Is U.S. Concentration In Global Equity Indices Too Extreme?
In the last 10 years, markets like Taiwan and India have kept up with the U.S., returning 12.3% and 10.1% respectively, compared to 12.0% for U.S. equities on an annualized basis.
The stellar performance of U.S. equities in the past 15 years has led to a record 63% weighting in the MSCI All Country World Index. While investors with high U.S. exposure have benefited from this trend, they may also lack proper diversification and exposure to other markets. This raises the question: has U.S. concentration in global equity indices become too extreme?
The U.S. is the largest equity market in the world, but its weighting in the MSCI AC World Index exceeds its global equity market weighting and its projected contribution to global GDP in 2023. Index providers must be selective with the countries and companies they include, considering factors such as liquidity, transparency, ownership restrictions, and other bans that may hinder foreign participation. Therefore, it makes sense for the U.S. to have a heavy weighting, but investors should be aware of the potential risks:
Weaker diversification and risk management: Investing in a global equity index today compared to 10 years ago means having a 16% higher exposure to the U.S. Investors who seek international diversification must pay attention to index weightings over time. Country-specific risks are also a concern. While risks in other markets may outweigh those in the U.S., the trajectory of U.S. government spending is catching investor attention worldwide. Investing internationally can help diversify risks in the face of a greater chance of fiscal deterioration in the U.S.
Strong performance elsewhere being overshadowed: In the last 10 years, markets like Taiwan and India have kept up with the U.S., returning 12.3% and 10.1% respectively, compared to 12.0% for U.S. equities on an annualized basis. While high concentration to the U.S. may not be problematic in years where the U.S. performs well, international diversification pays off in years like 2022. For example, Latin America outperformed the U.S. by 27% during that year due to its higher commodity exposure.
High concentrations don't always last forever: A high weighting within global indices signals that historical returns have been strong – and stronger than in other markets. However, history shows that high concentrations are not a reliable indicator of future performance. Japanese companies grew rapidly in the 1980s, leading to Japan having a 40% weighting in the MSCI ACWI, 10% higher than the U.S. However, Japan declined once its real estate and equity market bubbles burst and only has a 5% weighting today. While the U.S. isn’t facing the same issues, it may be close to peak concentration levels with the outlook in other countries improving.
While the U.S. has a dominant position in global equity indices, reflecting its strong economy and company performance, investors should be mindful of the potential risks associated with a high concentration in any single market. Diversification remains a key strategy in managing risk and potentially enhancing returns over the long term. The current U.S. concentration in global indices underscores the importance of understanding the composition of these indices and the impact on portfolios.
Weightings in global indices may not tell the full story
Source: International Monetary Fund - World Economic Outlook April 2024, MSCI, World Federation of Exchanges, J.P. Morgan Asset Management. All weights are based on market cap and GDP in USD.
Data are as of May 25, 2024.