Believing that there’s a material distinction between the size of a nation’s economy and its stock market, MSCI also devised a GDP-weighted EAFE index.  A few country representations significantly change.  Italy’s soared from 3.82 percent to 9.50 percent.  Switzerland and the UK, in contrast, fell from 6.89 and 20.87 percent to 1.91 and 12.46 percent, respectively.    

Performance history is inconclusive about whether the equal- or GDP-weighted variation is a better benchmark.  Both are trailing EAFE over the past year, with the equal-weighted version underperforming by 414 basis points.  Equal weighting is behind 162 basis points per annum over each of the last three years.  Five-year returns top EAFE by an annualized clip of 68 bps.

GDP weighting makes a bit more compelling case, topping EAFE by 63 and 87 bps over the trailing three- and five-year periods. 

Non-MSCI Alternatives

Until markets started turning south a year ago, both RAFI’s and WisdomTree’s alternatively-weighted international indices performed very well relative to EAFE.  But the collapse of shares over the past year, especially value-oriented stocks, has weighed more heavily on these two relative newcomers. While the performance gap between the benchmark and these alternatives closed over the past year, RAFI and WisdomTree have sustained their lead over EAFE across all time periods.

In support of traditional, market-cap weighted indexing, John Bogle, founder of the Vanguard Group exclaims, “Never think you know more than the markets; nobody does.” It’s hard to argue with a legend who has brought such benefits to individual investors through his ultralow-cost index funds.

But it’s easy to forget that he was a maverick when decades ago he suggested that indexing was a cheaper, more profitable way of gaining exposure to markets than more expensive active management. 

Bogle was proven right.  And while the new generation of indices no doubt has its own Achilles heels, they too have proven the value of thinking outside the box.

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