MSCI versus FTSE: Why they’re not the same

Small changes can make a big difference in underlying assets.

October 18, 2012

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story_images_mismatched-shoesVanguard’s big shift away from MSCI indexes has a lot of exchange-traded fund (ETF) investors (institutions in particular) asking big questions. Is this the right kind of move for all providers? And what does it mean for their ETF investments? Responding last week to Vanguard’s decision to ditch MSCI in favour of new benchmarks from FTSE Group and the University of Chicago’s Center for Research in Security Prices, Laurence Fink, CEO of BlackRock, expressed his firm’s intention to stick with MSCI.

But ever since Vanguard announced its decision, BlackRock says it has been fielding calls from clients about what the move means for the industry and why the firm is planning to stick with the status quo. According to Greg Walker, head of iShares institutional business at BlackRock Canada, the rival firm’s announcement has opened up an important conversation about indexes and why they matter. “We’ve had this discussion for years about the index, and cost is only one factor. There are many more decisions investors need to make when looking at ETFs. And one of the most important is the exposure and the index itself,” he says.

The firm has issued two client memos outlining the differences between the FTSE index and the MSCI in an effort to communicate that “this change is bigger than simply transitioning from one index provider to another.”

So what’s the big deal?

The two indexes have some key differences when it comes to holdings, countries, sectors and style. FTSE and MSCI have some fundamental differences: for example, the MSCI EAFE Index and the FTSE Developed Ex North America Index have a greater than 10% difference in holdings. Country allocations also differ: Korea, for instance, is a sticking point. MSCI calls it an emerging market country while FTSE classifies it as a developed country. Korea creates similar disconnects between FTSE and MSCI in their emerging markets indexes. It is the second largest country allocation in the MSCI Emerging Markets Index (15.57%), but it’s excluded from the FTSE Emerging Index. FTSE’s Emerging Index also includes exposure to the United Arab Emirates and Pakistan, while MSCI’s excludes both countries, because the firm classifies them as frontier markets.

The key message here for investors is that not all indexes have the same holdings, so they’d better be primed about the specifics of the switch. That means looking closely at the composition of the underlying index in a given ETF. Plan sponsors in particular need to understand how the shift could impact their own benchmarks and make sure they’re still aligned.

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