Indexing the world
Since its inception over thirty years ago, the FTSE Global Equity Index Series (FTSE GEIS) has matured and evolved in step with equity markets globally. While market capitalization-weighted indexes that measure global markets have been around since the 1960s, it wasn’t until international investment portfolios really started to take off in the 1980s that the investment community recognized the need for more adequate tools for mapping global stock markets. This realization was the impetus for the creation of FTSE GEIS, which today provides broad, modular coverage of the entire global opportunity set relevant to international investors via rules-based, transparent index construction methodology.
In this paper we provide:
- A brief history of FTSE GEIS, from when it first began as the FT-Actuaries World Index in 1987 to what it is today — an internationally recognized series of global benchmarks.
- An illustration of the broad coverage and modular design of FTSE GEIS.
- An explanation of how FTSE’s Country Classification process has evolved, including an introduction to its unique four-tiered approach to classifying markets.
- A step-by-step overview of the FTSE GEIS review process, including the region-relative approach to universe construction and size segmentation.
- An introduction to the FTSE Russell governance process.
- An example of how global equity markets have changed over time and how FTSE GEIS has evolved to reflect this change.
The history of FTSE GEIS
The predecessor to FTSE GEIS, the FT-Actuaries World Index, was conceived in 1986 through a collaboration between the Financial Times, the Institute and Faculty of Actuaries (specifically, its investment research arm), Goldman Sachs and broker Wood Mackenzie and Co. While each founding partner viewed the world of international investing through a different lens, all four firms recognized the need for a new breed of global equity indexes.
In 1987, Eric Short, a Financial Times journalist and actuary noted, “Local stock market indexes are not sufficient in themselves to provide the fund manager and adviser with all the tools needed to assist in their international investment, especially if certain stocks on the market are not freely available to overseas investors”. The FT-Actuaries World Index, which at that time covered roughly 70% of the market capitalization of 23 countries was their solution to this problem. From there, the following timeline emerged:
- In 1995, the London Stock Exchange and the Financial Times formed a joint venture (FTSE) which took over calculation of the index in 1997 and bought out the other partners in 1999.
- In 2000, The Barings Emerging Market Index was incorporated, adding 20 countries and extending target market coverage from 70% to 90%, giving rise to the FTSE All-World Index. This timing of this enhancement was important because investing in emerging markets was gaining in popularity, as was accessing companies deeper down the market capitalization spectrum.
- In 2003, the series was renamed the FTSE Global Equity Index Series and extended to include small cap stocks, with index reviews grouped into seven regions: Asia Pacific ex- Japan, Developed Europe, Emerging Europe, Japan, Latin America, Middle East & Africa and North America.
- In 2014, the London Stock Exchange Group acquired the Frank Russell Company, including the Russell Indexes. The FTSE Russell brand was born as a result, and today, FTSE Russell products, including FTSE GEIS, are used extensively by institutional and retail investors globally.
FTSE GEIS today
As illustrated in Figure 1, the coverage of FTSE GEIS extends to roughly 7,700 large, mid and small cap stocks across 47 Developed and Emerging markets via the FTSE Global All Cap Index, reaching over 98% of the world’s market capitalization. The series is divisible into modular subcomponents including the FTSE All-World Index, which includes large and mid-cap stocks from all covered markets, and the FTSE Global Small Cap Index. A wide range of sub-indexes are available to further segment the markets into sectors, regions, and individual countries.
The evolution of the FTSE Country Classification process
Countries eligible for the original FT-Actuaries World Index had “an established stock market with viable, reliable stock prices and company data” (Short, 1987). As one would expect, some countries initially fell short of this requirement. Finland, for example, was not included in the FT-Actuaries World Index until a year after its launch because of doubts about the reliability of the country’s published company data.
When the distinction between developed and emerging markets was introduced in 2000 with the launch of the FTSE All-World Index, the guidelines were somewhat arbitrary and tended to focus first on the relative wealth of a country with an added layer of subjective judgment around its market’s quality. FTSE set out to improve this process by conducting extensive consultations with over 100 institutional investors to propose a more efficient, transparent method of classifying countries. During the consultation process, FTSE tested the notion of a more structured, objective framework for determining a country’s development status. The proposed process considered additional criteria and was designed to encourage countries to adopt global best practices in the pursuit of promotion between classification levels.
The FTSE Country Classification process as it exists today was developed following the conclusion of the consultation and continues to be monitored closely by the FTSE Russell Country Classification Advisory Committee and the FTSE Russell Policy Advisory Board. The guiding principles for this formal market classification process, along with the Quality of Markets Matrix against which markets are objectively judged and compared, are published on the FTSE Russell website. To further improve transparency, FTSE Russell also publishes a Watch List of countries likely to be reclassified, enabling index users to monitor possible upcoming changes.
Two levels of Emerging markets
An attribute exclusive to the FTSE Country Classification process is its unique 4-tiered country classification structure, which classifies countries as Developed, Advanced Emerging, Secondary Emerging and Frontier (see figure 2). By providing two layers of classification at the Emerging markets level, users are able to identify which Emerging markets are closer to achieving Developed market status. While some FTSE GEIS users may choose to simply view the Emerging markets universe as one combined opportunity set, having the added option of dissecting where these markets fall along the Advanced Emerging / Secondary Emerging market spectrum allows for added flexibility in the development of portfolio strategies. For example, investors may choose to weight their emerging markets portfolio based on risk by focusing on countries with higher or lower country risk profiles. It should be noted that Developed, Advanced Emerging and Secondary Emerging markets are included in FTSE GEIS, while access to Frontier markets is provided through a separate set of benchmarks (the FTSE Frontier Index Series).
The FTSE GEIS regional-relative approach
Another design principle central to FTSE GEIS is its regional-relative approach to defining the global investment universe and segmenting stocks into to market capitalization bands. Through ongoing consultations with FTSE Russell index users, the view remains that this approach most closely reflects established practices across global portfolios. By employing a regional approach to global index design, the indexes included in the FTSE GEIS family align with the most common global investment management process. Reviewing each region independently rather than on a global scale also reduces the influence some of the world’s largest markets could have on the index’s representation of smaller countries. By capturing each of the seven regional universes separately, countries are grouped and reviewed with their peer markets, resulting in a balanced approach to universe capture and size segmentation.
The five steps below, also shown in Figure 3, summarize the semi-annual process conducted for reviewing the FTSE GEIS indexes and capturing the global investable universe.
Step 1: Countries are classified as either Developed, Advanced Emerging, Secondary Emerging or Frontier.
Step 2: Companies are assigned to a single country based on an assessment of a number of factors including country of incorporation, country of domicile for tax purposes, and location of headquarters.
Step 3: Companies are grouped according to their country assignment into seven regional universes. Within each universe, companies are ranked in descending order by total market cap and companies are allocated to large (the top 70%), mid (the next 20%) and small (the next 10%) market capitalization bands.
Step 4: Investability screens are applied to eliminate stocks considered unavailable to institutional investors.
Step 5: Index weights are determined based on market capitalization adjusted for available float and foreign ownership limits.
A changing global equity market
Global equity markets have grown and changed dramatically over the last 30 years, and because FTSE Russell is committed to providing accurate coverage of the global opportunity set via FTSE GEIS, users can rely on the indexes to accurately capture this evolution. Figure 4 compares the weights of the countries included in the FT-Actuaries World Index as of 1987 to the country weights of FTSE All-World Index as of 2017. In 1987, Japan represented roughly 35% of the FT-Actuaries World Index while the US represented 37%. Thirty years later, Japan’s representation has dipped to approximately 8%, while the weight of the US has grown to over 51% — an especially notable observation given that the number of countries included in the index has increased substantially over the same period (23 in 1987 to 47 in 2017).
FTSE GEIS governance
Transparency, reliability and accuracy are key attributes of FTSE GEIS. From its launch over 30 years ago, the FT-Actuaries World Index (now FTSE GEIS) was supervised by a diverse group of investment managers and industry professionals. The first Policy Group, responsible for ensuring that the indexes remained independent, broad, accurate and objective, included representatives of the three founding firms as well as members from external international investment and advisory firms. Today, FTSE GEIS (and all FTSE Russell indexes) is governed by a well-defined framework that draws from strong internal expertise with support from external independent committees of leading market participants (Figure 5). The external committees are made up of investment market professionals from around the world, including pension plan trustees, investment managers, consultants, and other market participants that make use of FTSE Russell indexes. Members serve in a personal capacity, and they are chosen for their ability to provide strategic input.
This formal process proactively evaluates all of the construction and maintenance rules applied to the indexes, from country classification to corporate action reflection, to ensure they are responding and adapting to the evolving markets.
Since 1987, use of FTSE GEIS indexes has expanded enormously. Today, FTSE Russell indexes are used by institutional and retail investors around the world. Leading asset owners, asset managers, ETF providers and investment banks have chosen the indexes to benchmark their investment performance and to create investment funds, ETFs, structured products and index-based derivatives. As of December 31, 2016 over $1.5T in assets under management are benchmarked to a FTSE GEIS index, with $1.2T in assets tracking a FTSE GEIS index passively via index-linked investment products.
FTSE Russell is committed to maintaining strong relationships with market participants, regulators and exchanges globally. As the global investment landscape has evolved over time, so has FTSE GEIS thanks to our global perspective and dedicated governance process. Today, FTSE GEIS provides investors of all types with accurate, comprehensive coverage of global equity markets using an approach to index construction that is objective, transparent and reliable.
 Assessing World Stock Markets: The Design, Calculation and Production of the Financial Times–Actuaries World Indices”, Eric Short, FIA, presentation to the Faculty of Actuaries Students’ Society, November 1987.
 This was achieved by setting a target of at least 70% coverage of the aggregate value of all listed equities in each local market, and at least 10% (and up to 30%) by number of the available companies in each market.
 Wood MacKenzie sold its share to Standard and Poor’s in 1995.
 For more information about the FTSE Country Classification process please visit: http://www.ftse.com/products/indices/country-classification
 For more information about the FTSE Frontier Index Series, please visit http://www.ftse.com/products/indices/frontier
 For a complete list of factors assessed in determining nationality, please review the FTSE Global Equity Index Series Ground Rules.
 For additional details on the governance process and committees please visit: http://www.ftse.com/products/indices/index-support-guides
 Data as of December 31, 2016 as reported on March 31, 2017 by eVestment for institutional assets, Morningstar for retail mutual funds, insurance products, and ETFs, and additional passive assets directly collected by FTSE Russell. AUM data includes blended benchmarks and excludes futures and options. Passive assets directly collected by FTSE Russell have been removed from third party sources to prevent double counting. No assurances are given by FTSE Russell as to the accuracy of the data.