Evercore Pan Asset

Most investors compare their equity investment with a world index like MSCI World. This Index just includes the developed world economies and markets. Around half the index is in the USA. Japan and the UK represent about one tenth each.  Euroland with Switzerland accounts for nearly one fifth. If you look at world population the US and Japan are the only two  countries in the MSCI World Index that feature in the top ten largest populations, unless you put all the EU countries together when they get into third place collectively.

If we compare this with world output, we see a very different picture. This year the world is forecast to produce around $60 trillion of output. The US accounts for about one quarter. China and Japan will produce about 9% each, Brazil, Russia and India about 8% between them. Europe including the UK produces around a quarter.

Some of these big changes in output, with the emerging countries representing an ever larger share of the world total, is reflected in total world stock market capitalisations.  The Chinese market now represents around 7% of the total world capitalisation, just a little ahead of the UK. Brazil’s market is now as large as Germany’s. India is around 3% of the world total, and South Korea and Taiwan are around 1.5% each.

There are still some big differences between the contribution of some countries to world economic output, and the proportion of the total value of world shares companies in their country represent. There are several reasons why this should be so.

Countries like the UK and US will probably continue to have a larger share of world stock market capitalisation than their share of world output. These countries act as host to more global companies listing on their exchanges. They also have a higher proportion of their domestic activity produced by quoted companies. Asian countries may continue to undertake more activity through unlisted state entities and a host of smaller companies, and may continue to be less successful in persuading footloose global companies to list on their exchanges.

Germany is an important contributor to world output but has a smaller share of world Stock market capitalisation than her contribution to world output. This too probably reflects the importance of bank and family ownership structures relative to quoted companies in her economic model.

Given these differences, what can we deduce about future trends from these figures? The first point is that the current composition of the traditional world indices is not designed to be a fair representation of the world economy. More and more investors will think they need to recognise the BRIC countries and other emerging markets as they grow in importance. The second point is given the relative growth rates, we should expect all things being equal the emerging economies to represent a rising proportion of total world Stock market capitalisation in the years ahead. This process will accelerate as a country like China makes more large share issues to transfer state enterprises to the market sector.

It is likely that in the years ahead there will be pressure to use a world index to measure funds’ performance which includes the faster growing economies. Before that happens more managers might come to see that a way of beating a developed world index may often be to run shares from emerging markets that could outperform.  As the emerging market economies come to the party and become more important in both world output and market capitalisation, so more funds will feel they have to buy into these newer economies and share offerings. As emerging markets become larger and gain more acceptance, so more investors will buy into these areas, boosting prices.

Global Population Figures

Source: June 2010 UN figures

India and China have over 2,500 million people. Their incomes are still on average low by first world standards. If they are just moderately successful these incomes could double over the next decade, whilst real incomes in the west will make only modest  progress. If the emerging markets go from their current level to contributing around one third of world output, whilst Europe and the US experience relative decline, what will that do to relative stock market sizes? Can you believe people will still be comparing their world shares to an index which says the US is half the world and Europe including the UK is around 30%?

I doubt it. That’s why we have positioned our portfolios with what we think are the weightings of the future, with much more in the faster growing economies not yet represented in the MSCI World Index.