I don’t agree with every word uttered by Jack Bogle, the founder of indexing behemoth Vanguard.
Of course, I have no problem with Bogle’s touting of index funds – in contrast to the active investing salesmen [1] who try to exploit people’s natural suspicion [2] of passive funds (“Cheap and dumb can’t really be smart and profitable, can it?”)
No, the thing I find disagreeable is Bogle’s claim that US investors needn’t bother investing overseas [3].
Bogle recently told Bloomberg [4]:
“When you look at global market capitalization it’s true that the U.S. accounts for about 48 percent and other countries 52 percent.
But the top three markets outside the U.S. are the U.K., Japan and France.
What’s the excitement about there?
Emerging markets have great potential, but have fragile sovereigns and fragile institutions.
I wouldn’t invest outside the U.S. If someone wants to invest 20 percent or less of their portfolio outside the U.S., that’s fine. I wouldn’t do it, but if you want to, that’s fine.”
All the other passive investing gurus point to the diversification benefit [5] of investing overseas.
But Jack Bogle doesn’t just suffer from unthinking home bias [6] – he presents it as an optimal strategy!
Team America
Bogle has been right about so much in his 85 years that I don’t dismiss his view out of hand. The man is a legend.
Also, the most important thing to appreciate from a UK perspective is that if you’re going to do Bogle-style home bias anywhere, you want to be a US investor.
It’s not just that the US has well-established regulatory institutions – compared to say China – or a sophisticated and liquid market – compared to say Peru.
We in the UK also have a good legal system and a liquid market (far better than China and Peru, anyway).
We also have a market where our top 100 companies earn more than 70% of their money overseas. That’s a superior global reach to the US multinationals, albeit I’d argue in part through lower quality sectors such as materials and energy.
However the pound is no longer a reserve currency, unlike the dollar, which is one big advantage enjoyed by US investors.
Also, the US market’s share of the global whole has only grown since Bogle opined on the subject.
- The US market now makes up over 50% of the world’s market capitalisation.
- The UK is good for just 7.4%!
This means a US-only investor is more than halfway towards the weighting of Vanguard’s Total World Stock Market ETF [7] without putting a cent overseas.
In contrast, a UK-only investor is under-weight some 92% of total world index.
In light of all that, you can see why a US investor might seek to sidestep currency risk [8] and the other complications of overseas investing (such as withholding taxes [9]). They are in a unique position.
As I say, I don’t think it’s the right decision even for them strategically, and as it happens (and sacrilegiously when writing on Passive Investing Tuesday, I know) I suspect it’s not a good idea tactically, either.
Why?
Because the growth of the US market to an even greater portion of the global pie may well suggest it’s due for a thwack with the old leveling stick (you know, the one labelled ‘reversion to the mean’).
But anyway, if you’re a passive investor [10] who doesn’t want to invest overseas, best you live in the US.
Techno-mericans
There’s another thing stay-at-home US investors have in their favour which I’ve not mentioned yet, which is that their market is host to the world’s most innovative and vibrant tech sector, by a supersonic mile.
In the US, technology is the largest single sector of the market, making up 17% of the total US market [11] (and nearly 20% of the S&P 500 [12] index).
And if you think about the companies that are driving humanity’s move towards the robot-powered, cloud-based, artificially intelligent utopia/dystopia of tomorrow – where there’s nothing for us humans to do but eat and swap pictures on Instagram – then you probably don’t want to hear about the UK’s puny share of the high-tech spoils.
Okay, you asked for it.
It’s roughly 1%.
Yes: The UK tech sector is about one percent of the total UK market.
I’ve seen tracker funds with higher fees than that!
Dotcom again
Being so underweight technology matters because while it’s a very volatile sector, it’s also been a huge driver of global returns in recent decades.
The following graph from Credit Suisse is an eye-opener:
[13]Note how the blue line (US tech) has outpaced the red (the world)
Yes, barely 15 years since the Dotcom boom and bust, the US technology has regained almost all the ground it lost, and it’s racing ahead of the World Market.
It’s the most surprising comeback since John Travolta appeared 15 years after Grease to dance with Uma Thurman in Quentin Tarintino’s Pulp Fiction.
Of course, things are very different today.
For a start, another 15 years have passed and now Mr Travolta is really too old [14] to be bothering young women.
More importantly, the US tech sector is a different beast, too.
According to CapitalIQ, the tech-focused Nasdaq index’s P/E ratio is about 28.
That might seem high, but the Nasdaq’s P/E ratio was around 200 at the end of December 2000!
(Yes, young ‘un, you heard me right. 200. Go read this prescient Chicago Tribune article [15] for more on the crazy time that by good fortune I witnessed only as a wallflower [16]. Crazy times.)
Not only are tech companies much more profitable than in 2000 – they’re far more economically embedded, too, in my view.
Apple is the largest company in the world, for example, and the smartphone revolution it spawned has enabled companies that didn’t even exist 15 years ago such as Facebook, Google, and Uber to reach hundreds of millions if not billions of customers around the world.
A lot of the recent growth of the Nasdaq has also been driven by a surge in biotech shares.
There’s perhaps a faint echo there of 2000 (the likes of GlaxoSmithKline and AstraZeneca were formed around then) but biotechs are really a different story (and very possibly will end up in their own bubble).
The bottom line is technology is a perennial growth engine, and the UK has very little of it – ARM Holdings, and, um, a few small caps.
Don’t let the sun set on your investment empire
Now this isn’t a post to say you should rush out and load up on technology stocks – although I think we will hear plenty of that over the next few weeks if the Nasdaq index does break through its old Dotcom peak.
It’s just to highlight one of the dangers of sticking too closely to home when investing your money in shares.
Remember, risk can be transformed but risk cannot destroyed [17] in investing.
Any passive investor seeking to avoid currency risk and overseas volatility by sticking to the UK market in recent years has paid for it with underperformance, partly due to that technology deficit.
The best way for passive investors to avoid this fate is by investing in diversified portfolios that pay their respects to global market weightings.
Our collection of simple ETF portfolio ideas [18] is a good place to start.
Bolt-on technology upgrades
Alternatively, if you’re not persuaded to properly diversify overseas but you have decided you want to up your tech weighting, adding a cheap Nasdaq tracker is a simple solution.
There are also long-standing tech-focused investment trusts [19] for those who are so inclined, such as the Herald Investment Trust and the Polar Capital Technology Trust. (Disclosure: I own the latter).
As a nefarious active investor [20], I’m more exposed to the UK than other regions of the world. That’s because while I’m deluded enough to think I can pick market-beating stocks in the relatively small market I know best, I’m not so arrogant to think I can also do it in Argentina or Indonesia or even Germany.
So I get my overseas exposure via index funds, ETFs, and investment trusts, with a smattering of US shares added to the mix.
And where do the majority of my US companies do their business?
You guessed it – in the tech sector!
The bottom line is while I make no short-term predictions [21], over the long-term I think the UK’s puny weighting in technology is a 1% club you do not want to be part of.
Note: In case you’re wondering, The Accumulator will be away quite a bit over the next few months as he’s writing the first Monevator book! So I’m afraid you’ll have to put up with me running a little more off-piste most Tuesdays, though I’ll try to keep it under control. Also T.A. will be popping in now and then with a fresh post when he’s had enough of his writer’s garret. We’ll also be taking the chance to update and re-run a few of his golden oldies, too.