Asian market indices do not provide an efficient risk/reward trade-off; the standard Asian indices are heavily concentrated in a few large-cap stocks. Most indices allocate as much as 60% of the index weight to only one-fifth of the stocks in the universe

Asian market indices do not provide an efficient risk/reward trade-off

Author: Wing-Gar Cheng

6 March 2013

Asian stock market indices have displayed a pronounced inability to provide an efficient risk-reward trade-off, according to researchers at EDHEC-Risk Institute.

The study of 10 major Asian stock market indices over the past decade –  “Assessing the Quality of Asian Stock Market Indices” – shows the standard Asian indices are heavily concentrated in a few large-cap stocks. Most indices allocate as much as 60% of the index weight to only one-fifth of the stocks in the universe.

Investors keen to hold well-diversified equity portfolios are advised to be aware of these inefficiencies. “Investors who want to capture the Asian market premium will do so in a better way if they use indices designed with an efficient weighting scheme.”

Asian equity indices also show severe fluctuations in style and sector exposures. Market indices in more developed countries (Hong Kong, Japan, Singapore, South Korea and Taiwan) demonstrate relatively more stability, whereas market indices in less developed countries (China and India) display higher variability over time in terms of sector allocation, the study found. “Investors clearly need to consider the weighting scheme that will allow them to extract the equity risk premium for a given geography in the best possible way.”

Total worldwide assets under internal indexed management rose to $5.994trn as of 30 June, 2011, a 25% increase over $4.781trn a year ago, the study said. In Asia, total ETF assets increased by 20-30% annually post-2008 and the number of products has risen by more than 200%. Currently, the total ETF assets in the Asia-Pacific are estimated at $81bn, it added.

Assessing the Quality of Asian Stock Market Indices

Posted by Veronique Le Sourd on Mar 1 08:56.

EDHEC-Risk Institute has recently conducted a detailed analysis[1] on a set of popular stock market Asian indices, including indices from Japan (Nikkei 225, Topix 100), China (CSI 300, FTSE China 25), Hong Kong (Hang Seng), South Korea (KOSPI 200), India (NIFTY), Taiwan (FTSE TWSE Taiwan 50), Singapore (FTSE Straits Times), as well as from the ASEAN region (FTSE ASEAN). This study was motivated by the considerable development of index products in Asia, with the overall level of ETF assets under management (AUM) in the Asia Pacific region currently estimated at about $124 billion (Deutsche Bank, 2012[2]). Until now little analysis was done to evaluate the quality of Asian indices, while over the years a number of investigations have been conducted which questioned the efficiency and stability of US and European cap-weighted indices.

Thus, it seems interesting to perform similar analyses on a collection of Asian indices. It should be noted that all indices used were cap-weighted except the FTSE China 25 Index, which uses capping rules to limit the concentration in large cap stocks and the Nikkei 225 Index, which is price-weighted. Several important results were evidenced from the study.

First, it appears that the existing Asian stock market indices are highly inefficient compared to either in-sample mean variance optimisation, such as Global Minimum Variance (GMV) or Maximum Sharpe Ratio (MSR), or compared to equal-weighting of the same stocks. As shown in Table 1, considerable improvements in terms of risk-reward efficiency (i.e. Sharpe ratio) are achieved by the alternatively weighted portfolios, except for the GMV weighted portfolio of FTSE China 25. It should be noted that such in-sample portfolios are not feasible investment alternatives as they abstract from the problem faced in practice with reliable parameter estimation. The aim of our study was not to propose practical alternatives to standard market cap indices, but rather to identify the magnitude of improvement in terms of efficiency that potentially exists over standard indices. Thus, our results show that, if parameters could be properly estimated, there is considerable room for improvement in principle when constructing well-diversified portfolios.

Second, Asian indices appear to be highly concentrated as evidenced by results displayed in Table 2. Most market indices in Asia exhibit a small effective number of constituents, compared to their nominal number of stocks. The KOSPI 200 index appears to be the most concentrated index, with an effective number of stocks of 21 compared to the nominal number of 200 stocks, while the FTSE China 25 Index appears to be the least concentrated index. If we compare the results obtained in Table 1 and Table 2, it appears that indices for which we observe the maximum difference in Sharpe ratio between the Maximum Sharpe Ratio portfolio and the cap-weighted portfolio – i.e. the less efficient indices – are also those exhibiting the highest concentration, i.e. the lowest ratio of effective number of stocks to nominal number of stocks.

Finally, stability tests have shown that the 10 Asian indices considered exhibit considerable variations in both sector and style exposures during the period of investigation. The market indices in less developed countries (China and India) were those presenting the higher variability over time in terms of sector allocation.

It appears from this study that standard Asian equity indices suffer from the major drawbacks previously identified for US and European cap-weighted indices (cf. Amencet al., 2006[4]). The lack of efficiency of the standard Asian indices is perhaps not surprising given that they exhibit a high concentration in a small number of stocks. In fact, by overweighting the largest capitalisation stocks, these indices end up being exposed to stock-specific risk. Asian indices also suffer from pronounced fluctuations of their risk factor exposures, causing investors to be exposed to implicit choices on risk factor exposures when tracking a market index. Our findings suggest that there are good reasons for investors to assess whether practical improvements over cap-weighted indices will be able to reduce these inefficiencies and instabilities when investing in Asian equity markets.

[1] Padmanaban, N., M. Mukai, L. Tang, and V. Le Sourd. 2013. Assessing the quality of Asian stock market indices. EDHEC-Risk Institute (February):

[2] Deutsche Bank ETF Research Asia. 20 October 2012.

[3] The Sharpe ratios for the Nikkei are invalid due to the negative aggregate return over the period. In fact, a negative Sharpe ratio is not meaningful as increases in volatility would increase the Sharpe ratio when excess returns are negative. Therefore we prefer not to report the results for indices where the Sharpe ratio is negative and hence indicate these cases as N/A.

[4] Amenc, N., F. Goltz, and V. Le Sourd. 2006. Assessing the quality of stock market indices: Requirements for asset allocation and performance measurement. EDHEC-Risk Institute:

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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