When it comes to stock market indices, there is one thing that investors should be aware of: An index is not an objective reflection of reality, but rather something man-made. Companies such as MSCI, Stoxx or FTSE construct the indices according to their own specifications. Therefore, an index can only be an approximation of reality, for example the stock market of a country or an industry.
The most common is the so-called market capitalization weighting. This means that an index is constructed in such a way that it corresponds to the weight of the companies on the stock exchange. The German leading index Dax, for example, includes the 40 largest German stock corporations, the global MSCI World index includes 1,555 companies from industrialized countries, and the MSCI All Country World includes 2976 companies from industrialized and emerging countries. The following principle always applies: a company that is worth twice as much on the stock exchange as another is weighted twice as much in the index.
But there are also other factors that index operators use to construct their indices. An example is that MSCI World Sector Neutral Quality Index. As the name suggests, MSCI wants to combine particularly high-quality stocks in it. “This is the typical procedure of an index provider to make his product attractive to investors,” says Ali Masarwah of the Fund platform Envestor.
But how does MSCI find its supposed quality stocks? The index operator states that it relies on three criteria: a high return on equity, low debt and low fluctuation in annual profit. Companies that meet these criteria are weighted more heavily in the index. Otherwise, it is based on the MSCI World Index, as indicated by the designation “Sector Neutral”: The individual industries are weighted in the same way as in the model. The selection means that there are only 297 stocks in the quality index – there are 1555 in the MSCI World Index. Some examples: Alphabet (Google), Nvidia (graphics cards) and Roche (chemistry) are weighted significantly more heavily in the quality index, Apple, Amazon and Tesla are weaker.
If you look at the performance, MSCI seems to be right with the selection of its quality stocks: The special index increased arithmetically by 8.1 percent per year over the past 20 years, the MSCI World Index was 6.3 percent per year. Fund expert Masarwah points out, however, that the index’s construction means that it relies heavily on stocks that have performed well in the past, especially US stocks. “It’s a bet that everything stays as it is,” says Masarwah. Therefore, the index is not suitable as a basic investment, but at most as an addition. If you still want to invest, you can do so, for example, with an ETF from the provider Xtrackers (ISIN IE00BL25JL35) or from iShares (ISIN IE00BP3QZ601).