but investors can do it

The MSCI World Index tracks the performance of large and mid-cap sized companies across 23 of the world’s developed markets. Investors can still beat the index, but this remains a challenge.

The MSCI World Index tracks the performance of large and mid-cap sized companies across 23 of the world’s developed markets. Investors can still beat the index, but this remains a challenge.

by
Charles Stanley

in Features

04.08.2021

MSCI’s World Index delivered stellar returns in the ten years following the financial crash of 2008. If you had bought and held the index for the decade, your returns would have averaged 10.6% a year. There were only two down years, 2011 and 2018, when losses were less than 10%. If you had opted for the All World Index, which includes shares from emerging markets such as China and Brazil, your return would have been lower, but still an impressive 9.9% a year.

The World Index itself ran with its increasingly profitable positions in the US, so today the American market makes up a staggering 67% of the total index. Its top four companies by market value are the four US technology majors – Apple, Microsoft, Amazon and Alphabet – all of which now have market capitalisations of more than $1 trillion. Together, they represent 12.9% of the composition of the World Index. 

By contrast, the three largest non-US markets are Japan, which represents just 6. 7% of the World Index total, the UK (4.2%) and France (3.4%). The once-mighty energy sector, which includes oil and gas, is now just 3% of the index and real estate is 2.7%.  The technology sector has a 22% weighting and consumer discretionary, which includes some suppliers of digital goods and services, represents 12% of the total. This is a sign of the times, demonstrating clearly how online has come to dominate many features of our lives, including investing.

Last year, the dominance of digital technology was always likely to accelerate, as the Covid-19 lockdowns forced many more people to “go digital” – buying more smartphones, tablets and laptops. They also used services to enjoy remote entertainment, social media, and social gatherings with social distancing – with this trend also boosted by a surge in home working and home education on the internet.

This year, it seemed possible that recovery sectors and geographical areas would fare better, yet it has still proved difficult to beat the World Index by investing in these areas. In the first six months of 2021, the European blue-chip Euro Stoxx 50 is up by about the same amount as MSCI’s World index with a double -digit gain, whilst Japan at 2.5% and China at 0.6% have disappointed – despite their industrial base and opportunity to recover.

It is not easy for an individual equity investor to beat an index. It takes research, skill and good judgement about market moods and trends. Most indices have three great advantages. The first is the index does not incur any charges buying and selling and holding a portfolio, whereas an investor does. The share buyer needs their result to be better than the index, merely to cover the extra costs.

Most indices only include the larger companies, or a representative sample of some of the smaller companies available. This means they are ruthless at cutting out underperforming shares. When a company drops below the minimum capitalisation required to be included in the index, it is removed. An investor might hold on, so in the many cases where the falling share price heralds a longer period of bad performance or even bankruptcy, the index wins.

The index also runs its successes. As a company’s share price rises, the index does not take profits on the way up. Quite often, market or index performance rests heavily on a limited list of very successful companies, so keeping good exposure to them is crucial to performing.

However, these strengths for index compilers can also be used as weaknesses for a good professional active manager to exploit when they are trying to outperform a benchmark. They may be right to take some profits before a success story tumbles or may be correct to pick up equity in a near-bankrupt company just before it turns itself round and starts generating good cashflow and profits. Professional funds do this regularly, beating the index by taking more concentrated bets on shares and sectors they are confident will do better than the wider market, backed by research to get more of those bets right than wrong.

The World Index reflects market feelings and views. In recent years, its compilers have been tough on traditional areas such as energy, real estate and some financials – and well disposed to shares in companies exposed to the digital revolution. This has led to a big rise for US values against the rest of the world with no other country above 7% of the World Index total. It is remarkable than four US companies are now worth more than the combined values of the world’s second and third largest stock exchanges, namely Japan and the UK. 

Whilst the older sectors are benefitting from the recovery from the pandemic, they are also having to tackle the problems of the green transition. Action required by governments will hit profits and require heavy capital spending. Good active managers can ring the changes as moods in the market swings or they can find long-term value companies that provide an edge. Nevertheless, the World Index still takes some beating. In its current shape it reminds us that this has been a remarkable ten years for shares. It also underlines that much of the gain has come from the US giants of the digital revolution.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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