Small Caps for IE Global Portfolio

Any updates on how to best include small caps in a non-US-domiciled global portfolio (IE accumulating preferred)?

I slightly prefer Vanguard to other companies (no strong feelings, but i like the ownership idea of Vanguard), and I am considering 70% VHVE, 20% VFEA and 10% WSML.

Interestingly, there seems to be no overlap between VHVE (FTSE) and WSML (MSCI). However, I find WSML really expensive (TER 0.35).

Oh, and I guess synthetical might be better performing tax-wise, but I just prefer holding physical stuff in case of bankruptcy. Also, I don’t really understand the synthetical build and fear intransparent derivative shenanigans :slight_smile:

Any thoughts?

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I saw that some people recommended WOSC on this forum but it seems to be more expensive than the one you mentioned.

With UCITS there is a collateral required to backup 90% of the ETF’s NAV, so you can lose only 10% in the worst case.

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At only 10% for a diversified global equity fund, it’s hardly going to make any tangible difference.
Even if there is - or will be - a 1% or 2% annualised premium on small caps, and you hold that fund for 10 years, with such a small part of your portfolio and high correlation between both indices/funds, it will likely (from historic figures) make a difference of less than 2% or 3% of your overall portfolio.

In other words: It’s as if you invested a lump sum into just one (large/mid cap) fund.
And then get lucky - or suffer bad luck - by not buying it 2 or 3 days earlier or later.

On another note, the 10% allocation for small caps is probably not much different from what they are in VT/VWRL. So again, you could pretty much have your three-fund portfolio all baked into just one fund.

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Good points, thanks! I’ve come across a very interesting article saying that leaving out small caps in a global market-weighted portfolio is leaving out 15% of the world market. I don’t know if I feel comfortable with that (FOMO-alert :slight_smile: ). Also, my idea with small caps is more diversification, less correlation, and who knows, maybe I get the next Amazon or Google in my small caps.

VT includes small caps, true that is, VHVE I believe not. I just prefer non-US-domiciled ETF due to policy risks / unforseeable tax developments. Also, I’m not getting retired any soon, so I like accumulating because it disciplines me to reinvest automatically. And keeping DM, EM and Small Caps apart enables me to rebalance when good opportunities arise (e.g. undervalued EM currently).

I don’t think a 10% allocation will have any large effect on diversification and correlation.

Which will be rotated out of the index once it reached a certain size.

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Agree, it’s great being able to discuss with you guys! Strangely enough, many banks have or recommend like 5% allocations to gold, real estate, specialized market segments etc.

Yeah, why wouldn’t they, theses products often have higher fees, meaning they make more money with it. Banks also want to sell you active equity funds with 1-2% mgmt fees :slight_smile:

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This is technically correct, as standard MSCI indices include 85% of respective market capitalization. But

Well performing small caps get promoted to the standard index, and you get demoted mid caps as top components of a small cap index instead. As I do believe in momentum, I don’t think it is a good idea. So it is total market or standard index for me.

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Coming back to small caps: I’ve just adjusted my pillar 3a to include 15% small caps in order to more correctly replicate MSCI ACWI IMI / VT.

Do you believe this quite considerable 15% chunk of the world market is (for now) often overlooked by global stock investors and might therefore lead to outperformance eventually? VT is not well known outside the US, and UCITS MSCI ACWI IMI ETFs don’t seem to be too popular (everyone’s talking about MSCI World/EM portfolios).

Also, I could imagine there’s kind of a little bias toward the big/sexy names (FAANG, Tesla etc.); 15% small caps might help counterbalance this a little

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Yes, there is some kind of sector rotation going on in the market and if there is a time to get into small caps & value, rather than growth, it’s probably now. So I think 15% small caps is quite reasonable I would probably even go a bit further.

Yes, MSCI world is about 70% US and 30% technology and large overvalued growth stocks, which is probably way too much. I think it makes sense to underweight those by adding small caps and it would possibly also make sense to overweight also other stuff a bit, but it’s difficult if ETF selection should be as small as possible, i.e. only 1 ETF or very few.

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Overlooked yes - but probably rightly or not wrongly so.
Over the long terms, it‘s pretty much a wash:

https://www.ftserussell.com/blogs/what-have-you-done-my-small-cap-premium

Yes. At only 15%, it will most likely not make a negligible (and „random“) difference to your overall portfolio performance. If anything, I‘d say you can (should) go 30 to 50%.

Though you aren’t underweighting US stock by adding a small cap fund.

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Interesting, so I take it that small caps could also outperform if you believe in the coming deglobalization / decrease in globalized supply chains (big global companies will do worse in that sense than small local ones).

(correction) Small cap value - not pure small cap - is expected to outperform over the (very) long runs.

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Interesting thought, why would that be? Isn’t quality kind of a sector bet (like growth, quality, low vol, momentum etc.)?

Not sectors but factors.

Here is a start of the thesis:

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Great video, I love the science-based approach. Probably I didn’t fully understand the content, but to me it still seems just like a quality-factor bet. Of course, this might work out perfectly well.

What I also cannot get my head around: Is Ben defining the “market” as a factor, just like value, growth etc.? To me, that wouldn’t make much sense, because the market’s supposed to be the sum of all factors.

I do admit that in theory, I find multifactor-ETFs a very interesting concept (very expensive though). However, having multiple factors in one ETF would in the end cancel each other out and amount to the “market” as whole again, just by means of a super-expensive “VT”. In essence: a ETF-industry marketing gag.

Anyone following, or do I need to drink some coffee to get my head straight :grin: ?

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Yes, they are a bit more expensive but TER is not the only thing to look for in an ETF. The outperformance of those ETFs are supposed to be higher than the higher costs of the ETF.

Well, there is some statistical analysis around it, so it’s not just a bet like in a casino, where it’s purely about chance. It’s more like taking advantage of events/characteristics that have a certain probability of happening. I mean, it’s more or less clear what happens when the Fed etc. intervenes, the question is usually just when and to what extent. Whole market ETF’s have the disadvantage that always during large changes in the market, e.g. moving into another phase of the economic cycle, sector rotation or whatever, you have to bear all the negative consequences that come along with that. With exposure the certain factors you can mitigate that to some extent, e.g. if growth stocks get into a crisis and you have high exposure to value factor, it is beneficial for you.

That’s right to some extent but it’s still not the same. VT contains also all the worthless crap whereas the multi-factor ETF contains only stocks with certain characteristics. But there are also ETF’s that expose you only to two factors. Someone posted already about Avantis ETFs as an example where you can get exposure to size (small-caps) and value factors.

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