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 who try to exploit people’s natural suspicion 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.
Bogle recently told Bloomberg:
“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 of investing overseas.
But Jack Bogle doesn’t just suffer from unthinking home bias – 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 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 and the other complications of overseas investing (such as withholding taxes). 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 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 (and nearly 20% of the S&P 500 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:
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 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 for more on the crazy time that by good fortune I witnessed only as a wallflower. 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 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 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 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, 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, 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.
Comments on this entry are closed.
I think its crazy to invest in the “UK market” when its just a bunch of random companies that just happen to have listings in London
In fact you can cover most of the world’s stock and bond markets with just a handful of vanguard funds/etfs and just think about more important things apart from once or twice a year
The article you refer to on the example ETF portfolios are mostly all created by American investors, so the home bias in them is based on the US. Should we change our home bias even more to reflect the UK’s stock market world level?
I see in Vanguard Lifestrategy the balance is much less:
100% Lifestrategy – UK = 25%
80 and 60% Lifestrategy – UK= 12%
Not saying these are right at all. I think they only changed the allocation in the last year away from a heavier home bias, to reflect the actual global equity spread more (just more US probably).
Does this all mean my Tadpole Technology shares I bout circa 1999 will rise from the ashes and enable me to retire?! 😉
@Geo — The total world market ETFs I reference do not reflect any home bias. That’s the point! 🙂
They are weighted according to global market weightings.
The LifeStrategy fund you cite *does* reflect home bias. They have more UK exposure, I believe to dampen currency risk. At still only 25% UK I think that’s fine.
@TI
I mean the ETF portfolios 😉
“Our collection of simple ETF portfolio ideas is a good place to start.”
http://monevator.com/9-lazy-portfolios-for-uk-passive-investors-2010/
I think it’s pretty impressive that our tiny little speck of land has so many profitable companies that go out and earn their money from all round the world. It’s not a bad thing to invest in them, especially in terms of currency and foreign tax perspectives.
That being said, I like to diversify, and I like small-caps – so I like to buy foreign trackers of smaller companies in the US and Japan.
With regards to tech, there are some sub-sectors in which the UK is rather good at, such as FinTech. FinTech financing in the region has
grown at twice the rate of Silicon Valley since 2008…
Cheers
I am sure the Monevator book will be very good. And I hope it will be extremely cheap:)
I think high yield/dividend bores will tend to have a UK bias and hold less tech stocks as they have historically not paid out much in dividends. Plus anyone who got burned in tech stocks in 2000 will have a long memory….
As to home bias I’m currently 50% UK and 50% rest of the world, but thats really because the FTSE 100 get 75% of its earnings from overseas anyway, and pays over 3% yield.
Interesting point though, never realised the UK market was so weak in tech compared to the US main market indices which explains some of the FTSE lag.
After years of (fairly profitable) messing about I have settled on a simple 2 fund mix for the passive part of my portfolio.
It consists of 25% in Fidelity’s FTSE UK All Share index and 75% in Fidelity’s World Index (which already contains a percentage of UK shares). I end up with about 30% overall in the UK and 70% in the rest of the world.
This portfolio was selected as it gives the most even sectoral split that I could easily manage using the minimum number of funds. Thus I avoid under-exposure to sectors like technology while also avoiding over exposure to other stuff.
Oddly enough, I’ve since found out that my portfolio has a very similar sectoral (and geographic) mix to the Vanguard Lifestrategy 100 fund – which has done rather well at insulating UK investors from stock market volatility over the last few years.
I’m sure in The Accumulator’s series on return premiums, he specifically mentioned at some point that there doesn’t appear to be a sector premium. So does it just mean that recent outperformance of tech was matched by outsized risk? As you say in the article, it’s a very volatile sector.
If you don’t like ETFs, the Legal & General Global Technology Index Fund is a good option.
Taxes often increase a home bias, at least they do in the USA.
“the smartphone revolution [apple] 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”
I think Google as a company has been around since around 1998 and reached billions of people long before the iPhone (back in the Dark Ages before the iPhone people used “desk top” and “lap top” computers mostly running some other company’s operating system). Also mobile is not as profitable as laptop/desktop for Google’s ad system. I think it’s a very common theme in tech journalism to imply that Apple is much more revolutionary than it really is. Apps for taxis and romantic hook-ups are fun though I suppose.
Anyway axe-grind over – tech as a whole is great. South Korea, Taiwan and Japan still have plenty to offer and China is making good ground as well, though most of China’s tech companies are listed on New York and don’t seem to be in either emerging or global indices from what I can tell, so you have to buy the shares directly. Ali Baba isn’t even on Nasdaq so you can’t just buy the Nasdaq Comp either.
To answer the question is the headline, my personal position is “Hell no!” because I’ve been sucking on that teat for many a decade. And yes, this spanned the dot com crash, and I even sold a technology company that I founded a couple of weeks after 9/11.
However, it really is a sector where hype is best ignored, and due diligence needs to be very deep.
I saw some research recently (don’t have the link to hand unfortunately, it might have been a link on a Bogleheads forum post) which went back over many decades, maybe before the war, which indicated that, over time, the sweet spot for American investors was 80% US, 20% RoW.
Conversely, for the UK it was around 25% UK, 75% RoW. It’s significant that last year Vanguard reduced the UK component of the equity part of their Lifestrategy funds from 33% to 25%.
So perhaps Jack Bogle’s advice, aimed at American investors, is not that daft. Also note that the American stock market is intrinsically more diversified than the UK one which is heavily skewed to a few sectors, mining being the most obvious.
Can anyone explain the advantage of holding several ETFs or funds in a similar ratio to their global weighting v a total stock market fund such as VWRL. If it comes down to eggs and baskets why not diversify by buying a similar product from a competitor.
On the same vein why would vanguard have so many constituents to their life strategy funds, surely from a purist perspective a simple total market is best, and if you want home bias buy some extra FTSE all share funds.
AG
@david — Don’t agree. 🙂 I was involved in setting up a company that had a lot to do with mobile in 2005/2006, and I can tell you that when it comes to anything other than making phone calls and text messages, it’s life before iPhone, and life after iPhone. It’s year zero.
Companies like Nokia were roaming the world giving presentations about how they were enabling all this incredible stuff, but frankly none of it worked — not from a human interface experience, from a connectivity experience, or even from a useful ‘app’ (although that word wasn’t even invented then) experience. Just buying a piece of software for your ‘smart’ phone was a hit and miss affair — some high double digit percentage of games, productive tools and other purchasable-over-the-air software pre-iPhone never even made it to your phone after you’d paid! (No personal offence meant if you work/ed for Nokia… I think the company was strategically incompetent in that era, and said so repeatedly at the time, so this isn’t just hindsight speaking! 🙂 )
You are quite right about how revenues for the likes of Google and some other Internet giants are higher on a per user/click/impression basis on desktop. However I don’t think that really refutes the importance of mobile at all.
Firstly, that’s where user base is growing. Secondly, those users are using those services more and more every day.
‘Apps for taxis and hook ups’ might not seem like a big deal to you currently (though Uber already has a $40 billion valuation so others clearly disagree 🙂 ) but this is really just the start of the process, similar to dial-up modems in 1995. Putting this stuff on a phone (or some other wearable) transforms its usefulness and integrates it with our every day reality. It is not at all unusual for me to go out to meet friends at an address I don’t know (google maps) after checking the tube status (app for that) and meeting (via text/a call/WhatsApp) before we decide on the fly to check out a couple of new places (Google / other apps).
As for Google’s revenues in 1998, my data only goes back to fiscal year 2001.
Here’s the skinny:
Google revenues and income in 2001: $86 million in revenue, net income $7m
Google revenues and income in 2014: $66 Billion, net income $14.4 Billion
The iPhone as you know came out in 2007. So for what it’s worth in 2006 Google had revenues of $10.6billion, which earned it $3 billion.
So revenues are up about 75-fold since 2001, or just six-fold since the iPhone. 😉
@TonyP
Thanks for your comment about Vanguard changing the %age of UK equities held. I had recently been beating myself up for for messing up my UK vs. rest of the world allocations in my pension.
These were originally based on the VLS split and I couldn’t see how I was suddenly c. 10% on UK equities!
This explains the change, thanks 🙂
Investing overseas should not automatically be assumed to have currency risk.
If one is intending to live abroad in future, or even take regular long holidays, that will involve spending money abroad.
In such cases, investing abroad can be a very good way to reduce currency risk.
@Jeff — “Currency risk” is a financial term that we could call “the risk of currency volatility increasing or decreasing your returns”. The risk is upside or downside. What you’re describing is not a way that currency risk does not exist, but a scenario where it might be seen as a positive. 🙂