The Relationship Between MSCI Emerging Markets Index, mini MSCI Emerging Markets Index Futures and the iShares MSCI Emerging Markets ETF

BY ICE FUTURES U.S.


This paper is the second in a series examining the relationship among certain international indices, and the futures and ETFs based on those indices. The first paper was authored by Mark Zurack and Linna Su of Columbia University, and considered MSCI EAFE, a broad global benchmark that tracks the performance on non-North American developed equity markets. In this paper, we extend that analysis to the most recognized benchmark for global emerging markets — MSCI Emerging Markets Index.


Both institutions and individuals invest in the MSCI Emerging Markets Index (EM) as a way to obtain global emerging market equity exposure. EM exposure is achieved in many ways:

  • Directly purchasing a portfolio designed to track EM
  • Investing in an Exchange Traded Fund designed to track EM
  • Combining Fixed Income Securities and EM Futures to create a “synthetic EM index”
  • Combining Fixed Income Securities and EM Equity Swaps to create a “synthetic EM index”

Many institutional investors are used to these choices when purchasing domestic indexes (like the S&P 500) and find on a day to day basis all four choices provide very similar returns. For EM index exposure, return differences are greater. In this report we investigate why these differences are greater, specifically comparing the monthly total returns for the MSCI EM index, the iShares MSCI EM ETF, and a synthetic indexing strategy that combines short-term Fixed Income securities with mini MSCI futures that trade on ICE Futures US. We leave out purchasing a portfolio of stocks; for most investors that is too cumbersome a process. We also leave EM Index Swaps out of the comparison; swaps expose the investor to credit and liquidity risk and reliable historical prices are hard to find.

We found that over the four year period studied, the annual return of EM and the iShares ETF differed by 98 basis points (bps), and the synthetic index using mini MSCI EM futures underperformed the index by 116 bps.

The standard deviation of return differences (tracking error) between EM and the Net Asset Value of the ETF was relatively low, with tracking error rising significantly when actual market prices of the ETF and Futures prices were considered. However, 50% of the incremental tracking error can be explained by timing mismatches between when EM is calculated and ETF and Futures prices recorded. We also found that the EM calendar spreads were overvalued during the period, explaining the great majority of the underperformance of the synthetic index strategy; but that the level of overvaluation declined significantly by the end of the period.


The securities discussed in this report are for illustrative purposes only and do not represent a solicitation by Equinox to invest in any security. The opinions presented herein are solely of the 3rd party author and may not represent the opinion of Equinox or any of its employees

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