You will be able to explain how an index chooses and weights its companies, and what that means for your exposure.
Open the app of any broker and search for "world". You get a page of ETFs with similar names, and the words after each fund manager's name start to blur: MSCI World, FTSE All-World, MSCI ACWI, FTSE Developed. It is tempting to read them as branding, when in fact those few words tell you which rulebook the fund follows, and that is the most important part of the name.
Module 1 gave you a target split. This module decides what fills the share part of it, and that decision starts with the index. The fund comes later.
An index is a set of rules for choosing and weighting a group of stocks. The rules say which companies get in, how much of each to hold, and how often the list is updated. The provider runs those rules, publishes the resulting list and calculates a daily value.
An index fund, including an index ETF, does not make choices of its own. It buys what the rulebook says, in the proportions the rulebook says, and adjusts when the rulebook changes. That is why two ETFs from different managers that track the same index hold almost the same things, and why the question "which world ETF should I buy" is really two questions. First, which index? Second, which fund tracks it best for you? Module 3 handles the second.
The most common rule for weighting is market capitalisation, usually shortened to market cap: the share price times the number of shares, which is what the market says the whole company is worth. In a market-cap weighted index, each company's weight is its market value divided by the total value of all the companies in the index. Providers usually adjust this for free float, counting only shares that are available to trade, so a block held by a founder or a government does not count in full.
Here is a made-up three-company index to show the arithmetic. Company A is worth S$600 billion, B S$300 billion and C S$100 billion. The total is S$1,000 billion, so A makes up 60% of the index, B 30% and C 10%. If A's share price doubles and the others stay flat, A becomes S$1,200 billion out of S$1,600 billion, which is 75%. The weight grew because the price did, with nobody buying a single extra share of A.
That has two consequences for you. The biggest companies, sectors and countries dominate a broad index, so a world fund is far from an equal slice of every country. And the weights move on their own as prices move, without any trading by the fund. You own more of whatever has risen most, which is good when the winners keep winning and uncomfortable if a few giants fall together.
There are other weighting rules, such as equal weight or weights based on dividends or company size measures. They are a choice of strategy layered on top of the market, and this course sticks to market-cap indexes for the core of a portfolio because they hold the market as it is and need the least trading.
A small number of companies build most of the indexes ETFs follow. MSCI, FTSE Russell and S&P Dow Jones Indices are the names you will see most. Each one publishes a methodology document with the full rules and a monthly factsheet for each index.
The factsheet is the page you want. It shows the number of stocks, the top ten holdings and what share of the index they make up, and the breakdown by country and by sector. It also shows past returns, which you can read as history but not as a forecast. Because the weights drift with prices, the figures change every month, so always note the date on the factsheet you used.
The word world means different things to different providers. Some world indexes cover developed markets only: the US, Japan, the UK, much of Europe, Australia, Singapore and a few others. An all-world or all-country index adds emerging markets such as China, India, Taiwan and Brazil. Some indexes cover only large and mid-sized companies, while all-cap versions add smaller companies too.
Providers also disagree at the edges. FTSE Russell classifies South Korea as a developed market, while MSCI classifies it as emerging. So a fund on an MSCI developed index leaves Korea out, and a fund on a FTSE developed index includes it. If you hold a developed fund and an emerging fund from different providers, you could end up with a country twice or not at all.
None of this makes one index right and another wrong. It means the name on the fund tells you what you are buying only once you have read the rulebook behind it. Pick one world index and find its latest factsheet on the provider's website, and you will see these figures for yourself in a few minutes.
Download the factsheet of one world index from its provider and record its number of stocks, top three countries and top ten holdings weight.
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