Freedom-Weighted Emerging Markets Index
Build an investable emerging-markets portfolio by weighting institutional freedom
- Difficulty
- Expert
- Time to result
- ~months to results
- Steps
- 7
- Confidence
- 98%
Begin with a recognized emerging-markets country universe, then remove markets that are too small or illiquid for an ETF. Apply independent personal and economic freedom data from established think tanks to the remaining countries and assign positive or negative weights based on their freedom levels relative to peers. Exclude negative-weight countries rather than making discretionary geopolitical calls. Within each included country, hold its largest, most liquid companies while excluding state-owned enterprises and companies whose value primarily represents an excluded-country holding. Rebalance annually when new freedom data becomes available. A separate decline rule removes a country at rebalance if its freedom score has fallen sharply, reflecting the observation that institutional deterioration can happen much faster than institutional improvement.
Origin
Perth Tolle developed the approach after living in China and Hong Kong, where she saw how personal and economic freedom affected individual lives. She later combined those observations with her indexing experience at Fidelity to create the Life and Liberty Indexes and the Freedom 100 Emerging Markets ETF.
Core principles
- 01Use independent quantitative data rather than subjective country judgments
- 02Screen for investability before applying philosophical or strategic factors
- 03Weight countries by freedom instead of market capitalization
- 04Exclude state-owned enterprises to reduce direct government exposure
- 05Apply rules consistently and rebalance on the data provider's schedule
- 06Treat sharp freedom declines as potential leading indicators of tail risk
How to run it
- 1
Define the country universe
Start with a recognized emerging-markets universe that clients can compare with their existing benchmark. Preserve the ability to add or remove countries as classifications and market conditions change.
Pro tip Using a familiar benchmark universe makes differences in country allocation easier to explain.
Watch out Do not assume every classified emerging market is practically investable.
- 2
Screen for investability
Remove countries that fail minimum market-cap, liquidity, trading-volume, or capital-access requirements. This ensures that the eventual index can operate as a liquid ETF rather than as a purely theoretical portfolio.
Pro tip Measure each country's market capitalization relative to world market capitalization.
Watch out A country may be highly free but still too small or illiquid to include.
- 3
Import independent freedom data
Use quantitative third-party measures covering personal freedom, economic freedom, rule of law, property rights, civil liberties, and related institutional conditions. Restrict analysis to eligible countries and avoid altering scores based on personal opinion.
Pro tip Use providers with transparent methodologies and broad country coverage.
Watch out Mixing subjective overrides into the inputs undermines the rules-based process.
- 4
Calculate freedom weights
Assign country weights according to freedom scores relative to eligible peers. Exclude countries receiving negative weights and allocate the portfolio among the strongest remaining markets.
Pro tip Use freedom as the primary weighting factor if the goal is to isolate its effect.
Watch out Adding unrelated factors may make it impossible to determine whether freedom drove the results.
- 5
Select investable companies
Within each included country, choose the largest and most liquid companies that are not state-owned enterprises. Apply an indirect-exposure rule when a company's assets are substantially composed of a business located in an excluded country.
Pro tip Keep security-level rules simple so the country factor remains dominant.
Watch out A company's legal domicile can conceal concentrated economic exposure to an excluded market.
- 6
Rebalance with fresh data
Rebalance after the annual personal and economic freedom data release. Hold the rules-based portfolio between scheduled rebalances rather than reacting discretionarily to every political headline.
Pro tip Align the rebalance date with the reliable availability of updated source data.
Watch out Annual data creates a lag between political deterioration and portfolio changes.
- 7
Apply the decline safeguard
At rebalance, remove a country that has fallen more than five points on a monitored freedom scale. This protects against rapid institutional decline even when the country's absolute score might otherwise leave it eligible.
Pro tip Track downward momentum separately because freedom tends to decline faster than it improves.
Watch out Do not use anticipated reforms as a substitute for measured conditions on the ground.
In the wild
The rules assigned insufficient freedom scores to Russia and China, so neither was included before their most visible market disruptions. The portfolio consequently avoided Russia's post-invasion collapse and much of the damage caused by China's technology crackdown without introducing an ad hoc country blacklist.
→ The freedom factor acted as a leading indicator of governance-related tail risk.
Turkey fell more than five points on the prior year's freedom scales during the 2018 index rebalance. The decline safeguard removed it from the index, and it had not returned by the time of the interview.
→ A rapid deterioration rule prevented continued exposure to a country with worsening institutions.
Feedback showed that South African company Naspers derived essentially its entire market capitalization from Tencent. The methodology was amended so a company could be removed when more than the specified share of its assets consisted of another company located in an excluded country.
→ The index closed a loophole that allowed indirect exposure to bypass the country screen.
Common mistakes
Weighting by market capitalization
Market-cap weighting can make the largest autocracies the portfolio's largest positions even when their institutions expose investors to severe governance risk.
Making discretionary country exclusions
Arbitrarily removing countries turns the strategy into a subjective blacklist. The framework instead applies the same independent measurements and rules to every eligible market.
Ignoring indirect exposure
A company domiciled in an included country may derive most of its value from an excluded market, defeating the purpose of the country screen unless look-through rules are applied.
Is it for you?
Best for
It is best for long-term investors who want liquid emerging-markets exposure aligned with institutional quality and personal and economic freedom.
Not ideal for
It is not ideal for traders seeking immediate reactions to political events or investors who want conventional market-cap benchmark tracking.
From the transcript
“It's a hundred percent freedom weighted. It's not a it's not a tilt, and it's not in an overlay.”
“we take the top ten largest most liquid companies in each country that is not a state owned enterprise.”
“There is a rule that, uh if if if country falls more than five points on one of our skills, that we do kick it…”
From the episode
Perth Tolle on ETF Freedom Metrics
Perth Tolle