You should add a disclaimer “in my opinion” in front of that statement. You’re saying that the market is underestimating the small caps and emerging markets in the long run. But why is it doing that? Maybe it has something to do with, as you said, volatility. Could you convince me why we should have that bias? Not just with past numbers, but with logic.
It is a conclusion of modern portfolio theory: There is the (more or less plausible) assumption that an stock A that has higher volatility than stock B should have a higher long term return than stock B. If stock A had a higher volatility but just the same retuns as stock B, no investor would buy it.
Historically a positive risk premium for each small, value and emerging markets is found. no guarantee for future returns…
[edit] thinking about this i dound the MSCI EM small Index has a few IE-dimiciled ETFs that track it: http://www.etf.com/equity_emerging_markets_small_cap
however they are not cheap with TERs around 0.5-0.7%. i might open a new thread for this, as it is derailing OP’s questions 
OK that sounds logical to me. So the current price levels are the effect of market forces striking a balance between expected return and volatility. I guess you could try to plot a curve between volatility and the average expected return. Maybe it would be linear, maybe not. But this curve would represent the propensity to risk of the whole market.
So what you’re suggesting is to be more risk tolerant than the average of the market. But why not go all the way? Why not invest only in small caps and emerging markets? They should yield the biggest returns in the long run, right?
I have another explanation, at least for small value caps.
No institutional investor goes for true small caps. if you are a fund manager with 10 billions to invest, 1% of your portfolio is 100 million USD. Therefore, you will totally ignore small companies with market cap inferior or equal to 100 Million USD, else, your stake in this company would have too big of an impact on the price of the stock.
Therefore, it is my experience that market are much less efficient in small caps.
Using a fishing analogy, if you were a retail fisherman, would you go fishing where the trawler fish boats are, with their industrial nets? Or would you go where they cannot go due to their size, and get some fish?
1 Like
what people come up with is this:
qualitiatively scientists agree that each additional portion expected return costs an increasing amount of volatility (or risk). so no, it is not linear.
That would be very consistent. you would end up with that single most risky stock available deep in the jungle of EM small value stocks. Then you have the highest expected return, the highest risk, and no diversification. and here i decided to not trade in the diversification of a world portfolio. it would go too far now to point out why you want diversification here 
also i like julianek’s point of fishes^^
2 Likes
That is a very cool chart! Exactly what I had in mind. So, first thing that comes into my mind is that it ranks growth stocks as more risky than value, thus, one would assume, more up your alley. Yet you recommend value?
Anyway, one might argue, that including too many small caps and emerging markets brings you a lot of risk for not so much more return.
That’s a good point. However, are small caps not what venture capital is investing in? And they are not guys with small wallets. I agree with your conclusion that small caps are less efficient, but that’s not necessarily a good thing when you buy a whole-market small cap ETF.
If I was a smart fisherman and I knew where to fish, I could probably find some small fish that the trawlers didn’t bother to catch. But for this I would need to actively bet on particular areas. An ETF is not like that.
Venture Capital guys buy private companies, not listed companies
Yes, an ETF is already at the scale of the trawler fishing boat.
It’s why am thinking about. Currently, my portfolio is 50% EM and will put more USA Value.
Yes, on the long rung the yield will be bigger. But the term “long run” also depends of your time horizon. Are you ready to wait XX year to see the bigger return?
The downside is that cost to own small-cap might be more expensive. You will need to check if the return after cost worth it.
For exemple:
-MSCI emerging market in the last 10 year has a return of: 1.68% by year. To track this index, the cost is around 0.25% + small/medium spread (around 0.2%)
-MSCI emerging market Small cap in the last 10 year has a return of: 2.78% by year. To track this index the cost around 0.74% (iShares MSCI Emerging Markets Small Cap UCITS ETF) + a big spread (around 1% on the SIX).
The spread applies only when you buy or sell the share. At the end the difference is not so big after cost.
I think it’s a bad idea to buy EM etf on the US market due to the withholding tax.
… and they usually buy the whole or a big fraction of the company, getting involved or overtaking management altogether. other than the tiny pieces passive investors buy
no, they are IE-domiciled! at least Ishares & SPDR, the other i didnt check
1 Like
her you go:https://www.ishares.com/uk/individual/en/literature/fact-sheet/iems-ishares-msci-em-small-cap-ucits-etf-fund-fact-sheet-en-gb.pdf
UCITS version
https://www.justetf.com/en/find-etf.html?assetClass=class-equity&groupField=index®ion=Emerging%2BMarkets&equityStrategy=Small%2BCap
One thing Gerd Kommer advocates for is using a GDP-weighted portfolio and not a market cap weighted portfolio. The reasoning being better historical and expected future performance, because a market-capped portfolio already invests in the “winners” so kind of like a bubble.
His 70/30 World EM Portfolio incorprated the GDP weighted approach. Another approach would be ~50World/20EU/30EM
However he uses the MSCI index for World and EM, we here like Vanguard and the FTSE index. If I were to recreate the 70/30 Portfolio with FTSE indexes would much change? I’m guessing less EM because South Korea isn’t in the EM index but world.
What are your opinions on this? In germany the GDP route seems to be preferred, here I don’t see it so much.
There are GDP weighted MSCI indexes, look them up. I don’t know out of what hole did he dug up his data from, but even official MSCI backtests say that they suck.
And there’s no reason why they shouldn’t, country of stock’s HQ in quite a few cases has nothing to do with actual revenue exposure. For example, Nestlé has a lot more exposure to India than Switzerland, S&P has over 40% non US sales. ACWI (world+EM cap weighted) actually has a decent 35% EM revenue exposure already (link)
Now, an index weighted by GDP of actual revenue exposures (or better yet GDP growth) could be interesting but I haven’t seen anyone do it
1 Like
I would be happy to invest in MSCI World Risk Weighted Index
https://www.msci.com/documents/10199/bd418831-7aaa-4024-985e-f52e4662578d
or even better MSCI World IMI Risk Weighted Index
https://www.msci.com/documents/10199/e42fb64d-8e3e-4ccf-86f5-05378748d1c9
Any ETF suggestions?
1 Like
There’s plenty of such factor etfs, search for ‘low volality’ or similar buzzwords. They tend to be fairly expensive compared to simple cap weighted index funds. Would not own either of them, they focus on the wrong kind of risk IMHO
The ones I found are all poorly diversified, usually along the lines of “The S&P 500 Low Volatility index tracks the 100 least volatile stocks in the S&P 500”.
The MSCI World Risk Weighted tracks the same stocks as MSCI World (Market Cap Weighted).