MSCI: Keeping Indexes Investable in Evolving Markets
Posted: 6 April 2017 | Source: MSCI
Market liquidity around the globe has changed drastically over the past decade, due to a combination of regulatory, technological and investment changes. Relative trading volumes on many primary trading venues have dropped by about 50% since their peak in 2009. Meanwhile, the use of passive management and Exchange Traded Funds (ETFs) has soared.
To ensure the investability and replicability of MSCI equity indexes, we regularly monitor the liquidity of index constituents, apply liquidity screening criteria and review index construction rules and liquidity measures. This paper outlines key trends in market liquidity over the past decade and illustrates how they were reflected in MSCI Indexes.
In this study, we analyzed liquidity in terms of trading volumes relative to market capitalization, trading costs and market impact over the last 11 years, across all equity markets included in the MSCI ACWI Investable Market Index (IMI). Our main findings are:
- Liquidity has improved in many markets after accounting for off-primary exchange liquidity, especially in the U.S., Canada and Europe.
- Markets with higher liquidity fragmentation have experienced higher relative volumes and lower trading costs.
- While the overall index level liquidity characteristics of the MSCI ACWI IMI have improved, since the sub-prime crisis relative volumes have generally declined since their peak in 2009. Meanwhile, spreads and market impact are near historical lows.
- Within developed markets, the Pacific region has consistently trailed the U.S., Canada and Europe on liquidity measures. Apart from Australia and Japan, this region did not experience any significant liquidity fragmentation.
- Emerging markets have generally lagged developed markets in all aspects of liquidity. In most markets, liquidity has remained concentrated on one exchange.
- Smaller companies have experienced higher dispersion in relative volumes and had wider spreads and greater market impact than large-cap companies.
Changes in market liquidity have affected construction methodologies and composition for the MSCI ACWI Investable Market Indexes. Enhancements have included: introduction of short-term liquidity measures; use of consolidated volumes for calculating relative traded volumes for U.S. and Canadian securities; and improved treatment of suspended securities.
While fluctuations in liquidity have not resulted in major changes in the number of constituents in the MSCI ACWI IMI universe, some emerging markets, such as Morocco and Pakistan, experienced acute liquidity problems and were reclassified to frontier markets. Voluntary suspensions in the China A-shares market have been a factor adversely affecting the potential inclusion of China A-shares in the MSCI Emerging Markets Index.