Fund global equity index choices have exposed NZ investors to widely different risk exposures and environmental, social and governance (ESG) factors despite ostensibly targeting the same asset class, a new Russell Investments NZ analysis found.
A footnote study to the recent Russell benchmarking series shows coverage of international share markets ranges from 99 per cent for the FTSE Global All Cap index to just 25 per cent for the S&P Global 100 with two other popular MSCI equity gauges capturing 78 per cent and 88 per cent, respectively.
Authored by Russell NZ investment analyst, Sam Tither, the report says: “Many New Zealand investors limit their international shares investments to developed markets only. They miss out on a significant slice of the world’s investment opportunities.”
Over the last 15 years the index tilt to developed markets has broadly favoured investors with the least-diversified global equities benchmark – the S&P Global 100 – returning an annualised 8.8 per cent in NZ dollar terms for the period compared to 7.3 per cent for the MSCI All Country World Index (which accounts for 88 per cent of the 10,000 or so listed companies in the investment universe).
But benchmarks that exclude, or severely limit, emerging markets reduce diversification and impact investor returns with the sector expected to grow in importance.
“As we have communicated for many years, we believe emerging markets are an essential component of modern global multi-asset portfolios,” the study says. “Many local managers do not have the capability to access emerging markets efficiently, and thus their clients are limited to developed markets only offerings, or access via inefficient feeder fund structures, or potentially tax-inefficient offshore funds.”
And the increasingly common specialist ESG indices also introduce differential risks both in broad market exposures as well as underlying exclusion factors.
For instance, ESG indices tend to focus entirely on developed markets while ad hoc exclusions can move the dial too far on tracking error and sector weights.
“ESG oriented investors should be aware of the tracking and performance risks they introduce to their portfolios by adopting these highly constrained and restrictive indices,” the Russell study says.
The ESG index impact on performance can be significant: over the 12 months to the end of this January, the FTSE Developed ex Australia Choice benchmark was down almost 9.7 per cent versus the roughly 6 per cent loss for a common MSCI global ESG index.
Russell published two reports earlier this year highlighting issues with common NZ fund manager and KiwiSaver scheme benchmarking practices.