Broad Global Equity Allocation Solution

Overview

According to MSCI, the global equity opportunity set is becoming the benchmark or starting point for asset allocation among institutional investors. This model is based on the MSCI AWCI index of 23 developed and 23 emerging country indices, cap weighted. It represents in excess of 85% of the global equity opportunity set. 

For US investors, it is common to think about global equity exposure in terms of the US market, the ex-US developed markets and emerging markets (US, EAFE and EM indices respectively). 

We have developed a solution which has been able to differentiate performance between these sub-indices of the MSCI AWCI over a one year horizon. The model ranks these sub-indices based on a combination of macroeconomic factors and adjusts their component weights by up to 15% from their benchmark weights depending on their ranking score. The revised combined component index would have outperformed the benchmark MSCI AWCI by an average of 2% per year over a 20 year back test with a respectable tracking error.

The Big Picture

It is insightful to look at how the global landscape has evolved over the past 25 years. The graphic below plots each category’s market capitalization as a percent of the global market capitalization from 1988 to 2012.

First, note the large decline from 1988-1998 for the ex-US developed markets, most of which was captured by the United States. The main reason for the decline of the ex-US developed markets was the deflation of the bubble in Japanese equities that occurred in the late 1980’s as shown in the next chart. Excluding Japan, the ex-US developed markets share has been fairly constant at around 30%.

Second, the big story was the growth of Emerging Markets, starting in 2004 primarily at the expense of the US. China was a big contributor from 2005-2009 as shown in the next chart.

Third, the Frontier markets have shown some growth but are still less than 5% of the global market cap. Given its small size and lack of good data going back 20 years, we do not focus on Frontier markets in this model.

Lastly, since 2006 we have seen all components maintain a relatively stable market share, with emerging markets holding on to their gains from last decade.

The Opportunity Set

Our goal at this level of allocation is not to “hit the ball out of the park” but tilt the allocations slightly in our favor without veering too far from the benchmark allocations, with the idea that it has a multiplier effect on returns downstream. While the opportunity set has declined in the past 10 years due to a stabilization of market shares, there is still value to getting these allocations correct, and if history is any indication, we will likely see more dramatic changes to the stable market share landscape of the past decade.

Aggregating country level data

In our developed and emerging countries models, we identified a number of macroeconomic variables that were related to country performance. This model uses those same variables that were common to both models and aggregates the data from the country level to obtain an outlook for each region/sub-index. The model ranks and weights the aggregated country data for each sub-index. There is a positive correlation between our model rankings and country performance rankings.

Implementation Solutions

This model is primarily used as an asset allocation tool for our downstream models as opposed to a standalone product, however for more passive index type investors it can be used on a standalone basis, implemented using three ETF’s.

Broad Global Equity Allocation Solution #1