GDP weighted index

Most global equity indices give a country weight in proportion to the value of its listed shares. That sounds neutral. The workbook explains why it is not.

• Market-cap indices ignore unlisted companies, yet all companies contribute to the economy, listed or not — and in many countries state-owned unlisted companies contribute significantly.
• Developed countries have relatively higher market-cap-to-GDP ratios, so market-cap global indices tilt towards developed countries.
• Emerging and frontier markets get under-represented.

Hence, the workbook says, there is a strong case for building world indices on GDP: country weights are allocated by economic size instead of by the size of the equity market.

The two weighting rules, side by side:

The workbook's real-world example. Leading index providers such as MSCI have created GDP-based global indices. The MSCI World GDP Weighted Index:

• is based on its parent, the MSCI World Index;
• includes large and mid-cap stocks across 23 Developed Markets countries;
• derives each country's weight from its economic size (using GDP data) rather than the size of its equity market;
• was launched on September 30, 1988.

The parent MSCI World Index, per the workbook, has 1,601 constituents and covers about 85% of free float-adjusted market capitalisation in each country.

Where it sits in the weighting menu. Chapter 8 names four ways to weight constituents — price, value, equal and fundamental — and says value weighting is the most popular. GDP weighting is applied at the country level of a global index, using an economic variable rather than a market price.

Country weight (GDP weighted)  = GDPᵢ ÷ Σ GDP
Country weight (cap weighted)  = Market capᵢ ÷ Σ Market cap

Countries and figures are hypothetical, in Rs lakh crore, to show the mechanism.

A global index covers three countries:

Country weights:

An Indian family office allocating Rs 10 crore to a fund tracking this index would put:

• Rs 7.27 crore in Alpha under cap weighting, but Rs 5 crore under GDP weighting;
• Rs 1.82 crore in Beta under cap weighting, but Rs 4 crore under GDP weighting.

Beta is a large economy with a small stock market — perhaps because much of its output comes from state-owned unlisted firms. Cap weighting gives it less than half its economic share. That is exactly the under-representation the workbook describes.

Chapter 8, section 8.5.8 (Global Equity Indices), under "GDP driven versus market capitalization driven", explains the case for GDP weighting and names the MSCI World GDP Weighted Index with its launch date. Section 8.3 lists the four standard weighting schemes. Expect "why do market-cap global indices under-represent emerging markets" and the MSCI World GDP Weighted Index facts.

• Market-cap global indices tilt towards developed countries, because those countries have higher market-cap-to-GDP ratios. They do not over-represent emerging markets.
• GDP weighting allocates weights to countries, not to individual stocks by their company revenues — that would be a fundamental-weighted index.
• MSCI World GDP Weighted Index: parent is MSCI World; 23 developed markets; large and mid-cap; launched September 30, 1988.
• Market-cap indices ignore unlisted companies, including significant state-owned ones — that is one of the workbook's two arguments.
• Constituent counts such as 1,601 for MSCI World are workbook snapshots and change over time.