Making the case for world equity index trackers is former hedge fund manager turned author Lars Kroijer, an occasional contributor to Monevator. His book, Investing Demystified, is focused on index fund investing.
I believe the only equity exposure you should buy is the broadest, cheapest, and most tax efficient – which is a total world equity index tracker.
Most Monevator readers are probably already willing to accept the following points, which in my view will massively improve your returns over time:
1. You accept that like most investors you don’t have an ability to outperform the financial markets (a so-called ‘edge’) and as a result you agree that you should invest in index tracking products. In other words you’re what I call a ‘rational investor’.
2. You agree that keeping trading to a minimum and investing tax efficiently with the lowest fees will boost your returns in the long run.
3. You accept that to have a hope of decent long-term returns you should have some equity exposure, as the dull returns that safer bonds or cash in the bank provide (which may not currently even beat inflation) mean those assets are very unlikely to do the job alone.
So having agreed to all that, the question is which equities should you own?
Investing without edge
From the perspective of the rational investor – an investor accepting and embracing the fact they don’t have an edge in the market – each dollar, pound, or euro invested in the various stock markets around the world is presumed to be equally smart.
If the markets say a share in Apple is worth $125 and a share in Microsoft is worth $40, then we as rational investors don’t have a preference for owning one of those shares over the other, at those prices.
If we did have a preference, then we would effectively be saying that we know more about the future movements in share prices than the aggregate market does.
As rational investors, we don’t believe that’s true.
We believe that the money/person buying Apple is no more or less clever or informed than the money that’s invested in Microsoft.
And so we follow the money.
The case for market capitalisation weighting
Extrapolating this logic to the whole market means we should own shares in all the market’s stocks, weighted according to their fraction of the overall value of the market.
Let’s assume for a moment that ‘the market’ refers only to the US stock market, and that right now Apple shares represent 3.5% of the total US market value.
This implies that 3.5% of our US equity holdings should be in Apple shares.
If we do anything other than this, then we are effectively saying that we are cleverer or more informed than we really are – that we have an edge over the other investors in the market.
But we don’t believe that’s true.
So 3.5% in Apple it is.
Follow the global money trail
Buying hundreds of shares in a stock market in proportion to their overall market capitalizations is much simpler today than it was even a generation ago.
It is pretty much what most index tracking products offer, assuming they are so-called market capitalisation trackers. (There are other sorts of trackers, which I believe we should reject as rational investors. I’ll explain more in a future article).
In our example above, Apple would constitute 3.5% of the value of a US index tracker.
But why stop at the US market?
There is no reason to think that the UK market is any less informed or efficient than the US one, for instance.
So if there is $15 trillion dollars invested in the US stock market and $2 trillion invested in the UK market, that’s what our portfolio should mirror if we’re to track each dollar, pound, or euro of global capital.
Likewise with any other market in the world investors can get access to.
We should invest in them all, in proportion to their share of the world equity markets, as best we can in practical terms.
No home advantage
Some of you may be nervously twitching at this point. You know you’ve got a lot more money in the UK stock market than in other markets around the world.
This is illogical for rational investors, although it is not unusual.
Many investors around the world overweight their ‘home’ equities.
For instance, the UK represents less than 3% of the world equity markets, but the proportion of UK equities in a typical UK investor’s portfolio is often 40% or more.
Why does this happen?
Investors feel they know and understand their home market. And perhaps active investors think they would be better able to spot opportunities before the wider market at home. (A fanciful notion for us rational investors!)
In fairness, the concentration in home equities can also be because of investment restrictions or perhaps because investors wrongly are matching their investment with liabilities connected to the local market.
Another factor that’s cited is currency risk.
While I think there is some merit in currency matching specific and perhaps shorter-term liabilities via your investment portfolio, I think such matching is better done through the purchase of government bonds in your home currency.
If you worry that major currencies fluctuate too much for you, then I would ask if you’re taking too much equity market risk in the first place?
Broader investment and currency exposure is in my view favourable not only from an additional diversifying perspective, but also as a protection against bad things happening in your home country.
Typically whenever a currency has been an outlier against a broad basket of currencies, it has been a poorly performing one because of problems in that country (though there are exceptions to this rule of thumb).
And it is exactly in those cases that the protection of diversified geographic exposure is of greatest benefit to you.1
Whatever the reason, various studies have suggested that this supposed home field investment portfolio advantage is not real, but many of us still continue to allow our portfolios to be dominated by our home market.
If you are overweight or underweight one country compared to its fraction of the world equity markets, then you are effectively saying that a dollar invested in the underweight country is less clever/informed than a dollar invested in the country that you allocate more to.
You would therefore be claiming to see an advantage from allocating differently from how the multi-trillion dollar international financial markets have allocated.
But you are not in a position to do that unless you have edge.
And we agreed we don’t have edge…
Since the millions of investors who make up the global markets have already moved capital between various international markets efficiently, the international equity portfolio is the best one for anyone without edge.
That’s on top of the other advantages of added diversification, simplicity, and cost.
Do you know better than all the world’s other investors?
Take me as an example. As a Danish citizen who has lived in the US and UK for more than 20 years, I might instinctively over-allocate to the US and Europe because I am more familiar with those markets than, say, Thailand or Japan.
But in doing that I would implicitly be claiming that Europe and the US would have a better risk/return profile than the rest of the world.
It might or might not turn out that way, but the point is that we rational investors don’t know ahead of time.
Similarly, you’ll often hear investors say things like: “I believe Brazil, Russia, India, and China are set to dominate growth over the next decades and are cheap”.
Perhaps you’d be right to say so, but you would also be saying that you know something the rest of the world has not yet discovered.
This is not possible unless you have edge.
Rational investors who accept they don’t have edge should therefore simply buy the global equity market.
The advantage of diversification
The world equity portfolio is the most diversified equity portfolio we can find.
And the benefits of diversification are great.
Consider the following chart showing how diversification impacts risk in a home market, such as the UK stock market:
As you can see from the chart, the additional risk reducing benefit of diversification tails off as we add ever more securities to a home market portfolio.
This makes sense. Shares trading in the same market will tend to correlate, since they are exposed to the same economy, legal system, and so on.
This means that after picking a relatively small number, you have diversified away a great deal of the market risk of holding any individual company.
But by further expanding our portfolio beyond the home market we can achieve much greater diversification in our investments.
This is not just because we spread our investments over a larger number of stocks, but more importantly because those stocks are based in different geographies and economies.2
So we could have similar chart to the one above, but one where “securities” was replaced with “countries” in the x-axis.
Only a few decades ago, we did not have the opportunity to invest easily across the world like this.
But with the range of index funds and ETFs now available, investing in a geographically diversified way is a lot easier than it used to be.
One fund to do it all
In fact today you can invest across the global equity market by putting your all your equity money into a single world equity tracking fund or ETF.
To summarize the benefits:
- Your portfolio will be as diversified as possible and each dollar invested in the market is presumed equally clever; consistent with what a rational investor believes. (I bet a lot of Japanese investors wished they had diversified geographically after their domestic market declined as much as 75% from its peak during the past 20 years.)
- Since we are simply buying ‘the market’ as broadly as we can, it’s a very simple portfolio to construct and thus very cheap to run – and of course we don’t have to pay anyone to be smart about beating the market. Over time this cost benefit can make a huge difference. Don’t ignore it!
- This kind of broad based portfolio is now available to most investors, whereas only a couple of decades ago it was not. (Most people then thought ‘the market’ meant only their domestic market.)
Even if you are already an index tracking investor, for some of you getting an internationally diversified portfolio may have involved combining multiple products in a bit of an ad hoc way to gain international exposure (perhaps based on gut feel of which markets will outperform).
Don’t bother. The market has already done all the work of allocating between countries and regions for you.
Instead, focus only on how much you want in equities overall compared to less risky asset classes and on collecting the equity premium.
The bottom line is you should buy the broadest based index tracking products you can.
By definition, that’s a total world equity market tracker.
Lars Kroijer’s book Investing Demystified is available from Amazon. He is donating all his profits from his book to medical research. He also wrote Confessions of a Hedge Fund Manager.
- Currency hedged investment products do exist, but in my view their on-going hedging expense adds significant costs without clear benefits, and on occasion further fails to provide an accurate hedge. Besides, many companies have hedging programs themselves meaning that a market may already be partially protected against currency moves, or have natural hedges via ownership of assets or operations that trade in foreign currency (like Petrobras owning oil trading in USD). [↩]
- I believe this is still true, despite international correlations having gone up as the world has become more inter-related and large companies increasingly global. [↩]
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excellent article. quick question though:
which is the lowest cost total world equity market tracker?
and what about bonds? is there a way o getting global bond exposure ( or at least a good mix )?
A really good article. The first dozen paragraphs really sum up the rational for passive investing well.
A follow up comparing world trackers would be very interesting. Not just which is best(!), but the 2nd and 3rd place trackers too, for those wanting to diversify across providers / asset managers.
Fantastic article. But what I really want to know is whether you think it is smart for current index tracking investor to swap his/her portfolio over to this one global tracker?
I currently have a portfolio based on the 90% equity suggestion from one of your previous blogs but having everything tied up in one tracker sounds pleasing.
@moneyshot
There is the Vanguard Global Bond Index Income (Hedged GBP) which tracks the Barclays Global Bond Index and charges (I think) 0.2% up front and 0.15% annually. If you want global the Barclays Index seems to be the one to track
I just bought a gilt with a maturity close to my retirement age myself, no ongoing fee
I don’t overweigh my home market because I understand it but because it goes some way to aligning the fortunes of my equity exposure to my likely day-to-day costs. It is not because I think I have an edge but because the UK is a relevant market for me. Is that illogical?
@Steve — Well, that’s the section Lars talks about in respect to currency risk. 🙂
I think it’s fair to say reasonable minds do differ on this, especially from a private investor’s point of view (as opposed to an institutional one) and given that a lot of UK large caps earn overseas (70% of FTSE earnings are generated overseas so there’s some potential offset to currency weakness there, as well as to suffer from a strong pound).
Whatever happens home bias does leave you more exposed to individual country risk. (e.g. UKIP and the Greens form an unholy alliance and privatise the FTSE 100! Obviously extremely unlikely but you get the drift. Japan is the key one to think about in recent times).
(I discussed some of the arguments from the point of view of the US with my recent tech shares article from last week.)
VWRL costs 0.25% TER
VEVE costs 0.18% TER but doesn’t include emerging markets.
Any thoughts on which one to choose ? Is VEVE technically a smart Beta product, because it is just the developed world ?
I put 2/3 of my ISA into VUKE (0.09% TER) a year ago, and how I am regretting it… Procrastinating about changing it to VEVE or VWRL.
When I looked at the composition of the VWRL fund on Morning Star it seemed that almost 51% of the fund was in the US. So if you switched all of your current investments into this one fund, then 51% of your money would go into the US market. Is that correct?
@Jim McG
And the US is very overvalued, expensive market now.
Is there an advantage to the Lifestrategy fund (which AIUI keeps its geographical allocation to fixed proportions rather than cap-weighted) compared with VWRL?
And, VWRL is quite expensive compared with individual funds covering the geographical sectors separately. I can see that the simplicity is valuable, not least from a behavioural perspective, but how much does it cost in the long run?
Can I add my name to the list of people wanting a review of the various ‘all in one’ trackers – it would be great to get a comparison of not just of the Lifestrategy vs VWRL but also look at other company’s offerings (Legal and General and Blackrock also provide something akin to the LS, with a fund of index funds. I’m not aware of many other whole world cap weighted trackers)
It’s getting less over-valued every hour at the moment…
I held a bit of VWRL, and then decided it was cheaper to remake it using VUKE, VMID, VUSA, VERX and VFEM. I’ve ignored Asian exposure. Oh well.
Buying it costs 25bp
Making it costs about 10bp, but more hassle. (but VUSA at 7bp makes half of it immediately very cheap).
Of course constructing it this way does mean that you need to keep an eye on the allocation and also you can really easily succumb to the temptation to home bias.
From a diversification point of view, you probably want to buy non-Vanguard funds in there as well. ishares has good matches for most of those listed.
As simple as choosing one all in World Tracker is I cant say its that clear.
I see a lot of people on here advocate ETF’s which is great for people with larger sums, but I’m sure as many people like funds and the options they give.
If only it was simple to compare apples to oranges. Not all funds follow the same world indexes, some have more diversification, a lot don’t include UK at all, some are income only (ETF’s have a habit of this) and long term investors with small pots want accumulation automation.
This just smacks of how hard it is for inexperienced investors to get into investing when if you like slightly under the bonnet everything is so hard to compare. Lar’s idea is great, from my experience it’s just not that simple or clear what you are getting with products.
I’m sure @TA has probably done a run down of all world options? Maybe not. It maybe be an idea to pull info for ETF’s and funds together and explain which ones fall in which camps – all world, dev world, all world but no uk, all world but no EM etc etc……
Great article Lars.
Have been struggling with the issue of UK weighting for some time and switching all stocks to VWRL is an attractive option.
What bemuses me is looking at pension funds where for example one major fund is :-
32% UK Equities
31% Overseas Equities
13% Corp Bonds
10% Private Equity
7% UK Property
4% UK Gilts
3% Cash
Why do they do it?
Is there something different for the retiree?
Thanks and All Best
Great article, especially the home bias discussion.
Regarding execution: If I’m going to stick my entire portfolio somewhere, personally I’d rather go with OEICs domiciled in the UK for the FSCS protection than ETFs which are usually based overseas. Accumulation units are less maintenance than ETFs too, which usually distribute dividends.
Monevator’s low cost tracker list suggests two candidates: Fidelity Index World Fund Class I (OCF: 0.15%) and Vanguard LifeStrategy 100% (OCF: 0.24%, 0.1% dilution levy). Both have problems – Fidelity is developed world only and Vanguard has a home bias and higher OCF. I’m not so worried about the dilution levy as it goes into the fund and offsets purchase costs, benefiting long term investors.
If I had the choice, I’d go for the Fidelity fund and add a cheap emerging markets tracker to the tune of 7-8%, handling bonds separately if desired. I’m in the unusual position of being only able to hold one fund feasibly, as I’ll soon have esoteric foreign tax obligations. I’m leaning towards the broader but more expensive Vanguard, although I admit part of that is due to my perception of the UK market as currently better value than the US (I’m so sorry Lars!) and I trust the Vanguard brand.
If anyone can talk me out of it and into Fidelity (or another global tracker with accumulation units) I’d be very interested to hear the discussion! Cheers.
Don’t World funds tend to have higher ongoing charges than UK only, e.g. Vanguard UK All Share = 0.08%, whereas their World ex UK = 0.15%
Two key tenets of smart investing, as stated in the article, are diversification and keeping fees low.
How to decide whether to pay a higher fee to achieve more diversification?
I’d also like to see a showdown article: world-index fund vs fund-of-funds. Targeted at people who interested in very simple solutions only, for whatever reason – such as people with very limited time availability, people with very limited interest in investing but who are persuaded by the need, people who are investing low amounts and so can only spread their cash across a very limited number of funds due to minimum purchase amounts, etc.
For the world-index fund you could have two funds – the index and a single bond fund. For the fund-of-funds you could have one – e.g. the Vanguard LifeStrategy, or Blackrock Consensus, or Legal & General Multi-Index.
Although it would be limited by the fact that these fund-of-funds haven’t been around for many years, it’d be interesting to see cost comparisons, available performance data, etc. I think it’d bring in boatloads of readers to your excellent site.
Any chance of doing this, The Accumulator, The Investor, or maybe Lars?
Hi All
If it is logical to Index at all which seems to be the general conclusion of this Board then the next step is to go on and index globally.
My equities were a basket of global investment trusts that were closet world index trackers anyway and certainly more expensive than a Vanguard Global Equity Index Tracker.
My UK five year laddered gilts were ok but again entirely UK based. The World Global Bond Index Fund -hedged -would seem to be a safer bet-diversified and a chance of better growth though there are running costs unlike the Gilts
Of course there is a large US component in this selection but that is the way the world is anyway .
The way the U.S. economy has recovered compared with other economies has been a bonus
Another benefit is that as I get older my investments get simpler-surely a good thing!
Logically I would move eventually to one fund only-a Life Strategy Fund which even my wife could handle as I descend into my dotage
What do you think?
xxd09
Of
A quick scan of what is obvious offerings:-
VWRL – 25bp – FTSE Global Equity Tracker. Qtrly income
SWDA – 20bp – MSCI World index. No distribution.
IWRD – 50bp – MSCI World index. Qly distribution (wow that divi is costly)
There’s a slight difference between the indices regional make-up. Roughly:-
60% North America
8% UK
15% Europe exUK
8% Japan
9% RoW (Emerging+bit of AsiaPac)
If you were to buy in Vanguard ETFs
60% VUSA (7bp) (possibly VNRT – 10bp)
8% VUKE (9bp)
15% VERX (12bp)
8% VJPN (19bp)
9% VFEM (25bp)
You’d end up with a fairly close match for VWRL but at 10.5 bp (or 12 if you VNRT).
Even simpler would be
90% VEVE (18bp)
10% VFEM (25bp)
Which costs 19bp
Either way, I can’t see Vanguard maintaining VWRL at 25bp, when the market is at 20 and their own products construct easily to create a cheap version of it.
Should you worry about 10 or 15bp? I think we know the answer to that already from TI’s article at the weekend.
Hi all,
Very good read.
It would be interesting to see what a portfolio tracking the true world index would actually look like. Or is the article from a theoretical perspective and in reality we would need to build this from various sub-funds to get as close? (As even VWRL is missing small-cap – and I’m sure more – perhaps dividends?).
Is there are an argument for increasing home bias as you near retirement, as some kind of hedge against domestic inflation (assuming home equities provide a ‘real’ return?)
Awesome article though, and the more I read the more I agree with the sentiment 🙂
Mr Z
@moneyshot, Malcolm Beaton – The same logic doesn’t really apply to bonds. You don’t necessarily want global govt. bond exposure since this either exposes you to currency risk or increases costs for currency hedging. But if you want to avoid the low chance of the UK defaulting, then you make choose to take the hit.
@algernond – If you wanted to follow the advice in the article, then VWRL would be the better choice since it includes emerging markets.
@vanguardfan, @mathmo – VWRL is more expensive than individual funds, but as it is only 0.25% I don’t really see it as a problem, saving 1% on fees makes a considerable difference, saving 0.1% doesn’t. I don’t want to rebalance lots of individual funds so I’ve gone for VWRL. Also there is a reasonable chance Vanguard will lower the fees on this in the future (from their past record).
@Andy, @Mathmo – It’d be great to see an analysis of the impact of costs between owning just the VWRL and the set of cheaper ETF’s (including all the required trading costs)…. if only I had the willpower.
@Geo – It would be nice to have of choice of funds also, but being with H-L and their 0.45% charge, that’s not an option.
Andy
Thanks for your thoughts on Bonds
0.15% Running costs for Global Bond Index Fund-hedged!
0.20% Dilution cost on purchase
Holds mostly short term Govt Bonds but a few Corporates.
Jan 2014-2015 returned 8.52%.
xxd09
@algernond — the maths of your question is relatively straightforward. If you were to assume that equities get real returns of – say – 5% and you were looking at a period of – say – 40 years. Then you compare the relative cost of 10bp vs 20bp thus:
(1.048/1.049)^40 = 96.2%
The extra 10bp costs you about 4% over 40 years — 10 month’s performance.
If that were 10bp vs 40 bp then you’d be looking at about 10% drop.
10bp vs 100bp and you’re at the staggering 30% drop.
10bp vs 250bp of TI’s last article and that’s a 60% drop.
Global funds generally have quite a high US component.
That market is currently on a high PE & has a currency that’s towards the top end of it’s long term valuation range.
Holding a currency I might spend in the future REDUCES my currency risk. However, the USA is one country where I’m confident I’ll not be retiring to. I won’t holiday there much if at all. Although I might just spend some USD holidaying in Cambodia or other countries that use the dollar. Nevertheless, there are other overseas currencies which better suit my risk profile.
Over 90% of my portfolio is in stocks. About 17 % is in the UK, 9% is in “multinationals” & the remainder is overseas. I think about 2% is in the USA.
In the year or more since I bought Investing Demystified I have read it through several times, and it has revolutionised my investment thinking. Thanks to Lars Kroijer my previously irrational c.100K portfolio is now eminently rational, and for the first time since I began investing I feel genuinely confident, to the point of relaxation, that I have the optimal configuration for my needs, in the simple form of VWRL, VGOV and an instant access NISA, allocated cheaply and efficiently in the proportions of my choice.
Albert Einstein said, “There are five ascending levels of intelligence, smart, intelligent, brilliant, genius, simple, and simplicity is Kroijer’s watchword.
Correction: “There are five ascending levels of intelligence, smart, intelligent, brilliant, genius, simple.”, and simplicity is Kroijer’s watchword.
If home bias is a significant thing, then wouldn’t it inflate the market cap of markets in the most populous countries? I’m thinking particularly of the US, of course, with its daunting ~50% share of these global trackers. All those American investors putting too much money in their home market.
At least that’s my excuse for underweighting the US market in my collection of trackers, despite talking the passive-investing talk. Not because I think it looks expensive, no sir-ee!
Might I suggest you all stop squabbling and simply buy a Vangaurd All World Index (100% minus your age , adjust to taste) and a Vangaurd Goverment Bond Index (your age as a percentage) and then get on with your life.
i think its OK to drip feed into expensive markets as you can convince yourself that one day you will be drip feeding into cheaper markets and it will all level out in the goodness of time, the killer comes when you end up with a big lump sum on your hands for whatever reason.
we know that drip-feeding a lump sum is probably not going to pay off, but we also know that relatively high P/E ratios, CAPE valuations etc. probably mean relatively low future returns for that lump.
how do you square that circle?
is the answer a mechanical asset allocation that takes into account P/E, CAPE valuations, and if so how do you write that spreadsheet? has RIT shared his? Is there an article in there somewhere? Or maybe it already exists in the Monevator archives?
I understand the case for a single tracker to track everything (total world), given that I have no edge. But, I also recall ‘sell high, buy low’ in the context of re-balancing between several trackers, which is obviously impossible with just a single tracker. I wonder, is not being able to re-balance not going to hurt returns long-term?
@DaveS – well, one might expect a link if the percentage of the population involved in investing (either directly or via pension funds etc) per capita were the same for every country, but that seems unlikely.
A related point does bother me somewhat, however: Lars’ argument for global indexes makes a similar assumption….this time that home bias is equally strong across all nations. But if it’s stronger in (say) the US than in (say) Russia, then the former’s equities will be over-valued and the latter undervalued.
Going for global indexes over regional/national biases is not just a strategy based on the idea that “I’m no smarter or dumber than anyone else” (which I’d be comfortable with). It also assumes investors in all markets are no more or less gung-ho about their home markets, which seems unlikely.
This would predict that famously patriotic nations like the US are generally overpriced, and those who are somewhat more downbeat (eg UK) would be less overpriced. And recent p/e valuations suggest this is the case.
@Mathmo
Thanks for that illustration. I realise it’s quite an easy one to do, but it’s the extra cost of all the extra trading required for maintaining the multiple ETF portfolio that I was bemoaning the effort to factor in to the calculation….
Forgive me, I agree with most of this, but I still don’t understand how one defines the ‘world market’. e.g. Is it MSCI or FTSE (particularly with their differing EM views)?
Similarly the MSCI Frontier 100 is a pretty narrow index for the number of countries it covers.
As far as I see it, every tracker has an element of ‘Smart Beta’ to it – as there is no ‘one true world market’.
I went for two Vanguard ETFs for my global equities:
-50% VXUS @ 0.17% fee (inc. 19% emerging markets and some smaller cap I believe)
– 50% VTI @ 0.05% fee (inc. full US market, ie large, medium and small cap)
Total cost is 0.11% annually which is cheaper than a single fund.
I realize that this is a little US heavy, as US market cap is approx a third or so of global market (cost would be 0.13% with this weighting).
Vanguard published a research paper on home country bias a few years back:
https://pressroom.vanguard.com/content/nonindexed/6.26.2012_The_Role_of_Home_Bias.pdf
Surprisingly, for UK investors an 80% UK bias produced the best historical return consistent with lowest volatility.
I find this a very good article supporting the passive equity investment argument.
Although I hold an international spread of mainly index funds I do not carry in proportion to proportions in the world index.
I have a slight concern about the US proportion. (It has been raised already in replies above.) If there is a tendancy to home invest, and maybe a flight to large developed markets from other less developed markets, home of the $, etc etc…then the US market size may not be rationally efficient. It is what it is but does this mean we should follow it? Clearly I can’t second guess the future size of the US market! (sadly)_
Thanks.
Good article.
@Oldie: I’ve just discovered that Kyle Caldwell has crunched numbers relevant to this issue for the DTel yesterday: http://bit.ly/199oXSW
Essentially uses CAPE anomalies to detect value in various markets. An argument could be made for creating a global tracker by bolting together regional trackers in proportion to these anomalies, thus avoiding home bias/US bias etc.
@algernond — that would depend on your trading costs (which is a function of the size of your portfolio and platform). You would also have to factor in the rebalancing benefit that you would have with 6 holdings instead of 1…
@TheRhino — I was wondering this very thing this morning as I looked at FTSE fall and wondered if it was cheap yet. I can’t easily find a good source of the numbers to calculate the PE10s of the various indices. Are these easily available somewhere?
I know I shouldn’t but I fancy making my asset allocation partially dynamic.
There will be many readers here who have not actually read the Lars Kroijer book in question. Perhaps I can quote, selectively but essentially verbatim, from the section in it that is relevant to the theme of this thread and where he refers in one case to making something as complicated as the world financial markets into something almost provocatively simple .
“If the world equity markets are too risky for you, combine an investment in that with an investment in minimal risk bonds to find your preferred level of risk. With this simple rational portfolio you will, over the long term, do better than the vast majority of investors. And keep in mind that the portfolio can be created by combining just two index-tracking securities; one tracking your minimal risk asset and one tracking the world equity markets.
Remember that the world equity exposure represents an underlying exposure to a large number of often well-known companies in many currencies all over the world.”
another great article.
just an ALERT for anyone wanting to open an account with i web they .are putting up their account opening charges from £25 to £200 from 16 th march .
@Topman. Many thanks for that.
“And keep in mind that the portfolio can be created by combining just two index-tracking securities; one tracking your minimal risk asset and one tracking the world equity markets”.
In fact, one can now do it with one, via the Vanguard LifeStrategy range (am a 60/40 man myself….and v happy with it).
Certainly agree with other posters that one advantage of going with a simple global index is that all that mind-wrecking stuff like rebalancing, reacting to fads etc is all taken out of your hands.
I know my limitations…..
@ Hammy
Moi aussi!
LifeStrategy does retain a UK bias, at about 23% of its equities portion. An article last year suggested that they would like to go to a true market-cap weighting, but “…acknowledgement of the home bias was why Vanguard had not taken its LifeStrategy funds entirely global, because investors may not like such a move.”
http://www.ftadviser.com/2014/04/07/investments/etfs-and-trackers/vanguard-slashes-uk-exposure-in-lifestrategy-funds-eNRrzxCoQB0XTmXKCPMpIN/article-0.html
Some data :-
At the end of year Global Tracker ETF IWRD showed following top country allocations :-
Dec 2014 (PE) [Dec 2009]
USA 58.34% (18.21) [47.77%]
Japan 7.90% (21.35) [9.72%]
UK 7.87% (15.70) [10.30%]
Canada 3.93% [4.83%]
Eurofirst 300 (20.02)
France 3.63% (25.66) [5.24%]
Switzerland 3.52% [3.70%]
Germany 3.45% (17.34) [3.86%]
Australia 2.75% (19.82) [3.97%]
Apologies for the formatting.
WARNING : Before comparing PEs it may be prudent to also contemplate projected growth rates for the countries concerned (i.e. PEG ratios). e.g. Russia may look cheap for more than reasons of sentiment, it may also lack growth.
http://www.starcapital.de/research/stockmarketvaluation?SortBy=Shiller_PE
If the above link works, will provide the CAPE (PE10) requested in earlier comment.
Geo
“I see a lot of people on here advocate ETF’s which is great for people with larger sums, but I’m sure as many people like funds and the options they give.”
Haven’t you got that the wrong way round?
Which funds can be traded in seconds, have a low ter like ETFs, lower AMC and performance fee?
I gave up on Funds years ago and, apart from a few very specialised investment requirements, wouldn’t touch them with a sterilised bargepole!
Steve
@Steve21020
I’m sure some people can only invest small sums regularly, say maybe even only £50 a month…. even with a good regular ETF invest option at £1.50, that’s a 3% theoretical initial charge.
All new Tracker funds “have a low ter… low if not lower AMC and NO performance fee” and they accumulate without more trading costs – not sure where you live?
Why you need to trade in seconds is a mute point unless you are a day trader 😉
I know ETF’s are good for lots of people but not all. Maybe I’ll try and do a round up of funds in the comments if I get time.
@mathmo
strictly speaking it is
(1.048^40)/(1.049^40)
the difference is trivial in this case.
First of all thank you so much for all the warm comments. Easily the most satisfying aspect of writing this book has been the feeling that it has provided real actionable help to its readers.
I agree with one comment that there are sometimes so many variations of this supposedly simple world equity tracker that it becomes almost a tyranny of choice. Regarding income vs growth or ETF vs Index fund, etc. in my experience that choice often comes down to the individual saver’s specific tax or domicile situation and therefore hard to make general comments on. Regarding which specific world index to track keep in mind that that correlation between the various global equity indices is actually incredibly high (the overlap in securities is 95%+ I think). So it is a fair assumption that they are roughly the same.
On the currency stuff I appreciate with the asset/liability matching point, but really think that currency specific liabilities are better matched with same currency bonds (where you can also match maturity risk); depending on this risk appetite you can then add world equities instead of doing sort of mixed solution via domestic equities.
There is a beautiful simplicity in embracing that you really can hold all your equity holdings in one index tracking ETF, etc. but please know that this article was really not meant to suggest that I have any view or insight that equities are particularly attractive right now (or not). It was based on the premise that for someone who has decided to own equities this is what they should own. And that I believe.
Thanks again for the nice comments.
@lars thanks for the article and comments. Really amazing times we live in when this is available to small retail investors. Anyone with thirty quid can buy a bit of the world equity market so simply.
@hari those two formulations are identical. The power of a ratio is the ratio of the powers. Simplicity wins for me.
This article basically seems to be a rehashing of the efficient market hypothesis (EMH). It doesn’t take long investing to realise that the market is not efficient. It is inefficient because it has emotional actors who like to follow the herd, so it often overshoots in either direction. The market also exhibits recency bias. There are other inefficiencies too.
You can exploit them if you can keep on top of your emotions and biases, and have the time to pay attention. However, if you don’t want to do that, the advice here is good advice.
@Matt — Hmm, that must be why so many investors have a track record of beating the market… Er, hang on…
Don’t get me wrong, I invest actively for various reasons and I think there’s some truth in what you say, but exploiting it is another matter and it’s definitely not down to “having time to pay attention”, in my view.
In short: let’s not write off a sensible approach that will beat 90% of professionally managed funds (and I may be being generous to the other 10%) over 5-10 year periods or more as a “rehashing”, or suggest that beating the market is anything other than very difficult. 🙂
@All — On a related note, I hope everyone who is saying “the US is expensive” realizes they are expressing the view that they have edge and thus know better than global money (or have other motivations).
i.e. I hope everyone *gets* the point of the article, and that thus people realise that their view contradicts it (unless they have edge).
Now as one of those delusion people who believes he has edge, I have some sympathy with the view the US market is looking expensive, but please realize people have been saying that’s “obviously expensive” according to CAPE on comments on this blog and elsewhere since at least 2012. E.g. Here’s the excellent Meb Faber saying it looks a “tad expensive” in October 2012.
Please note that I am not attributing the “obvious” quote above to Meb and his excellent research. I mean private investors, blog commentators, etc. The S&P 500 is up at least 40% since “the US is market is obviously expensive” became pretty much consensus among DIY asset allocators, I’d estimate.
As I said to Matt above, more power to you if you think you can call these things — I hope you have carefully documented evidence of outperformance to prove it to yourself, for the sake of your wealth. 🙂
I am mainly addressing my words of caution to those casual readers who thought “hey, that article sounds sensible, I get it” and are then confused by all the DIY George Soros and Warren Buffetts in the comments (again, I am one 🙂 ) who might seem to being stating some obvious truth that they’ve missed… or to have completely missed the point. 🙂
@DaveS — That point about Home Bias inflating larger-by-population markets is *really* interesting IMHO. Have never heard it made before, and I think well worth some pondering. I presume academics have looked into it. Will try to get some time to dig something up.
I’m not sure saying something along the lines of ‘high PE or CAPE or somesuch similar metric prob means reduced future returns’ is anything to do with edge.
It seems a fairly reasonable thing for anyone to say based on statistical evidence, charts and such like you see in respectable literature.
Its not some prediction of future prices that has required novel new information or is a clever interpretation of the information currently available.
Say you were Lars, and Aunt Agatha suddenly bequeathes you £1M tomorrow afternoon. Would you slap it all in a world tracker? Or would you secretly have a good old worry about whether the world looks expensive based on historical measures?
I don’t know the answer, but I know those returns vs CAPE charts seem pertinent, especially when it comes to lump sums.
@TheInvestor: Fund managers have a whole heap of problems which lead to their persistent underperformance. They are hostage to short term results, otherwise they get in trouble from their investors. Not to mention the fees they charge. They are a large part of the inefficient market, and you can exploit their short term bias.
And I’m not writing off your approach, I think it is a good one. What I’m disagreeing with is your argument for the approach. In the same article you are saying that the market is efficient, but that it has a home country bias. All the people who you are addressing this to are part of the market. We all have our own biases, and when enough people have the same bias, it flows through to the market. The dot-com boom/bust is a great example of this. That alone should be enough to dissuade anyone from believing that the market is efficient, unless they have a huge capacity for cognitive dissonance.
Finally, I did not say “having the time to pay attention” is what it comes down to, that was one of the last things in my list of what is needed. Far, far more important is recognising and controlling your emotions and biases. And that is hard. That is why you have correctly said that beating the market is hard in your comment, as opposed to your article which suggests it is pure luck. Everyone thinks it’s about being some sort of genius, and it’s not.
Another excellent article. Thank you.
Is it irrational to say, for example, that the FTSE250 has generally beaten the FTSE100 over time (admittedly the past is no guide to the future, etc) and so overweight the FTSE250 w.r.t. FTSE100 in my portfolio?
@TheRhino — You wrote:
“I’m not sure saying something along the lines of ‘high PE or CAPE or somesuch similar metric prob means reduced future returns’ is anything to do with edge. ”
I’m afraid this is what I mean when I say I fear people aren’t getting the argument. (An argument you’re at liberty to disagree with of course 🙂 ).
As Lars explained in detail above, the world’s money has made its mind up about where the best returns are.
Everyone and their dog knows about the CAPE ratios, knows that cheap markets are better than expensive ones and so on and so on. I’d bet more money than every blog commentator in the world added together sits in an averagely large macro hedge fund that is making these decisions everyday, based on likely millions of variables, not the odd CAPE graph they see on the Internet.
But that weight of money has been placed as it has.
For one to say “I will put less in the US because *reasons*” is to express a claim to edge, because you’re saying the weight of global money is wrong.
As I say, we can all do what we like, but understand that is the argument here.
Note one might have other reasons/biases not to just use a single global tracker even if you fully buy Lars’ argument, perhaps to do with your view on risk reward, or on currency risk or you find having several different trackers fund to be good fun, or wotnot.
But “better risk-adjusted returns will come through a different allocation” is an expression of a claim to edge.
For the record, I don’t think I’d use a single global tracker myself, even if I was a predominately passive investor.
This article isn’t my view, it’s the view of Lars Kroijer.
I do all sorts of crazed things with my portfolio today, and if I went back towards a more passive approach some of that would linger.
i.e. I would still claim some edge, I think.
Similarly, incidentally, acting on the back of the interesting points made about Home Bias earlier in the thread (and referred to here again by Matt) is still an expression of a claim to edge, I think.
You’d be saying “I think I know better than the market that home bias is distorting returns”. You may or may not be right. Home bias is not a secret, so presumably a rational market has already bet against it’s impact to some extent.
Note that Lars doesn’t say edge doesn’t exist, he says it’s incredibly rare. It’s a matter of record that he has relationships with some hedge funds etc, but equally that aside from this he invests his money passively, as described in his book.
He was a full time hedge fund manager for many years, but he thinks this approach is generally best not just for Joe Blog Reader like us but for a financial insider like himself.
By all means allocate as you see fit, and have your opinions about whether a market is expensive or not. We can stock pick if we want to! 🙂
But understand what you’re up against, that’s my message.
@Matt — I mentioned your biases comment in my summary of your post, but you’re right I didn’t focus on it. Never enough time etc.
So just to note that I take on board you’re saying (and said!) this is a good approach as far as it goes and so on. My comments are about the other parts of your comment. 🙂
Just to be clear, this global tracker approach isn’t my approach, the article is by author Lars Kroijer. We agree his approach makes a lot of sense though.
As I already mentioned, I have a lot of sympathy with the points about inefficiencies you made. I also agree that fund managers are hampered by career risk and so forth, and also know that the impact of high fees that erodes away any outperformance some few do manage to deliver.
But to quote myself: “I think there’s some truth in what you say, but exploiting it is another matter”.
My back goes up (as a comment moderator / website owner / someone who believes passive investing is best for most) when I read comments with the general tone of the first part of your first comment, because the Internet is strewn with people claiming that sort of thing and the fund industry promotional material similarly, and yet the evidence is *overwhelming* that most fail to beat the market, whether professional or amateur.
And that’s been my observation in reality, too. Anecdotally, the more strident the voicer of such opinions, the worse calls they seem to make. (I have no idea as to your record and I don’t mean you, this is a general thing I’ve noticed).
The stuff you cite is not novel, although it’s come more to the fore in the past 5-10 years I concede. But anyway it’s well known. And alpha has shrunk further in the meantime.
The market may not be efficient, we agree, but exploiting its inefficiencies is hard.
Hence the proper approach in my view (and I am talking my own book) is to be incredibly humble about attempts to beat the market, to proceed with due caution, and to try to make sure you’re attempting it not because you think it’s anything like straightforward, but perhaps because you’re compelled to (or because you’re paid to — it’s totally rational for well paid fund managers to try to beat the market!)
The longer I invest, learn about investing, and write about investing, the more convinced I am that most people are bad investors, and many of the good ones will also lose to the market unless they’re lucky.
Well, the classic economics theory would have it that the reason the FTSE 250 has outperformed is because the companies are smaller. Hence they are riskier (/more volatile). Hence if you overweighted the FTSE 250 you would have been rewarded for exploiting the so-called size premium, at the expense of taking on more risk (/volatility).
If you think that the size premium is likely to continue to persist than I wouldn’t say it’s irrational, no, if you were committed to a very long-term view. But who knows how things will turn out?
From the point of view of Lars’ article, it’s possibly a claim to edge though. The size premium is known. I am not sure how Lars’ definition of edge treats risk/reward premiums, I can’t really speak for him. 🙂
@TI yeah I see what you mean – I just need Aunt Agatha to do the bequeathing bit now..
@TheRhino — “I just need Aunt Agatha to do the bequeathing bit now..”
Hah! 🙂 How we could all do with an Aunt Agatha (though from memory in the books they seemed to stick around… 😉 )
The US CAPE , based on annual averages, has been above its long-term average for 25 consecutive years. During that time it has averaged 25…..its current level.
Not the most useful metric!
@Lars
Your discussion of currency risk is quite general, but you don’t address the more specific issue of whether holding >50% of all your equity in the US, even if it is ‘right’ in terms of global market weighting, could increase this currency risk to unacceptable levels. I would be interested to see some exploration of actual scenarios, in a similar way to considerations of how different equity:bond allocations would have performed if they had been held during the ups and downs of the past. My guess is that currency risk is overstated (and that we tend to ignore the potential for lost returns as a result of UK home bias!) but it would be good to have this intuition either confirmed or overturned by some hard data.
here’s a review of the main fund of fund products out there: http://monevator.com/passive-fund-of-funds-the-rivals/
Thing about measures like CAPE is that the predictive value is about 40%. So while an expensive market is quite likely to deliver below average returns at some point in the future, there is every chance that it will confound your expectations.
So what you gonna do? The answer is, as neither you nor anyone else has any real clue what will happen, so you must suck it up.
A high CAPE reading doesn’t tell you to lower your US allocation by 10% or whatever. It tells you that there’s a reasonable chance returns may be lower than you’d expect in the future. So you may well need to invest more now, or invest for longer to achieve your objectives as future returns are liable to be less than the long-term average.
If they’re not less, well, that’s a bonus.
Nobody believes the market is efficient. Anybody can see they are not. But they are mostly efficient. And you have to seriously question whether you’ve got any reason to suppose that your best guess about what will happen is better than the weight of the market’s opinion.
You’re more likely to fall victim to your own biases than exploit anyone else’s consistently.
I don’t buy this theory about populous countries overheating their own markets through home bias. The US has been one of the best performing markets over the last 100 years. If it was systematically overvalued by dumb money then smart money would bet against it and it would mean revert. And there are so many other factors to take into account. How would you isolate this one possible tendency and take action?
Your best ballast against the risk inherent in equities is a strong slug of bonds. Domestic, government bonds.
Suppose I take the point in the Vanguard report (thank you, Mumble) that I can hope for a decent return with lowest available equity volatility by having 80% of my equities in the UK: I’d do that with a tracker.
I’m tempted to go for my 20% overseas equities as individual shares held in SIPPs, because that should (have I got this right?) avoid withholding tax. Such tax avoidance is presumably an “edge” that is perfectly genuine.
I suppose I might reflect that my equities are heavily UK, as is all my cash, and a bunch of Index-Linked Savings Certificates. You can see where this is going: should my fixed interest then actually be in a tracker of foreign bonds?
@The Investor: I’m happy to describe my performance to date, though I’m not sure it will be that illustrative.
Mostly I haven’t been investing long enough to draw any reliable conclusions. The first stock I bought was in Sep 2012 (and that was a conservative, diversified LIC), but overall my funds have had an average time in the market of about 10 months (due to most of the money only being invested more recently). In that time, my performance has been very slightly market beating after costs, though you could call it market matching and I wouldn’t argue.
In that time, I have had some stocks bottom at 40% down (didn’t sell), and some almost double. As of now, my worst position is down 14% (bought 6 months ago), and my best is up 79% (about 40% CAGR), though I have another up 48% over the 6 months I have had it. As I said, not enough time to tell.
Everyone is a brilliant investor in a bull market though. Once I have been through a crash/recovery cycle, I’ll have a better idea of how I’m doing. If I’m not beating the market at that point, I’ll probably switch to index funds and save myself a lot of time (a small part of my portfolio is already index funds).
I don’t mean to sound like I have all the answers. Initially I thought I had stumbled into an EMH circlejerk which I now see that I haven’t.
@Matt — Cheers for sharing. Early days as you say, but of course nicer to see a promising start then a bad one!
Mind you they do say with some justification I believe that a hefty loss early on helps a stock picking career over the long-term. (Buffett being the outlier as ever, he seems to have got by with a lesson about opportunity cost… 😉 )
I had two near-wipeouts in my first couple of years back in the day, both times due to seemingly unpredictable issues (fraud at one, targeted by activists that ultimately forced a firesale at the other) that with hindsight I still might have avoided. A good spanking loss makes one humble about the limits of one’s knowledge/strategy going forward. 🙂
Anyway, good luck with your investing!
Whilst I can accept the notion that an individual national market is somewhat efficient, I find much harder to believe that allocation of funds between rather than within markets is efficient,
One of the reasons already mentioned above is home bias and another is the desire by investors rightly or wrongly to avoid currency risk.
A major reservation that I have about the notion of efficient markets is that although markets may embody information in the public domain, they must also reflect the behavioural traits of investors too. Markets must also reflect the investment decisions by institutions such as pension funds which a) often have a very poor track record and b) in the case of funds supporting final salary pension schemes have criteria biased towards meeting long-term liabilities rather than purely targeting return.
a couple of comments:
1: US is easily the biggest market obviously so the biggest exposure and a worry to some. Couple of points on that. Assuming efficient markets, if there were benefits from diversifying away from the US (or not) that would already be reflected in the capital flows by bidding up the equities of other countries. My sound like archaic point, but in the absence of better knowledge (or having an edge) I think it is plenty good for most investors and better than actively trying to outperform by actively reallocating. Not having looked at this for a while but think the US is around 35% (but keep in mind that Apple and other of the largest companies there are very international so in my view overstates the actual exposure even if that is true elsewhere too). This ratio has been declining in the past decades less b/c performance and more because of IPOs elsewhere (like Alibaba and huge former state owned companies being listed). When I first looked at this stuff in the early 90s it was more like 45% from memory. This lower ratio adds to geographic diversification. I don’t really subscribe to the “US is toppy” argument b/c I think it implied edge (go short US and long MSCI world ex-US, gear it up 3x and you are a macro hedge fund. All that is missing is the fees :)). There is a bunch of stuff on all this in chaper 5 of my book (breaking the rule to not pitch my own work here).
2: An interesting point was made on risk premium and expected return. We say expect 4-5% above inflation from equities. But obviously it seems wrong that people investing in a low risk environment should be compensated the same as someone entering the fray in March 2009. The 4-5% is really an average expected return for average expected risk. There isn’t a ton of academic work here, but the few studies here suggest that the risk premium does indeed change over time in line with the risk of the market. So a good indicator is the implied volatility of the equity market. If you have access to long term option info (so 1-2 years) that is a great place to start, but even the VIX gives some info. The lower the volatility, the lower future returns you should expect. Again there isn’t great amounts of work done on this, but it also kind of makes sense that even within equity market index trackers the whole risk/return maxim holds.
Hope this answers questions. To give an idea, I was giving a talk earlier in the week where I had to explain the difference between bonds and equities to a group of tech entrepreneurs so by comparison this group is doing really well whatever the choices made.
Have a great weekend!
I have seen in a few places that number of around 30% for the US share of global market capitalisation. It does bother me a bit, then, that global trackers always seem to allocate about 50% to the US.
Does it imply that the so-called global trackers only cover 60-70% of the actual global market? Although I suppose it would affect equally all markets that they do cover.
@DaveS
In respect of Vanguard VWRL, Morningstar says:
“This Fund seeks to provide long-term capital growth of capital by tracking the performance of the FTSE All-World Index, a market-capitalisation weighted index of common stocks of large and mid cap companies in developed and emerging countries.”
Morningstar categorises VWRL as “Global Large-Cap Blend Equity” and shows its benchmark as being “MSCI World NR USD” and shows the United States at 50.47% in its “World Regions” table.
On what basis is the 30% that you cite arrived at?
Correction: “….. long-term growth of capital …..”
@Topman – many different figures are reported, but usually in the 30-40% range. Of course it also varies over time. Examples:
40% – https://blogs.law.harvard.edu/willbanks/2013/08/25/top-20-nations-listed-by-company-market-cap/
37% – http://inflation.us/countryshareofglobal/
34% – http://visual.ly/top-10-countries-world-stock-market-capitalization
I have not yet found any cite supporting the 50% figure, apart from the funds’ own breakdowns such as the one you give.
I just googled US share of global market cap. There are a couple of links giving the US about 35%. Quite different from the 50% weighting in the MSCI and FTSE World indices.
http://www.ftportfolios.com/Commentary/MarketCommentary/2014/10/21/u.s.-equities-share-of-total-global-market-capitalization-is-growing
http://inflation.us/countryshareofglobal/
Any ideas why this is so? I suppose the indices are mainly large cap, so perhaps there are more small caps outside the US, but I doubt that. Maybe the indices exclude some markets, but I can’t imagine what they are excluding.
I think that Lars Kroijer makes very valid points and I used his strategy (ie a single, Global Tracker) for some years.
But these days I’ve moved away from that and towards an allocation that gives me the most even sectoral allocation I can manage.
Don’t get me wrong – I’m not claiming edge (or maybe I am) but we don’t know which sector is going to boom or bust next. And it’s all very well talking about “Efficient Markets” but markets develop bubbles and at times the Global Market (judged in hindsight) has been overweight in certain sectors – in tech, in banks, possibly more recently in oil etc.
Now I’m not looking for out-performance, I just don’t want to find that my portfolio has become overweight in the next “Bust” sector which has been bid-up globally.
The market isn’t always right, don’t put all your eggs in one basket etc…
US stocks are quite expensive:
http://mebfaber.com/2015/03/13/stocks-are-the-most-expensive-since-the-1960s/
@Andy et al
Lars ‘enters the fray’ by saying (Investing Demystified – Page 61), “….. some world indices do not include all the countries with functioning equity markets …..”, implying that these indices thus overstate their constituents’ % shares vis à vis the full global market breakdown.
@DaveP “The market isn’t always right …..”
I’m sure that’s probably true but without genuine edge it’s a brave man or a fool who bets against it. To do so is essentially “to claim to see an advantage from allocating differently from how the multi-trillion dollar international financial markets have allocated which you are not in a position to do unless you have an edge.” (Investment Demystified, page 57)
I carry no special torch for Lars Kroijer but I do find the overarching theme of his book very compelling.
I’m perfectly happy with the principle of basing my portfolio allocation on the market, not pretending to possess an edge that I don’t really have, and not worrying too much about the finer points of the detail.
However, I’m not sure there is a single fund that actually embodies this approach – i.e., one that doesn’t overweight the US and underweight/exclude emerging markets – and also has low charges.
I wonder whether it’s better to bite the bullet on this one, track down reliable figures on global capitalization by country and put together a selection of funds that broadly reproduce the market.
The following chart suggests a figure of 37% for the US in 2014 and would put emerging markets at around 15%:
http://bespokeinvest.com/thinkbig/2014/11/6/us-expands-its-market-dominance.html
You could reproduce this with a developed world ex-UK, a UK and an emerging markets tracker in a proportion of 80:5:15. (And this would also allow you to up the UK share to include home bias, if that’s your preference, or reduce the emerging markets share if you find it too scary.)
@Tim G @Andy
A rough comparison with the Tim G link table seems to show that the FTSE All-World Index is primarily underweight Asia. A fuller comparison would nail all the differences large or small but I’m time poor just now. Anyone have a spare hour?
@Tim G
On reflection, I wonder if the differences are basically down to nothing other than the fact that the FTSE All-World specifically represents the performance 0f large and mid cap stocks only?
It is useful to separate the world based on GDP and market capitalisation. Some countries have more businesses in private or state hands than publically investible. Look at asia in particular.
One small final thought. Comparing the “safe bets” of a Vanguard Life Strategy 20% Equity Fund with a VGOV 80% plus VWRL 20% portfolio, the former does appear to have more risk since it has only about 11% of its total “Bonds” allocated to straightforward gilts, with the majority of the remainder being instead allocated to “Bonds – Global”. This might be unhelpful were we ever to face another “run for the hills” situation.
Ok, so is there a list of world indice trackers sorted by fee anywhere?
i think the main reason for the higher US weighting in the FTSE All-World Index is that the index is of “investable” equities, i.e. it excludes both:
1) large blocks of shares held by a single investor. so if a single shareholder has 75% of the shares in a company, the company will only be given a weighting proportional to 25% of its market capitalization. this can happen in any market, but perhaps the effect is biggest for chinese companies in which the PRC has a majority shareholding. this may affect the weightings for both china and for HK (since some mainland companies are listed in HK).
2) share which foreigners aren’t allowed to buy, or not easily able to. this currently includes certain classes of share (“A” shares) in some mainland chinese companies (though these restrictions are gradually being relaxed).
I quickly did this with a spare moment hope it helps someone:
—————————————————————————-
World index funds, (not ETF’S)
L&G International Index
Index = FTSE World (ex UK)
Number stocks = 2283
OCR = 0.13%
US Exposure = 55%
Emerging Markets = YES (8%)
Vanguard FTSE De World ex-UK
Index = FTSE Dev World ex-U.K
Stocks = 2019
OCR = 0.15%
US Exposure = 56%
Emerging Markets = NO
Fidelity Index World
Index = MSCI World Index
Stocks = 1644
OCR = 0.20%
US Exposure = 52%
Emerging Markets = NO
Aviva Intl Index
Index= FTSE World (ex UK)
Stocks = 2252
OCR = 0.26%
US Exposure = 55%
Emerging Markets = YES (8%)
—————————————————————————-
Other options /additions
Vanguard LifeStrategy 100%
Index= notional
Stocks = 5742 0.24%
US Exposure = 40%
Emerging Markets = YES (7%)
Contains Home Bias / UK Exposure = 25%
Vanguard Global Small-Cap
Index= MSCI World Small Cap Index
Stocks = 4219
OCR = 0.38%
US Exposure 60%
Emerging Markets = NO
—————————————————————————-
What’s interesting is the make-up of Vanguard LifeStrategy means it includes a huge amount of extra stocks – I am guessing probably the small caps stocks in full country indexes, which although it has home bias means it is much better diversified.
Cheers
Geo
@Geo
So – we don’t know what the global market really looks like, and ‘global’ trackers don’t seem to make much attempt to follow it anyway.
There is even a HSBC ‘global’ tracker that is 50% UK equity – a reminder to read the ingredients list carefully!
@Tim G
With all the various spurious accuracies in these “globals”, I guess you pays your money and you takes your choice (which phrase apparently first appeared in print in a Punch cartoon of 1846).
If investing in a world fund at adequate prices would be possible then I would be all for it. But where I’m living, I can’t do that unless I’m willing to shell out 5% commission to my broker. Not everyone has access to cheap index funds and this question is not as clear cut in the “unsophisticated” countries.
The total world equity tracker makes a lot of sense.Not everyone has got the heart to see the country specific portfolio in red for good 8 years.No one knows exactly when market is going to be up or down.A lot of people are buying emerging market growth on the basis of latest performance but they have to keep in mind that emerging tracker markets can go down by 50% if us is down by 25%.
We need to look at the average performance of the markets and not just recent.I was going through morningstar India mutual funds data and their average performance is 15% for last 10 years.If we add currency losses then it goes further down.
The DB x-trackers India equity data is matching the morningstar Indian trackers data closely but what is the point in buying when average performance is not more than total global equity tracker and unnecessary purchase add further expenses to the portfolio.
@Geo “….. the make-up of Vanguard LifeStrategy means it includes a huge amount of extra stocks …..”
Rather than that and unless I’m completely wrong, is it not the case that comparing VWRL for example with LS100 the total of USA and UK is 58% and 63% respectively, i.e. not a hugely significant difference but nevertheless containing a major swing in home bias from the USA 51% UK 7% in VWRL to the USA 40% UK 23% in LS100, and that it would in fact be a comparable home bias swing for the funds you have shown, not extra stocks, that is the essential cause of the LS100 situation you have highlighted?
@Lars Kroijer Congratulations Lars! This is the 89. comment! I hope more and more people read Your book.
@Topman – yes the home bias is the big difference for LS100, but also number of stocks. What is mildly interesting is, if like me you looked at the region breakdown of the funds within LS100, the number of stocks in them varies greatly:
LS100 US=3490 PAC=150 JPN=314 UK=550 EU=399 EM=839
L&G US=731 PAC=246 JPN=475 UK=0 EU=419 EM=994
Total stocks
LS100 = 5742
L&G = 2283
VRWL = 3026
The vanguard ETF (VWRL) just adds 130 UK stocks.
I wasn’t comparing it to VWRL in the first place unfortunately as this was just to give some help to people wanted to buy funds.
Not sure but this is probably getting too detailed. The indexes have to have makeup rues and just choose by weighted market cap I think.
If choosing ETF’s I think VWRL is the bees knees, if choosing funds on a pure Global basis L&G is probably best, LS100 was just an interesting comparison. I’m a fan of LS 60/40 as it does everything without my brain even having to think about anything – not sure why I am writing these detailed comments, other than to hope to help other people a tad.
@geo, don’t apologise, I for one am finding this info really interesting – just the sort of detail I’d never get around to looking out myself, but it’s fascinating to see just how variable what looks superficially like the same ‘product’ actually is. It would be great if TA could run with this and perhaps explain the differences or help us work out what to look for in a global index tracker. When he’s finished the book that is 😉
I’m really hoping his book will be the kind of entry level UK focused guide I can give to my teenage children…the older is currently lapping up ‘millionaire teacher’ but I’m not sure he will get the differences with the US situation.
I thought I had made a calculation error on the total number of stocks in the L&G fund, however none of the funds it seems actually truly follow the index….
Total stocks:
L&G = 2283 / FTSE All world ex UK Index = 2865
VRWL = 2841 / FTSE All world Index = 3026
I guess you lose the smaller stocks. What difference this makes? Who knows? Unless you could maybe see it in the benchmarking over 30 years.
I wonder whether the whole concept of a ‘global market’ in equities is valid.
Let’s imagine a very simplified world in which there are only three countries: A, B and C. They are all the same size and all of their investors invest equally in the equities of all three countries. Now imagine another world, consisting of countries X, Y and Z, in which all the investors invest exclusively in home equities.
We can describe both of these situations as a global market in which ‘the money’ suggests we should split our investment equally between the equities of the three countries. However, in the first case this global allocation is indeed the result of money flowing between the different countries, while in the second it is just a statistical artefact, produced by aggregating the results from separate markets. Perhaps the investors of X, Y and Z are just a bunch of irrational xenophobes. In which case we will probably do better to diversify our holdings between their nasty little countries. Or perhaps they are wisely investing in their home markets because of extreme currency volatility, tax disadvantages of overseas investment etc. If the latter is the case, then we might be well-advised to follow suit.
Obviously, in the real world money does indeed flow between national equity markets to some extent, but I’m not sure that it does so to quite the degree that efficient market theorists suggest. If you think about your own approach to investment you will probably see a couple of reasons why.
The first is that most investors do indeed display home bias. If we assume that home bias is irrational, then we can ignore it. But if home bias is rational, then we have to take it into account. The jury is still out on this one, but it’s worth nothing that Vanguard research for the US, UK, Canada and Australia over the period 1988 to 2011 suggests that for investors in all of these countries some degree of home bias was advantageous (see Figure 1):
https://pressroom.vanguard.com/content/nonindexed/6.26.2012_The_Role_of_Home_Bias.pdf
The second reason is that, as well as choosing between different equities, we also choose between equities and other products. For example, when deciding on a portfolio allocation, we choose between equities and fixed income. In this instance, our ‘market’ therefore consists of both shares and bonds. And we may also consider other options such as cash, buy-to-let or staking it all on The Flying Dutchman in the 1.45 at Cheltenham. So it’s not at all clear where one market ends and another one begins.
Does this matter? Well, it’s one thing to say ‘we should capture the global equities market because this reflects the aggregated decisions of investors across the world’ and quite another to say ‘we should capture the global equities market because this reflects a small portion of a whole bunch of decisions taken in a series of only partially interconnected markets’.
If the market is truly global, then any decision to diverge from it is, at least implicitly, a claim to edge. If, however, the market is not global, then behaving as if it is could lead us into the reassuring but mistaken belief that ‘the market’ has decided to ignore issues such as home bias and currency risk, and that we should too.
I would argue that the global asset allocation partially reflects a general search for a balance between risk and returns (countries A, B and C) but is also the result of aggregating together quite separate decisions about home bias and currency risk (countries X, Y and Z). The first set of decisions can be combined as an average, but the second can’t. In this case, by simply tracking a global index we are unwittingly according priority to a general risk-return consideration but ignoring country-specific considerations. If home bias and currency risk are real, then we might do better to weight our equity investments somewhat to our home countries, and to steer clear of being over-invested in any single country (e.g., the USA). If this feels like going against the market, just remember that ‘the market’ also consists of US-based investors for whom home bias and currency risk have a different meaning, and (for example) Chinese investors seeking an overseas haven for profits generated in their emerging but still in many ways insecure home economy. Their decisions might be rational for them but bad for us.
Just returning to my own Lars influenced c.100k rational portfolio if I may, which consists merely of VWRL and VGOV plus an instant access NISA, I did consider using LS100 in lieu of VWRL but the deciding factor in favour of my ultimate choice of VWRL was my conclusion, rightly or wrongly in my ubiquitously simplistic mind, that VGOV meant that I was already effectively long on the UK and that I could therefore “afford” to be long on the USA in VWRL.
@Gregory – “Congratulations Lars!”
Amen to that!
Great article but what exactly is the name of the world tracking fund please….?
@Barry “Great article but what exactly is the name of the world tracking fund please….?”
There’s a lot of added value in the comments, so might be worth trawling through them. You could start with comment 83 by Geo, which gives a good summary of available products. (Be warned that, as far as I can tell, at least for UK investors, there is no single, cheap product that embodies Lars’ approach.)
Also, while I agree that this is a great article, I would be inclined to treat it as food for thought, rather than a simple “read and apply”. In the comments, there are a lot of questions raised, including:
1: How specific funds map (or fail to map) onto the global market, including analysis of fund contents and costs.
2: Problems with identifying how the global market breaks down in terms of country weightings (e.g., ranges of from 40 to 60% for the US, depending on who you believe!).
3: Whether the efficient market hypothesis really provides a basis for equity allocation decisions by individual investors: i.e., are we right to ignore home bias and currency risk?
@Barry
Up to a point I agree with Tim G about the worth of “trawling through the comments” but it does seem to me that many and perhaps most of these comments have been made without their authors actually having read Lars Kroijer’s book, Investing Demystified.
I strongly recommend that you do read it before you take any action; its language is clear and eminently uncomplicated but it is far more than just the beginner’s primer that its title might imply.
Thanks again for comments. I know it is just a small subset of Monevator readers on this comments thread, but I was thinking of hosting a talk in London for 50ish people in the next 4-5 weeks where people could come and chat about the stuff in this blog, and general investor issues. Do you think there would be an appetite for this?
@Barry — As TimG says, there’s a lot of discussion in these comments. I can also reveal an imminent article on this subject is headed Monevator’s way, so watch this space! 🙂
@Lars “….. an appetite …..?”
Thanks but no thanks in my case; you would be preaching to the converted. ~:-)
@The Investor ” an imminent article on this subject is headed Monevator’s way”
Excellent. Look forward to reading it!
@Lars “talk in London…”
Could you give some more details?
Hi Lars,
I would very much like to attend such a talk.
I live in the north but would travel to London to attend..
Some thoughts:
– Please announce the date as far in advance as possible, so that time off work can be booked, if it is not on a weekend
– Can the talk details be announced on the Monevator blog so that the details of it are easy to find
Thanks,
Is there any real TER?
Look the Vanguard FTSE All-World UCITS ETF. In 2013 and 2014 the fund outperformed the Index. See the Key Investor Information Document: past performance.https://www.vanguard.co.uk/adviser/adv/detail/etf/overview?portId=9505&assetCode=EQUITY##overview
And an “old” article about:
http://www.ft.com/intl/cms/s/0/90cea80e-9b8d-11e2-a820-00144feabdc0.html#axzz3RA6V09Nm
I am totally sold on this idea. I only wish I’d come across an article like this when I started investing.
This is so right for my goals that I have basically sold my entire equity portfolio and put the proceeds into VWRL.
Great article and sums things up very succinctly.
One thing that sprang to mind, when investing with a relatively strong currency (GBP, USD) would there be even greater benefit to tracking “world” markets?
@Nick — Cheers. Well as you know, when, say, the British pound is very strong compared to the US dollar, a £ buys you more dollar assets. Roughly half of a world tracker is in the US, so at such times of £ strength your £ would buy you more units of the tracker (or the ETF price would be lower than otherwise in £ terms). After you’ve invested, the value of the tracker (and any $ dividends you’re paid or that are reinvested) will continue to fluctuate as the £/$ rate fluctuates, which is currency risk in action. And of course your exposure to other countries’ currencies via owning the world tracker will follow the same path.
See this article for more: http://monevator.com/currency-risk-fund-denomination/
I’ve currently got and drip feed the following etf’s in my Fidelity SIPP. I plan to reduce the % of the non VWRL funds into VWRL when the U.S is cheaper, eventually ending up with 90% VWRL & 10% Gilts
15% Vanguard VWRL
15% Vanguard VUKE
15% iShares EuroStoxx 50
15% iShares Japan
15% Vanguard VFEM
15% iShares Pacific ex Japan
10% iShares Gilts 0-5
is this a flawed plan? How does the quarterly re-balancing work?
if say, over the next few years, non U.S stocks out-perform the U.S will my existing block of VWRL move it’s allocation from 50% U.S to the other countries that are doing better? or is it just new purchases that are at the new percentages?
I really like the idea of having all my equity allocation in one fund, but don’t want to be in the situation where 50% of my investment underperforms & I’m drip feeding 50% of my new cash into it every month.
Powerful arguments. But wouldn’t a global small-cap tracker be a useful diversifier giving a different view of the market.
I’ve wondered about this Graham.
My thinking is that for people who are invested 100% in equities, then global small cap is useful.
However, if you hold bonds in your portfolio you might as well just increase your all world holding and reduce your bonds/cash.
Guys – I’ve read Lars’ book and this thread. I must admit I am very taken by the idea of a single simple global tracker fund which aims to yield the index average. I’ve read so many people’s view’s and blogs and everyone has an opinion on active vs passive vs providers vs assets mix vs……. All of which implies they have an edge/view – which is inevitably different to everyone else’s. So the conclusion I have come to is that the majority of people actually don’t know anymore than I do (I’m not an expert by the way). So for what it’s worth here’s my view:-
I’m about to retire and have decided on a draw-down approach. I therefore need to put my pot of DC fund somewhere. After countless hours of reading and talking to anyone who wanted to I’ve decided to go with Lars’ simple approach implemented as a bucket model – i.e. 3 buckets/pots/assets:-
1 – A Global tracker
2- A Bond/Gilt tracker
3- A Cash fund.
The mix is obviously down to your own risk tolerance but I’ll keep about 5 years of living in cash. I’ll then draw money from the Cash fund every year and rebalance.
That’s it! Job done!
Chris
BTW on the discussion of US allocation in global funds has anyone looked at the Vanguard Global VHYL tracker? It seems a bit lighter in the US – 35%.
Hi Chris
Been on this road for some years now
Down to 3 funds plus cash float
There weren’t any World Index Trackers then so I have a Vanguard FTSE Index Tracker(4%)-a Vanguard World Index Tracker ex UK(26%) and my Gilts are all exchanged for a Vanguard Global Bond Index Fund Hedged to the pound(66%) plus Cash(4%)
Been through 2002,2008 without any problems
Very cheap to run-18 Basis Points(0.18%)
Got a life ,sleep at night and drawdown from appropriate fund as required-rebalancing Portfolio at the same time
Works for me
Malcolm
Lars,
You seem to be fixated on cutting costs. You should be more focused on proper asset allocation.
The disparity between the returns of equities in one part of the world and another can be 30%+ in any given year.
Your strategy has too little allocation to UK companies. By putting all your equities money into an ‘all world’ or ‘global’ index fund you will get about 6% in companies listed in the UK and 94% overseas.
Using a UK all-share index alongside a global index will ensure more UK exposure than the average company listed in the rest of the world has (e.g. those in US index, the Europe index, the Japan index, the Emerging Markets index etc). This would be better for the average UK consumer (who lives their life in the UK and anticipates spending pounds in the UK in retirement) – has some ‘home bias’ ; while the All-World or Global All Cap equity fund products do not.
That different asset allocation will result in a different level of gross return and volatility. If you lived outside the UK and had no reason to ‘overweight’ the returns of companies with UK assets or revenues then you would probably prefer a global fund (though might well want to add to it, something from your own country, because people do like to bias their investments domestically).
So, not including a UK all share index, but using one global equity index and one bond index will give you an inferior result, because you’ve changed the asset mix within the equities away from a UK bias.
To summarise: yes you can save a few basis points on fees by building your own dirty portfolio with only two fund components instead of three. In doing so you will have different results and likely greater volatility due to the limited exposure to UK equities. If you are happy with doing that, and believe the results will be no less desirable, go right ahead and build it yourself to save your 0.05% to 0.1% a year in costs.
You are just speculating and have missed the point of the article.
I have no edge so I’m sticking with market weight
The vanguard LS trackers are overweight in the uk .They have 22-25% of UK instead of 6 or 8 percent.
As a renter with no capital in property, would it be ok to use property fund(s) for the bonds part of my portfolio?
No-it is like buying a single company share-it is just another form of equity investment
You are very exposed to a sudden downturns in the commercial property/ housing market just when you need the money
Bonds should make less money than equities but are safer
With Bonds the money is spread across many companies and governments
Government bonds are very safe-Gilts(UK),US Treasury Bonds etc
Companies issue Corporate Bonds-these are not nearly as safe as Govt Bonds and should be bought with great care-often as risky as Shares
Good advice in Bonds in this website-get reading!!
xxd09
I still find myself coming back to this article. Digressing for a minute, at the moment there seems to be a big controversy in the media between growth or value equity investing. This doesn’t seem to be a classic active versus passive argument as there are indices such as the Russell group which provide Growth and Value indices that can be tracked. The history seems to show that total return for growth and value indices changes year by year, on balance favouring value in the long term but not extensively so. Coming back to Lars’ article using a global tracker based on market capitalisation will ignore the growth/value issue. The particular blend of growth v value v blended will fall out of the index based on market size. At the moment this would buy a large investment in US FANG stocks which some people think are much overvalued and ripe for a year-2000 type-correction. What I can’t quite get my mind around is Lars’ assertion that buying the global market based on market cap automatically takes into account the ‘no edge’ approach in which we take the global index as reflecting the aggregate world view and that this is the best overall guide to use. Can anyone help me?
@Graham — It’s a long term approach. If/when you first invested in the global market tracker a few years ago, FANGs were at a much lower valuation. You’ve followed them up with a global tracker. In the meantime value shares have done nothing. If FANGs reverse here, well, you also own all those value stocks that (may) mean revert.
If you’re saying you know that FANGs are overvalued then you are claiming Edge, which is fair enough (if unlikely) in which case choosing how to track a market is the least of your ways to try to make money. 🙂
The early comments in this discussion from 2015 saying not to buy the US market because it is too expensive really support the thrust of the article that most investors don’t have an edge!
This article gave me food for thought.
I have stopped thinking I have an edge and I am now shifting my portfolio to ETF-based portfolio following a Core(85%)-Satellite(%15) approach and with a bias on tracking indices that have performed better than others in the past.
Can you please give me your thoughts on this:
Core:
——
50% CSP1 (S&P500 Index )
20% SWDA (MSCI World Index )
20% FTSE250 or FTSE UK All Share Index
5% IGLT (UK Gov Bond – Gilts)
5% Cash
Satellite:
———–
5% SGLN (Physical Gold ETF)
5% EMIM (Emerging Markets ETF)
5% IUKP (REIT UK property ETF)
Great article. As the other poster said, wish I’d found this some time ago! However… when I put 100% into a ‘total world index tracker’, I get a return since 1970 of about 6.5% (https://portfoliocharts.com/portfolio/my-portfolio/). If I put 100% into the FTSE all share, I get about 7.6% since the 1970s. That’s a significant difference, going back 50 years. In short, it looks like historically, the Brits have punched above their weight (which may also explain why the UK economy is still up there in the top 6 or so, despite the relatively tiny size of the population). The FTSE 100 (which is about 80% of the all share, if I recall correctly) is also basically an ‘international index’ of large caps; put all this together and wouldn’t you say it’s a better ‘bet’ than (eg) VWRL?
Do you consider VWRL being underweight on China?
At the moment China represents about 5% on the ETF yet it’s about to become the number one economy in the world.
Thanks
China is a totalitarian police state with little regard for rules unless they are directly beneficial to the country
This applies to their financial system-disregard of reporting rules ,disregard of the truth when it comes to financial facts etc all normal behaviour for them
This may explain that our current financial system based essentially on trust is wary of a country that has a pragmatic attitude to the truth as we perceive it
Doubtful that the two systems are compatible except at the fringes
You have been warned-sup with a long spoon!
xxd09
Following on from Lars comments on owning the world we now have more competitive offerings such as the Invesco FTSE All World Acc ETF (ticker FWRG) with TER of 0.15%. If only it had been available sooner. I understand that a further World ETF has been launched in Europe recently with a TER of 0.07%. Uncertain if this will be available in UK. Fingers crossed.
Following on from Lars comments on owning the world we now have more competitive offerings such as the Invesco FTSE All World Acc ETF (ticker FWRG) with TER of 0.15%. If only it had been available sooner. I understand that a further World ETF has been launched in Europe recently with a TER of 0.07%. Uncertain if this will be available in UK.