Global trackers are broken – here’s how investors can fix them

Picture the scene: you’re at a party, the nation’s best-loved weekly investment magazine artfully positioned in your jacket pocket. Spotting the well-known calling card of a stockpicking sophisticate, someone sidles up to you with a question to which they’ve clearly given some thought.

“I know I need to put my money to work,” they begin. “But is there a good way to do it if I don’t know anything about investing, don’t really want to learn, and worry I’m going to get ripped off?”

Aha, you think, public service calls. And so, with calm efficiency, you explain the basics of platform-based passive investing: its low fees, low maintenance, and superior performance to all but a few active funds. Other partygoers glance over, with what you suspect (though you’re not certain) to be an expression of awe.

“This global equity tracker thing – does the ‘global’ bit mean you’re invested everywhere?” asks your companion, clearly intrigued.

Good question, you reply, pointing out that this is where it gets tricky. You explain that when factoring in the relative and absolute weight of American stocks, the maths of index funds means that a typical ‘all-country’ index is 64 per cent invested in the US – even if, strictly speaking, just a fifth of the holdings are US shares.

The most popular global equity index doesn’t invest in most stock markets or even the world’s second-largest economy, you add, outlining how these quirks then bump the US allocation to over 70 per cent.

“So let me get this straight,” your interlocutor continues. “This ‘passive’ investing approach, developed in the US by US academics and largely sold to ordinary US investors by US asset managers, says US stocks are at least twice as important as the rest of the world combined? That doesn’t sound very passive to me.”

To which, you concede they might have a point.

All-seeing MSCI

If our newbie investor friend did opt for a passive global fund, there’s a good chance it would look like the MSCI World Index. In an era of free-moving capital and information, the benchmark has become the north star for many global equity investors.

Launched in 1986, it tracks the performance of around 1,500 of the largest, most liquid listed companies across 23 “developed” markets. As an advert for passive investing, it could hardly have been a bigger success. By taking a (nearly) global approach to stocks, it offers a big expression of the idea that by buying the ‘entire’ market, investors can both diversify and give themselves the best chance of capturing winners.

It has also set a remarkably high hurdle for returns. Since MSCI began publishing the index, its nominal returns (that is, before inflation) have averaged 9 per cent a year in sterling terms. Over the past 10 years, those annualised returns have climbed to 12 per cent, and to more than 14 per cent in the past five.

The challenge of consistently beating that record explains why cheap tracker funds that mirror the MSCI World and peer indices such as the FTSE All-World, Morningstar Global Target Market Exposure or S&P Global 1200 have become the default option (and indeed recommendation) for millions of investors.

Despite that challenge, many more investors – both retail and institutional – have managed to outperform, without doing any more work. To achieve this, they simply went all-in on the overwhelming driver of global indices’ underlying returns: the S&P 500. For UK-based investors, a 9 per cent fall in the dollar over five years hasn’t stopped the US blue-chip index from compounding at 15.7 per cent a year in sterling terms.

Of course, the outperformance of US stocks long predates the post-Covid-19 era. Over the past four decades, the US has shrugged off the dotcom crash, the financial crisis, the pandemic, the 2022 return of inflation and (so far) Donald Trump, to post the strongest stock market performance in the world.

This might is nowhere more clearly demonstrated than in the evolution of the MSCI World’s regional weightings (see chart).

When the index was first devised, all eyes were on another market – Japan – which accounted for nearly the entire value of the Asia-Pacific region. Then, after the Japanese asset bubble popped in the early 1990s, soaring US and European stock markets quickly filled the gaps. Trouble eventually arrived in the 2000-03 and 2007-08 crashes, but while the US was arguably most humbled by those episodes, no market was immune. In any case, those calamities are now a flicker on a long-term trend line. Since bottoming out in relative terms in 2009, both America’s stock market and its currency have only gone one way, swamping all before them.

The result of this run is that, as of April, the MSCI World index has a 71 per cent allocation to US stocks, down from a peak of 74 per cent at the end of 2024.

From one angle, this has striking implications for future returns. If the price of a stock is the present value of its future expected cash flows, the same is also true of a stock market, and of the combined value of all the stocks and stock markets in the world. A 71 per cent weighting to US stocks, even if passively assigned, therefore represents a huge bet on global equity markets’ future source of profits.

Of course, if all companies were valued the same, investors might have less to worry about. But as we know, this isn’t the case. At the time of writing, the S&P 500 trades on around 25 times earnings, against 17 for non-US “developed markets”. In absolute and relative terms, then, US stocks have further to fall when they revert to their long-term mean. This is doubly true for the largest and most highly valued US stocks, which in a break from historical norms are now expected to deliver the highest returns.

Given the index represents the world’s largest “developed” markets – where risks tend to more closely resemble one another than in fledgling, less liquid stock markets – this suggests remarkable faith in the US. What’s more, given US corporates’ aversion to paying dividends, the two-thirds allocation to US stocks further lowers the future cash returns investors can expect (or might hope to more efficiently redeploy in an accumulating tracker fund). A big weighting to the US magnifies the speculative focus on capital gains.

Second, the way MSCI and other index providers classify global markets is often odd. Despite being controlled by Beijing and home to hundreds of mainland Chinese companies, Hong Kong is a “developed” market, while China – perhaps the world’s most advanced technological power, and certainly its largest economy in terms of purchasing power parity – is still “emerging”. That label also applies to South Korea, which finds itself lumped next to countries such as financial aid case Egypt and inflation-ravaged Turkey.

However, these contradictions obscure the biggest problem with major global equity indices, which is the dominance of the world’s deepest and most highly valued market. Even in an ‘all-country’ index such as the MSCI ACWI, the largest “emerging” market (China) makes up just 3 per cent, which is just a little less than the UK. In portfolio terms, that’s a rounding error, and means that if Chinese or Japanese equities are the next decade’s big winners, they will require a gargantuan run of outperformance to make a difference at the index level.

US and them

Strictly speaking, indices are forward-looking. But by neutrally accepting the price set by the market, global equity indices also accept plenty of assumptions that are rooted in the recent past.

For many passive investors and pension holders, the opening months of 2025 will have produced a sudden realisation of the risks of a US equity-dominated portfolio. For overseas owners, this has meant a double hit. When souring economic sentiment was followed by increasingly belligerent trade noises from the White House, the fall in US equities was compounded by a falling dollar.

This, it turns out, is another problem of extreme US concentration.

In a global portfolio, the relative strength of other currencies should help soften the occasional weakness in the greenback. But when more than two-thirds of the portfolio is priced in dollars, this additional layer of diversification is reduced. If, as some believe, the US is taking active measures to weaken the dollar, then this could lead to sustained price falls in global equity trackers, which are a dollar-denominated asset.

With hindsight, such blind spots are easily traceable. At the start of 2025, market commentary was awash with talk of ‘US exceptionalism’, the notion that there was no better investment destination on earth, and belief that American capital markets’ gravitational-like pull on investor capital and international business would continue to propel it forward. Nosebleed valuations were justified because, well, America wins. And on the days it doesn’t win, every American with a 401(k) will be using a chunk of their pay cheque to buy the S&P 500 regardless.

If there is a silver lining from the “liberation day” tariff announcements, it is that global investors no longer see America with such starry eyes. Markets may have neutered Trump’s wildest threats, but the idea of the US as a reliable partner, let alone the leader of global trade and the financial order, has taken a big knock. The toothpaste, as they say, is out of the tube.

Those global investors who for years wanted a reason to sell expensive US stocks, but clung on for fear of missing out, now have several. The double-digit returns made by European equities in 2025 may give similar pause for thought.

Unwinding the exceptionalism story could conceivably lead to sustained selling for several years. For the passive investor mindful of this threat, then, what might a more sensible level look like?

Finding ‘enough’

For true believers in index investing and efficient markets, quibbling over the ‘right’ level of US equities in a global equity portfolio misses the point. The market, and the market alone (which in this case, means the dollar-denominated value of global stock markets) sets the level. End of.

We don’t have to take the purists’ word for it, however. After all, beneath global equity indices’ elegant construction are lengthy rule books and judgments on inclusions, exclusions and balances. Ultimately, everyone struggles to define the limits of the global equity market.

One approach would be to stay with the MSCI World but trim the size factor. The Invesco MSCI World Equal Weight UCITS ETF (MWEQ), which launched in September and is based on MSCI’s own equal-weight version of the index, does just that. However, because its investable pool of stocks is based on the same market-weighted list as the MSCI World (albeit rebalanced every quarter), US stocks still make up 40 per cent, with continental European nations on a combined 25 per cent, Japan at 14 per cent, Canada at 6.3 per cent and the UK at 5.7 per cent.

This pivot might suit someone who is particularly worried about the outlook for certain US sectors or megacap names. The downside is that by levelling the playing field across all markets, you get the same exposure to every great “developed” market company trying to take their place. A value tilt, such as the SPDR MSCI World Value UCITS ETF (VALW) takes a different spin, by cutting exposure to the priciest US stocks and overall US allocation to 38 per cent, while lifting the value of Japanese and UK holdings to 19 and 12 per cent, respectively. Continental Europe again accounts for around a quarter of the fund.

Another route, if you simply feel there’s too much US in your global tracker, is to sell a portion and use the proceeds to overweight the non-US world, solely through an MSCI World ex-US tracker such as iShares’ MSCI World ex-USA ETF (XUSE), or in conjunction with an allocation to a corresponding “emerging” index, such as the iShares MSCI Emerging Markets ETF (EEM). An investor wanting to mirror MSCI’s equal-weight version of its ACWI index might aim for as little as 21 per cent in the US, for example. This, it turns out, is also much closer to the relative size of the US economy in a global context.

While this method might increase global diversification, it’s important not to conflate regional markets with their respective economies. Just as the FTSE 100 shouldn’t be seen as a ‘play’ on the UK economy, the members of the S&P 500 do a lot of business overseas. Just 38 per cent of Apple (US:AAPL) sales are domestic, for example.

For the average US blue-chip, that proportion is higher, at 71 per cent, per FactSet data. But reweight by market cap, and average home market sales fall to 60 per cent. What’s more, global-facing S&P 500 constituents tend to be more profitable, thereby attracting a higher rating (see table). The ratio of America’s stock market value to its GDP – used to determine the cheapness of US stocks and a metric Warren Buffett once described as “probably the best single measure of where things stand at any given moment” – matters less than it once did.

Still, as the table shows, some of this effect is cancelled out by the often sizeable profits generated in the US by corporates domiciled in Europe, Korea, Japan and elsewhere – although their stocks are typically less highly valued. Even in a passive global equity portfolio that drastically lowers its headline exposure to America, there’s no getting around the US – a fact that every international trade minister now knows too well.

Quite how passive you want to be about that fact, of course, is up to you.