“The superfluous fixation on MSCI World ETFs”

Investors are fixated on single-product solutions - ETFs on the MSCI World are particularly popular with many. But they're also taking the same line with “substitute MSCI World ETFs”. The hunt for the super ETF is becoming absurd, says Ali Masarwah, analyst and managing director of the financial services provider envestor.
 

26 August 2024. FRANKFURT (envestor). Let me start with the confession of a perplexed man: I will never understand why investors believe that a single product is the perfect solution for an entire, hopefully very long investment life. This fixation is particularly evident with ETFs on the MSCI World. Index funds that track this global equity index have become the stars of the show over the past ten years. I have overheard acquaintances ask me “Do you also have an MSCI World ETF?” instead of “Do you invest?”. Sometimes I get the impression that MSCI World ETFs have become a generic term for investing - like “Tempo” for handkerchiefs or “Uhu” as a synonym for glue or “Nutella” as a generic term for chocolate cream.

In a way, this is understandable. The rise of MSCI World ETFs came at a time when neobanks were offering investors low-cost custody accounts and savings plans. Since 2009, the MSCI World Index has also had a fantastic run. Because the index brings the world's most liquid and largest companies under one roof, it has perfectly captured the “American Tech Decade” of Apple, Google, Microsoft, Amazon and co. Because the US stock market is the largest in the world, it was already the largest block in MSCI World ETFs 15 years ago. And because the major US tech platforms have had a huge run since then, MSCI World ETFs have fully “participated” in this bull market.

And because the other characteristics of the MSCI World also provided perfect catch phrases (1,600 stocks under one roof, stocks from 23 industrialized countries combined, etc.), investors not only found ETFs with an outstanding performance record from 2014 onwards, but also had supposedly good arguments that MSCI World ETFs would continue to be a perfect investment target in the future. The “slipper portfolios” of Stiftung Warentest or the constant odes to MSCI World ETFs by the consumer platform Finanztip bear witness to the hype surrounding the MSCI World.

However, the seemingly unstoppable boom in US mega-techs has had consequences: The US now accounts for over 70 percent of the weight of MSCI World ETFs. Europe and Japan play a minor role in the ETFs, emerging markets and small companies are not represented. At 25 percent, tech stocks are the largest block. Even though MSCI World ETFs contain 1,600 individual stocks and invest in 23 countries, good diversification looks different.

Is the fixation of investors good, harmless, unhealthy or even harmful? Opinions differ widely on this. Critics - mostly fund managers who actively manage funds - like to invoke the example of Japan. In 1990, Japanese equities accounted for around 40 percent of the weighting in the MSCI World. The subsequent crash in Japanese equities put massive pressure on the MSCI World. A crash in US tech stocks would have similar consequences. The year 2022, when US tech giants hit hard, shows that this is not a breezy scenario. As share prices shot up again in 2023 and 2024, most of those affected are likely to have forgotten this. However, crashes can last 2, 3 years or longer. By then, a notch in the portfolio would have become a hollow.

But even those who see no problem with the high US weighting should know that the fixation on MSCI World ETFs is superfluous and entails unnecessary risks. (Whether these become manifest is another question). The fixation on one-product solutions is superfluous because a wonderful democratization of investing has taken place in recent years. Inexpensive fund platforms and neobrokers now offer custody accounts at zero cost, orders cost either nothing (savings plans) or one euro (one-off investments). In addition, the ETF market is so competitive that investors can buy ETFs at rock-bottom prices. It is therefore simply unnecessary to put all your eggs in one basket. So how should investors proceed? Some ideas:

- The obvious solution would be to invest in enhanced MSCI World ETFs. The MSCI ACWI or FTSE All World, for example, also include emerging markets, which are missing from the repertoire of MSCI World ETFs. However, this solution is only recommended to a limited extent. The MSCI ACWI only invests in homeopathic doses in emerging markets. Here too, the USA accounts for around 65 percent of the weighting. Instead, investors in the “ACWI” buy Chinese state-owned companies, which play an important role in emerging market indices.

- Investing in “substitute MSCI World ETFs” is definitely a bad solution. In recent years, resourceful providers have repeatedly launched one-product solutions on the market in order to profit from the MSCI World hype. At first glance, such ETFs may address some of the MSCI World's weighting problems, but they have other shortcomings and generally cost more than twice as much as low-cost MSCI World ETFs. Comfortable investors should stick with their MSCI World or MSCI ACWI ETFs for total convenience. 

- A good solution is to rely on low-cost robo-advisors. They combine several ETFs under one roof. A little research is required here, as it is important not to get expensive active management through the back door. Robo-advisors address the fundamental shortcoming of the MSCI World: they bring the diversity of the ETF world into play. There are over 1,000 ETFs traded on German exchanges. It's a good idea to have more than just one type of ETF working for investors!

- DIY investors who build their own portfolio only need paper, pencil and 10 minutes to put together a portfolio of 4, 5 or 6 building blocks. The beauty of ETFs is that they are transparent and granular building blocks. So if you mix ETFs for different markets, you can be sure that there will be no overlaps in your portfolio. What would happen if an investor decided to allocate five free savings plans to five ETFs instead of one? They could combine US equities, European equities, Japanese equities, emerging market equities and global small caps in individually defined weightings. If, after a savings period of 3 or 5 years, an imbalance has developed in one or other ETF, this could be quickly relativized by simply adjusting the savings plan contributions (savings plans on winners are reduced, savings plans on losers are increased). That doesn't just sound simple - it actually is.