Active investors look for stock with the highest return, also taking risk into account. Market cap is the derivative of that. And you, as a passive investor, are riding on that wave.
Again, you’re cherrypicking. Would I like China to be fully included in VT? Of course! That’s why I’m happy when more and more companies get included. It’s hard to invest in some company, when there is no way to do it through a stock exchange.
A market cap based portfolio doesn’t care where a company is based or traded. A hypothetical relocation won’t change the part it makes up in your portfolio. Furthermore, you won’t need to rebalance if one part of the world does better than the rest.
China is a complex topic
https://en.wikipedia.org/wiki/List_of_largest_Chinese_companies - many of the biggest chinese companies are private and/or state-owned (=> driven by other motives that shareholder value) and/or you’re not even to allowed to buy them as a foreigner (A shares).
Much of GDP is also just building stuff for overseas companies, it’s the world’s factory. The brands and much of profits from the end sales and correspondingly shareholder value remains overseas. For example look at Foxconn’s market cap vs Apple’s. They may be building stuff for Apple now, but Apple’s controlling the brand and pulling all the strings. The can conceivably switch to other factories any time and end user won’t care - end user cares only that it’s Apple.
It doesn’t seem rational to me to significantly overweight the part of chinese market that you can buy based on the numbers(GDP) that have little relationship to it
“Feels” much better to me personally.
How so? In a theoretical “efficient” market maybe, yes. Market cap is - at least to a considerable - a resolut of accessibility. Which is worse for chinese stocks than U.S. ones.
Sure, to illustrate my point by way of examples.
Especially in electronics (and smartphones all the more so) one definitely should not discount the Chinese. Companies like BBK, Huawei or Xiaomi are neither just assembling for western manufacturers - nor are they limited to developing cheap clones. They provide fierce competition to Apple for market share and sales in most markets (albeit arguably less so in Switzerland)
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2633557
“A growing body of evidence suggests that the benefits of international diversification via developed markets have dramatically declined. While emerging markets still offer diversification opportunities, their public equity indices capture only a fraction of economic activity of emerging countries. We propose a diversification approach that exploits the global connectedness of developed countries to gain exposure to emerging countries’ overall economies rather than their shallow equity markets. In doing so, we demonstrate that developed markets still offer substantial diversification benefits beyond those available through equity indices. Our results suggest that relying on equity indices to assess diversification benefits understates diversification gains.”
I have been interested in and considered equal-weight strategies. They do have their risks, including risks of overweighting certain sectors, but this can be countered by selecting.
Also, while we are at it, “misweighting” by market cap isn’t limited to countries.
It also applies to sectors. The stock market cap is hardly always reflective of “economic reality”, however many ways you are going to define it.
A glaring example would large banks and financial companies, which - by their very nature of business - are more likely to be (and thus are over) traded publicly. This is especially true of smaller “developing” markets.
For instance, according to sector weights, MSCI Poland is made up of 44% financial companies. Now I’m no admittedly no expert about Poland - but I assume that’s hardly representative of the Polish economy as a whole.
And again, yes, that would be just an(other) example. However there’s just too many such examples to conclude that market cap indexing is far from the only sensible and reasonable approach to investing (unless, of course, I am striving to replicate this very market cap index).
That’s not to say that it doesn’t have its advantages and merits. Market cap indexing through ETFs is easy, accessible, inexpensive, cost- and (often relatively) tax-efficient.
I’m still leaning to deviating from (pure) by market cap indexing, by diversifying my investments geographically and by sectors and/or industry. Though it’s harder due to lack of products. I am even considering holding my own portfolio of individual stocks, as I feel comfortable with.
There’s also sectors/industries that I consider unworthy to invest in. Like the airline industry: too low margins, too volatile, too many bankruptcies, too much dependent on political climate, government subsidies, too prone to being effected by singular events and incidents etc…
(To quickly add and make this clear: While my opinion might be straying away from conventional “mustachian” advice and therefore this forum, I am still very much on board with much: making regular savings and investments, a largely passive buy-and-hold approach, diversification and not trying to be too clever at timing or picking the market. It’s just a couple of things that I probably feel more comfortable to deviate from purely holding VT/VWRL)
If you deviate from market cap, why wouldn’t you include known risk factors that have a higher expected return? Value and size etfs seem to be a better way of diversifing a portfolio.
Over or underweighting certain sectors or regions will not change your expected return nor the risk of your investement.
Thanks for updating and resurrecting this. AFAIK, these three simple and bare-bones portfolios still represent good choices for buy-and-hold with long time horizons and minimal hassle.
I would be inclined to give more like 55/20/25 split on the #3 to give more weight to emerging. Is this purely matter of taste or one of the two (the former or the adjusted) appears superior?
Furthermore, I am currently outside Switzerland (in EU) and work in research, which in turn limits my income a bit and means it will take me about ~3-4 years before I will cross the 100’000 USD border. In light of that, wouldn’t degiro be superior to IB? Even the fees may be somewhat higher initially, I am in favor of IB, as it offers also currency exchange which fits my needs well. With degiro, I would still go for USD based ETFs, which would incur some extra conversion costs.
You cannot purchase US-domiciled ETFs on Degiro.
In the past @hedgehog has posted a link to a MSCI paper, where they showed that in many cases GDP to stock market return is uncorrelated (or even negatively correlated in some cases). Common sense says that there’s something to it - US is “only” 25% of World GDP, yet historically (not in all periods though) it outperformed rest of the world in stock market returns. This is obviously because American companies sell their products to the entire globe. Similarly, if you would only analyse prospects of growth of Japanese economy, you’d rather cut it off entirely from your portfolio, but taking into account the fact that, for example, Toyota is selling internationally (and has international supply-chain) one might still consider investing in Japanese companies.
So to sum up, I’d just add my 3 cents: (1) it’s not that simple, (2) because it’s not that simple, it’s better to stick to the market-cap, (3) I’m not saying equal-weight is a bad idea, I just think market-cap is a reasonable default option.
To clarify: I am not saying that allocating by GDP per se “feels better” to me.
But I prefer the “result” (as posted by cortana above) at least a bit over allocating by market cap.
Why is it “better”?
It’s just different.
I’m not saying it’s particularly bad. Yes it’s probably a reasonable default option. But at the risk of really going in circles here: I still fail to see why it’s supposedly “better to stick to”.
If it’s not simple (which it certainly isn’t), any other sufficiently diversified allocation might be just as good. Or better. Or worse. At least I mitigate that cluster risk of investing more than half in one single jurisdiction (by market cap) - which has a comparably and historically high valuation at the moment.
The expected return of both strategies is the same, cap weight is simpler to implement. Why spent time and energy to deviate from it?
There is another reason to keep US > 50%:
Good factor etfs that offer exposure to size and value are mainly available for the US market. They have a significantly higher expected return and make the effort worthwile to deviate from a market cap portfolio.
Is there a good ex-US variant of VIOV, IJS, SLYV?
I haven’t found one with decent factor exposure.
All smart beta etfs I found have so little factor exposure that they are not worth their TER
I ditched VT completely because of VIAC.
My plan is to invest in VTI and VIOV (maybe a 50/50 split) in IBKR and cover Canada, Europe, Pacific and EM with VIAC. As soon my assets in IBKR are big enough, I would ditch EM in VIAC as well and cover that with VWO. Leaving only Switzerland, Europe and Pacific in Viac.
Target AA is: 60% North America, 14% EM, 12% Switzerland, 8% Europe ex CH, 6% Pacific.
Because with market cap you get more exposure to diversified portfolio of bigger, well established companies, which should be the core of any reasonable long-term buy and hold strategy.
Market cap is always the most efficient portfolio too. You can’t get the same expected return with less risk.
So it only makes sense to do something else if you want to increase your risk and also your expected returns, like a SCV tilt or maybe higher allocation to EM than market cap weight.
Small cap and value can reduce the overall risk of the portfolio while increasing the return.
What do you mean? They usually increase volatility (which constitutes the definition of risk in finance).
How much SCV do you have?