Such a comparison demonstrates how market cap weighted index country weights may not be representative of relative economic strength. A dramatic example of this divergence can be observed in Japanese equity markets in 1989, when Japan’s share of world economic output was 10% yet the country comprised over 40% of the FTSE All-World Index. This disparity was a result of Japan’s equity market value outpacing its economic output.
It appears the reverse is true with respect to current Chinese markets. While Japan’s economic output did not correspond with its equity market growth, China’s GDP growth is not fully reflected in its equity market. As a result, what is now the world’s largest economy represents just a small share of the global equity landscape, as measured by market capitalization.
A GDP weighted structure like that of the FTSE GDP Weighted Index Series is designed to break this link between country weightings and market size. Instead of weighting by market cap, these indices set country weightings in proportion to GDP. As such, GDP weighted indices can correct for lack of correlation that may exist between economic and equity market growth.
This objective is perhaps best illustrated by comparing China and US weights in the FTSE All-World GDP Weighted Index over the past decade. As China has risen to become the world’s top economic power, its weighting in the FTSE All-World Index has risen in lockstep. Further, as China has overtaken the US as the world’s largest economy, the gap between their index weightings has narrowed.
Source: FTSE data, March 2004 – September 2014.
As of November month end, China’s weight in the FTSE All-World GDP Weighted Index reached 21.3%, only lagging the US weight by 0.7%. This is in stark contrast to China’s 2.1% weight in the market cap weighted FTSE All-World Index. Such examples where country weight differences are so pronounced highlight how varying approaches to index construction can result in markedly different outcomes.
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