I’d make a bet that the S&P 500 and similar passive indexes will deliver poor returns due to ridiculously overvalued startups (like Tesla).
This video was subsequently recommended and pretty much sums it up.
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I noticed that MSCI World Health Care performed remarkably similar to MSCI World Quality over the long term - just with less volatility, compared to the quality indices (or „plain“ MSCI World). It is also more more accessible as ETF - and should be available as (more tax-efficient“?) US-domiciled ETF as well?
I‘m not sure if the 1994 start date is of any significance, but both MSCI World Quality and World Health Care have shown annual historic overperformance of about 3 percentage points over MSCI World since then.
Do these calculation make sense for growth companies? Tesla has to build factories first to be able to deliver that revenue.
Finpension let’s you buy into MSCI Quality ETF at a very low price (albeit with 3a money).
However it’s pretty much only IT and Healthcare for now (which is good, these two did bring the world forward the last 5-8 yrs).
I’m thinking about a majority allocation in MCSI quality with one of my 3a products (35% of my 3a wealth). Does any reasonable argument say I shouldn’t?
Investments will go into 75% real estate (already there) and 25% SP500/MSCI Quality/Fundsmith mixed.
@Julianek
I hope it’s ok if I post a question somewhat related to this post:
What is your opinion about how an index investor should view the equity premium puzzle?
Until recently I thought stocks and thus ETFs outperformed quasi-riskfree assets like government bonds because of the risk premium. But now I’ve learned that the equity premium puzzle is quite robust against many explanations.
It seems that and FIRE index investor should possibly:
- be glad that the premium exists, because it makes FIRE much more attainable
- be worried that they don’t really understand why this premium exists (and therefore) under what circumstances it will continue to exist.
Most FIRE calculators already suggest to use a more conservative expected return (4-5%) than historical returns (~8%). Does this already adjust for a possible discontinuation of the equity premium, or should we possibly be even more conservative in our assumptions?
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As we know, investing in U.S. securities is preferably through U.S.-domiciled ETFs, due to their tax efficiency and the possibility to have withholding tax refunded. However, as I previously wrote (above), I’m not aware of an MSCI U.S. Quality index-based fund domiciled in the US (the iShares “factor” one “sector-neutrally” tracks another index).
This begs the question: Why limit oneself to MSCI-based funds?
Looking into this, I also come across the SPHG that wapiti already mentioned above:
TER 0.15% - 0.21%, U.S.-domiciled.
Seeing that this was during a 5-year (largely) bull-market, I’m not concerned. I’d guess the quality ETF should hold up better in a downturn or correction.
P/E for SPHQ is like 25.
MSCI U.S. Quality = 27.
S&P500 = 31.
So kind of a value play, too.
Think I’ll be switch from my Irish MSCI USA ETF to SPHQ.
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Also, for Japan, I’ve looked into 1460 MAXIS JAPAN Quality 150 Index ETF so far.
(The other other developed markets are kind of negligible)
Since Health Care makes up for about a quarter of all three indices/funds, investing in a separate Health Care ETF (as I’ve done) seems a bit pointless. This will simplify things with less funds.
AVUV is a multifactor fund that uses value, size and profitability as primary factors and screens out companies with negative exposure to conservative investment and momentum factors. It has a PE of 13.
If you are just after a slight tilt, the core finds from Dinensional or Avantis are probably better. DFAU has a PE of 25.
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For people interested in learning more about the (missing?) relationship between “risk” and returns, I can recommend this book: Finding Alpha. The title is a bit cheesy, but most of the book is actually a critique of the standard risk/return models in finance.
In particular, the basic idea that higher risk (as measured by volatility) leads to higher returns is not really backed up by the data. More sophisticated models (like Fama-French mentioned by @Julianek further up in the thread) are second-order refinements on top of a first-order model that doesn’t seem to really work out in practice.
A related concept is the “betting against beta” strategy that’s pretty common in the hedge fund world: Betting against beta - ScienceDirect.
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I still don’t get this one: if you are a believer in factor investing (since you’re a believer in quality), why not invest in a multifactor ETF? There, all the factors are represented. Or you only believe in quality, but not in (high) value, (high) momentum, (small) size, (low) volatility?
I explored the Ken French Data a bit, there are portfolios constructed based on a three way sort of size, operating profitability and book to market for the US since 1963:
The S&P500 returned 10.4% per year during that period.
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what’s the point you’re trying to make?
That is just for reference.
I hate the iShares implementation and believe fixed sector allocation is pointless. It’s not like it’s god-given or something. There’s many countries in the world where the stock market is merely a few big banks that are dominating the stock indices and its index weights. So the sector allocation does not reflect the “real” economy at all.
Point in case: MSCI Poland which is like 35% Financials - with no other sector accounting for more than 15% of the stock market. It’s a very highly developed country with a fairly large population and an EU member state. (Can you guess how big the share of Financials in MSCI Switzerland is? A country that’s so renowned worldwide for its financial sector).
As for the overweighting of information technology, I think it’s “top-heavy”, i.e. mainly the biggest constituents are responsible for that: Microsoft, Apple, Visa and Mastercard alone account for nearly half of it - and I do believe they have sustainable and defensible (if not entrenched) business models.
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A single large company can skew the characteristics of an index of a small country. In Poland this is done by 3 large companies:
- 15% - PKO BP - the monopolist bank of the former Polish People’s Republic
- 10% - PZU - the monopolist insurance of the former Polish People’s Republic
- 6.5% - PEKAO - another bank, formerly used for international affairs of the P.P.R.
I guess in Switzerland pharma is over-represented, thanks to Novartis & Roche.
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I noticed as well that index methodologies for smaller economies are quite curious.
To stick to the Polish example:
- MSCI Poland has only 14 components
- the Warsaw Stock Exchchange Index (WIG20) has 20 components
… while there are more than 400 companies listed on the Warsaw Stock Exchange.
As a result, passive investors are piling up on the 15-20 bigger names of the Polish economy. I haven’t checked the relevance of PKO, PZU and PEKAO (maybe they are good value creators, maybe they aren’t), but there are very interesting companies that are left outside of the whole indexing universe.
For instance, Livechat Software SA (LVC) is a SaaS company with almost $1billion market capitalisation; not huge, but not tiny either. As far as I know it is not included in any index, either worldwide or local. In spite of this it is a fantastic business:
- Annual return on invested capital is superior to 100%
- it distributes 70% of earnings to sharholders because it does not need much capital
- it grows its earnings at more than 30% per annum
- Although it is listed in Poland, the vast majority of its business is done in the USA
- it is trading at roughly 30 times past earnings, while its US SaaS equivalents are trading at twice or three times this multiple, even those that are not profitable)
Why it is not included in any index is beyond me, but I won’t complain. I’ll let indexers pile up on the Polish financial sector, while I can focus on this kind of nugget.
(Disclosure: long LVC).
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I obviously chose Poland since it’s so glaring an example.
(and maybe because some of the most prolific contributors in this forum are from the country)
But… the same is (in principle) true for any other country or region.
Just because S&P 500 has a couple hundreds of constituents more, that doesn’t mean it is an accurate representation of the country’s “real” economy.
Likewise, neither is a “broad”, multi-sector world index (such as FTSE All-world) an accurate representation of the world’s economy.
They may be good representations of the respective stock markets - but again, I see no particular reason to only follow listed companies according to their market cap (though that’s probably still one of the better “no-brainer” strategies).
You can’t help but ask yourself if its stock price somehow has a discount priced in - with all the huge billions flowing into index constituents from passive funds.
Sidenote: Did you share your sources of inspiration or tools of research for these kinds of picks?
Or do we have a thread about it (and individual stocks in general) on this forum?
I am gradually shifting my entire IBKR to equities, and it won’t be index funds.
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I see a reason. Capital looks for the highest, risk adjusted return. They take two/three/more companies and make technical/fundamental analysis and compare. Sure, it’s not perfect, that’s why there is so much volatility. But I don’t think there exists a more logical alternative to market cap weighting.
Index funds don’t. They instead rely on other market participants / someone else doing the work.
Kind of like the open source software model in regards to security vulnerabilities: The numbers (the code) are out in the open. Someone surely will the due diligence, right? Eventually, you end up with something like Heartbleed.
And then, sometimes, some of the most prominently featured due diligence is actually a steaming pile of shit intended to (…no, wait, I’m not allowed say to that, so let’s say) suited to prop up the stock.
The increasing influx in passive funds is only going to increase that.