Emerging Markets - Equal Country Weight

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Emerging Markets - Equal Country Weight

Postby AppelSienSapFrietjes » Fri Jun 28, 2013 10:06 am

Hi all,

Most investors invest in the emerging markets through an ETF which covers a broad index, such as MSCI Emerging Markets.

Does it make any sense to invest in each country separately and equally weighted, instead of in the broad index? For example, if you want to invest 20K (this is just a number):

1k in MSCI India
1k in MSCI Taiwan
1k in MSCI China
1k in MSCI Korea
1k in MSCI Singapore
1k in MSCI Thailand
1k in MSCI Malaysia
1k in MSCI Indonesia
1k in MSCI Thailand
1k in MSCI Philippines
1k in MSCI Brazil
1k in MSCI Mexico
1k in MSCI Chile
1k in MSCI Peru
1k in MSCI Colombia
1k in MSCI South-Africa
1k in MSCI Poland
1k in MSCI Turkey
1k in MSCI Czech Republic
...

This list might not be complete, but I assume the example is clear.

What is your opinion? Thanks.
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Re: Emerging Markets - Equal Country Weight

Postby Bogle101 » Fri Jun 28, 2013 10:11 am

Why over complicate things like that?
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Re: Emerging Markets - Equal Country Weight

Postby AppelSienSapFrietjes » Fri Jun 28, 2013 10:14 am

Bogle101 wrote:Why over complicate things like that?


I agree things become complicated, but by doing this, smaller EM countries have an equal impact than the larger EM countries. If you look at the EEM index, a huge percentage is taken by China, Russia, Taiwan and Korea. The other countries don't really matter.
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Re: Emerging Markets - Equal Country Weight

Postby BigOilTexan » Fri Jun 28, 2013 10:16 am

Do you have a specific reason for that allocation? Do you prefer to be overweight on Peru and underweight on China relative to the index?

For example, VEMAX holds...

China 20.0%
Brazil 14.4%
Taiwan 12.6%
India 8.9%
South Africa 8.3%
Russia 6.3%
Mexico 5.6%
Malaysia 4.8%
Indonesia 3.3%
Thailand 3.1%
Korea 2.6%
Turkey 2.4%
Chile 2.1%
Philippines 1.5%
Poland 1.5%
Colombia 1.0%
Hungary 0.3%
Peru 0.4%
United Arab Emirates 0.4%
Czech Republic 0.3%
Egypt 0.1%
Netherlands 0.1%
Morocco 0.0%
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Re: Emerging Markets - Equal Country Weight

Postby Investing is boring » Fri Jun 28, 2013 10:17 am

What justification do you have to deviate from:

GDP Weighting?
Market Cap Weighting?

What evidence do you have to suggest that equal weight among countries lowers risk or increases returns?
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Re: Emerging Markets - Equal Country Weight

Postby BigOilTexan » Fri Jun 28, 2013 10:18 am

AppelSienSapFrietjes wrote:
Bogle101 wrote:Why over complicate things like that?


I agree things become complicated, but by doing this, smaller EM countries have an equal impact than the larger EM countries. If you look at the EEM index, a huge percentage is taken by China, Russia, Taiwan and Korea. The other countries don't really matter.


If you prefer to invest equally in Peru and China than you can slice 'n dice it up, but do you have an investment reason for doing that?
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Re: Emerging Markets - Equal Country Weight

Postby AppelSienSapFrietjes » Fri Jun 28, 2013 10:19 am

Investing is boring wrote:What justification do you have to deviate from:

GDP Weighting?
Market Cap Weighting?

What evidence do you have to suggest that equal weight among countries lowers risk or increases returns?


I don't have any evidence that it lowers the risk and increases the return. I did not say that lowering the risk was a goal. I am simply asking the question and starting the discussion.
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Re: Emerging Markets - Equal Country Weight

Postby AppelSienSapFrietjes » Fri Jun 28, 2013 10:29 am

(to be ignored, see below)
Last edited by AppelSienSapFrietjes on Fri Jun 28, 2013 10:40 am, edited 1 time in total.
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Re: Emerging Markets - Equal Country Weight

Postby Investing is boring » Fri Jun 28, 2013 10:29 am

AppelSienSapFrietjes wrote:
Investing is boring wrote:What justification do you have to deviate from:

GDP Weighting?
Market Cap Weighting?

What evidence do you have to suggest that equal weight among countries lowers risk or increases returns?


I don't have any evidence that it lowers the risk and increases the return. I did not say that lowering the risk was a goal. I am simply asking the question and starting the discussion.


Well let me settle the discussion. Without extensive evidence that tilting (and this is tilting) improves risk adjusted returns - like we have with Small and Value factors - there is NO REASON to deviate from the tried and true GDP or Market Cap weighting.
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Re: Emerging Markets - Equal Country Weight

Postby G-Money » Fri Jun 28, 2013 10:32 am

AppelSienSapFrietjes wrote:Does it make any sense to invest in each country separately and equally weighted, instead of in the broad index?

IMO, no.

First, there's the theoretical. What justification is there for doing this? Are you equal-weighting your developed-market equities, too? There has been plenty of research showing premia for overweighting small and value stocks, but not for overweighting smaller-capitalized countries.

Second, there's the practical. The many of the single-country ETFs are very thinly traded. The bid-ask spreads are likely to be significant.

What is your opinion?

My opinion is that you should have a good reason for deviating from the broad market indexes. Your observation that some countries constitute a large percentage of the EEM index doesn't qualify, IMO. They have significantly higher capitalization for a reason. Unless I could expect a premium (either higher expected returns or lower risk) by investing in equal country weight, I see no reason to do it.
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Re: Emerging Markets - Equal Country Weight

Postby AppelSienSapFrietjes » Fri Jun 28, 2013 10:40 am

Some calculation. According to MSCI website (http://www.msci.com/products/indices/co ... mance.html).

MSCI EM 10y Net = 13.38% annually

Each country separately:

China 0.1555
India 0.1590
Indon. 0.2454
Korea 0.1199
Malaysia 0.1478
Philippines 0.2007
Taiwan 0.0726
Thailand 0.1897
Brazil 0.1991
Chile 0.1625
Colombia 0.3254
Mexico 0.1688
Peru 0.2260
Czech 0.1474
Hungary 0.0930
Poland 0.1017
Russia 0.0809
Turkey 0.1870
Egypt 0.2238
Morocco 0.1051
South Afr. 0.1492

Each row added and divided by 21 gives 0.1648.

So the difference for the last 10 years is around 3% annually.
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Re: Emerging Markets - Equal Country Weight

Postby Investing is boring » Fri Jun 28, 2013 10:46 am

AppelSienSapFrietjes wrote:Some calculation. According to MSCI website (http://www.msci.com/products/indices/co ... mance.html).

MSCI EM 10y Net = 13.38% annually

Each country separately:

China 0.1555
India 0.1590
Indon. 0.2454
Korea 0.1199
Malaysia 0.1478
Philippines 0.2007
Taiwan 0.0726
Thailand 0.1897
Brazil 0.1991
Chile 0.1625
Colombia 0.3254
Mexico 0.1688
Peru 0.2260
Czech 0.1474
Hungary 0.0930
Poland 0.1017
Russia 0.0809
Turkey 0.1870
Egypt 0.2238
Morocco 0.1051
South Afr. 0.1492

Each row added and divided by 21 gives 0.1648.

So the difference for the last 10 years is around 3% annually.


What do you THINK this proves?
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Re: Emerging Markets - Equal Country Weight

Postby AppelSienSapFrietjes » Fri Jun 28, 2013 10:47 am

G-Money wrote:
AppelSienSapFrietjes wrote:Does it make any sense to invest in each country separately and equally weighted, instead of in the broad index?

IMO, no.

First, there's the theoretical. What justification is there for doing this? Are you equal-weighting your developed-market equities, too? There has been plenty of research showing premia for overweighting small and value stocks, but not for overweighting smaller-capitalized countries.


This is exactly what I am doing, but on the level of a country. I am over-weighing smaller countries, instead of smaller companies. Reasons why smaller companies appear to have higher returns are not applicable to countries?
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Re: Emerging Markets - Equal Country Weight

Postby Investing is boring » Fri Jun 28, 2013 10:48 am

AppelSienSapFrietjes wrote:Reasons why smaller companies appear to have higher returns are not applicable to countries?


No. They are not.

Just because a smaller airplane uses less gas, does not mean a smaller apple uses less gas.
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Re: Emerging Markets - Equal Country Weight

Postby AppelSienSapFrietjes » Fri Jun 28, 2013 10:51 am

Investing is boring wrote:
AppelSienSapFrietjes wrote:Some calculation. According to MSCI website (http://www.msci.com/products/indices/co ... mance.html).

MSCI EM 10y Net = 13.38% annually

Each country separately:

China 0.1555
India 0.1590
Indon. 0.2454
Korea 0.1199
Malaysia 0.1478
Philippines 0.2007
Taiwan 0.0726
Thailand 0.1897
Brazil 0.1991
Chile 0.1625
Colombia 0.3254
Mexico 0.1688
Peru 0.2260
Czech 0.1474
Hungary 0.0930
Poland 0.1017
Russia 0.0809
Turkey 0.1870
Egypt 0.2238
Morocco 0.1051
South Afr. 0.1492

Each row added and divided by 21 gives 0.1648.

So the difference for the last 10 years is around 3% annually.


What do you THINK this proves?


It proves that this would have worked for the last 10 years with respect to return. Nothing more, nothing less.

If this is a stupid question from your perspective, fine. I am asking and initiating a discussion.
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Re: Emerging Markets - Equal Country Weight

Postby Investing is boring » Fri Jun 28, 2013 10:52 am

AppelSienSapFrietjes wrote:It proves that this would have worked for the last 10 years with respect to return. Nothing more, nothing less.

If this is a stupid question from your perspective, fine. I am asking and initiating a discussion.


And what does this have to do with expectations of the future?
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Re: Emerging Markets - Equal Country Weight

Postby AppelSienSapFrietjes » Fri Jun 28, 2013 10:54 am

Investing is boring wrote:
AppelSienSapFrietjes wrote:Reasons why smaller companies appear to have higher returns are not applicable to countries?


No. They are not.


Why not?
What about the arguments in chapter 1 of The Four Pilars of Investing? See http://www.efficientfrontier.com/t4poi/Ch1.htm.

Thanks.
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Re: Emerging Markets - Equal Country Weight

Postby AppelSienSapFrietjes » Fri Jun 28, 2013 10:56 am

Investing is boring wrote:
AppelSienSapFrietjes wrote:It proves that this would have worked for the last 10 years with respect to return. Nothing more, nothing less.

If this is a stupid question from your perspective, fine. I am asking and initiating a discussion.


And what does this have to do with expectations of the future?


Nothing.
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Re: Emerging Markets - Equal Country Weight

Postby Investing is boring » Fri Jun 28, 2013 10:57 am

AppelSienSapFrietjes wrote:
Investing is boring wrote:
AppelSienSapFrietjes wrote:Reasons why smaller companies appear to have higher returns are not applicable to countries?


No. They are not.


Why not?
What about the arguments in chapter 1 of The Four Pilars of Investing? See http://www.efficientfrontier.com/t4poi/Ch1.htm.

Thanks.


Rather then pointing to Bill's website and suggesting that it in its totality proves your point, putting the burden of proof on the reader to decipher what the heck you mean... why dont you specifically cut and paste the section you are referring too that supports your argument.
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Re: Emerging Markets - Equal Country Weight

Postby AppelSienSapFrietjes » Fri Jun 28, 2013 11:00 am

To "Investing is boring":

I believe that there are always 3 valid answers:

- Yes, true.
- No, false.
- I don't know/I have no opinion.

In case of the second possibility, could you please elaborate why you believe this is stupid?
In case of the third possibility, thanks for your input.

I believe that you are mixing the second and the third possibility, because of lack of arguments.

Thanks.
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Re: Emerging Markets - Equal Country Weight

Postby AppelSienSapFrietjes » Fri Jun 28, 2013 11:04 am

BigOilTexan wrote:
AppelSienSapFrietjes wrote:
Bogle101 wrote:Why over complicate things like that?


I agree things become complicated, but by doing this, smaller EM countries have an equal impact than the larger EM countries. If you look at the EEM index, a huge percentage is taken by China, Russia, Taiwan and Korea. The other countries don't really matter.


If you prefer to invest equally in Peru and China than you can slice 'n dice it up, but do you have an investment reason for doing that?


I have no particular reason. I am just trying to ask a question and start a discussion.

Thanks.
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Re: Emerging Markets - Equal Country Weight

Postby AppelSienSapFrietjes » Fri Jun 28, 2013 11:10 am

Investing is boring wrote:
AppelSienSapFrietjes wrote:
Investing is boring wrote:
AppelSienSapFrietjes wrote:Reasons why smaller companies appear to have higher returns are not applicable to countries?


No. They are not.


Why not?
What about the arguments in chapter 1 of The Four Pilars of Investing? See http://www.efficientfrontier.com/t4poi/Ch1.htm.

Thanks.


Rather then pointing to Bill's website and suggesting that it in its totality proves your point, putting the burden of proof on the reader to decipher what the heck you mean... why dont you specifically cut and paste the section you are referring too that supports your argument.


I don't have any arguments. He says:

"Be especially wary of data demonstrating the superior long-term performance of U.S. stocks. For most of its history, the U.S. was a very risky place to invest, and its high investment returns reflect that. Now that the U.S. seems to be more of a "sure thing," prices have risen, and future investment returns will of necessity be lower."

Are China/Russia/Brazil/Taiwan/Korea (being the top contenders of the EM index) more of a "sure thing" than Singapore, Malaysia, Thailand, Chile, ... (being the bottom contenders of the EM index)? I think they are.

But please, again, I am NOT trying to prove anything. Please re-read all my posts. I am trying to ask a question and start a discussion. I am asking for arguments.
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Re: Emerging Markets - Equal Country Weight

Postby Investing is boring » Fri Jun 28, 2013 11:13 am

Your question has been answered.
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Re: Emerging Markets - Equal Country Weight

Postby AppelSienSapFrietjes » Fri Jun 28, 2013 11:15 am

Investing is boring wrote:Your question has been answered.


Thanks. Feel free to elaborate or explain them.
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Re: Emerging Markets - Equal Country Weight

Postby Investing is boring » Fri Jun 28, 2013 11:17 am

AppelSienSapFrietjes wrote:
Investing is boring wrote:Your question has been answered.


Thanks. Feel free to elaborate or explain them.


Re-read my posts and G-Money's. Thank you.
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Re: Emerging Markets - Equal Country Weight

Postby hafius500 » Fri Jun 28, 2013 11:21 am

What you suggest is called "naive diversification". According to Behavioral Finance investors equal-weight investments if they do not possess more information.
Thus it is an uninformed decision and, on averge, you cannot expect any improvement. IOW, any choice is not better or worse than any other choice.[*]

Instead of equal-weighting countries you could equal-weight global sector funds, regional funds, factor-tilted global (large-small, value-growth) funds, socialistic and capitalistic countries, countries with and without harbors, and...

OTOH, you could have a strategy that selects a few portfolios (e.g., countries). You could equal-weight these portfolios if you don't have additional information. (And such funds exist)
BTW, what would be the transaction costs of an equal-weighted portfolio?

[*]See the papers by Arnott, Perold and Kaplan I quoted here in a thread that discusses (among other things) equal-weighting.

Other threads Equal weighting or market cap weighting?

50 biggest companies dominate the S&P 500
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Re: Emerging Markets - Equal Country Weight

Postby G-Money » Fri Jun 28, 2013 11:29 am

AppelSienSapFrietjes wrote:
Investing is boring wrote:
AppelSienSapFrietjes wrote:Reasons why smaller companies appear to have higher returns are not applicable to countries?


No. They are not.


Why not?
What about the arguments in chapter 1 of The Four Pilars of Investing? See http://www.efficientfrontier.com/t4poi/Ch1.htm.

Thanks.

I read Bernstein's argument more for the idea that investing in international equities (as opposed to 100% US equity) is a good idea. I do not recall him ever advocating equal weighting all countries.

To take your approach to its natural conclusion, there are approximately 80 countries with stock exchanges. (Source, courtesy of a basic Google search: http://www.tradingeconomics.com/country ... ock-market). Do you intend to simply put 1/80 of equities into each country? This would make for a dramatic overweight of some countries (e.g., Bahrain), and a dramatic underweight in others (e.g., U.S.). But without a risk-return justification for doing so, I'm not sure why you would use this approach.

In contrast, holding all COMPANIES at their market weight has extensive support in the research. For an easy-to-read primer, take a look at some of Larry Swedroe's books. He also thoroughly explains how overweighting small-cap or value stocks can improve risk-adjusted returns.

AppelSienSapFrietjes wrote:Some calculation. According to MSCI website (http://www.msci.com/products/indices/co ... mance.html).

MSCI EM 10y Net = 13.38% annually

Each country separately:

China 0.1555
India 0.1590
Indon. 0.2454
Korea 0.1199
Malaysia 0.1478
Philippines 0.2007
Taiwan 0.0726
Thailand 0.1897
Brazil 0.1991
Chile 0.1625
Colombia 0.3254
Mexico 0.1688
Peru 0.2260
Czech 0.1474
Hungary 0.0930
Poland 0.1017
Russia 0.0809
Turkey 0.1870
Egypt 0.2238
Morocco 0.1051
South Afr. 0.1492

Each row added and divided by 21 gives 0.1648.

So the difference for the last 10 years is around 3% annually.

You've outlined 2 approaches: market weight and equal country weight. Over ANY period of time, unless one approach has higher expected returns (because it is riskier), the odds of either approach outperforming the other is 50/50, i.e., random.

Now, your equal country weight approach significantly overweights smaller-capitalized countries. My guess would be that you are thus overweighting small-cap stocks. There's a significant body of research suggesting that small cap stocks are riskier and thus offer a risk premium. I believe small-cap stocks in general have outperformed large cap stocks over the past ten years. So the results you are showing can probably be explained by small cap outperformance. You'd need to do the regressions to see if there's any alpha to equal-weighting. Assuming the results can be explained by the small-cap stock effect, it would be cheaper, simpler, and more efficient to hold simply hold some combination of market-weight and small-cap funds.

Also, be careful with projecting index results to index fund results. You can't actually invest in indexes. There are significant costs to investing in the smaller, illiquid funds you're proposing. I imagine tracking error could also be material. I'm not sure if any of them have been around for 10 years, but it'd be worth your time comparing the fund/ETF results with the index results you posted.

Again, I'd recommend using a broad index, perhaps tilting to small or value if desired. I don't know a lot about investing, but I try to learn from authorities I trust (Swedroe and Swensen in particular for me, but also Ferri, Bernstein, and some posters on this forum). To my knowledge, none of them have endorsed the approach you've proposed. Though not dispositive, I would proceed cautiously before blazing a new trail.

Good luck.
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Re: Emerging Markets - Equal Country Weight

Postby AppelSienSapFrietjes » Fri Jun 28, 2013 11:37 am

hafius500 wrote:What you suggest is called "naive diversification". According to Behavioral Finance investors equal-weight investments if they do not possess more information.
Thus it is an uninformed decision and, on averge, you cannot expect any improvement. IOW, any choice is not better or worse than any other choice.[*]

Instead of equal-weighting countries you could equal-weight global sector funds, regional funds, factor-tilted global (large-small, value-growth) funds, socialistic and capitalistic countries, countries with and without harbors, and...

OTOH, you could have a strategy that selects a few portfolios (e.g., countries). You could equal-weight these portfolios if you don't have additional information. (And such funds exist)
BTW, what would be the transaction costs of an equal-weighted portfolio?

[*]See the papers by Arnott, Perold and Kaplan I quoted here in a thread that discusses (among other things) equal-weighting.

Other threads Equal weighting or market cap weighting?

50 biggest companies dominate the S&P 500


Thanks a lot for your insight and information. I will make to sure to read it and come back to it.

In essence, I fail to understand why it is accepted/common to deviate from the MSCI ACWI IMI index (in the assumption this index covers all equities), but wrong to deviate from the MSCI EM IMI index. In the first index, US is about 50% if I am not mistaken. However, there are a lot of lazy portfolio's which have a smaller or greater exposure to US. In essence, they are are also tilting from/to US. This is accepted/normal.

So, why is it wrong to do the same on the level of EM (which might be part of your lazy portfolio)? Why doesn't it make sense to tilt to the smaller EM countries?
Why should we see the EM index as one single block, while we don't see the world as one single block?
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Re: Emerging Markets - Equal Country Weight

Postby hafius500 » Fri Jun 28, 2013 11:45 am

AppelSienSapFrietjes wrote:
Investing is boring wrote:
AppelSienSapFrietjes wrote:Reasons why smaller companies appear to have higher returns are not applicable to countries?


No. They are not.


Why not?
What about the arguments in chapter 1 of The Four Pilars of Investing? See http://www.efficientfrontier.com/t4poi/Ch1.htm.

Thanks.


Maybe, I missed something. But I don't see Bernstein recommends equal-weighting here:

These are the markets with the shortest histories, and are exclusively what we would today call "emerging markets." Although there is a fair amount of scatter, note how in general, the countries clustering on the left half of the graph have lower returns than the "developed" nations on the right half of the graph...
it is a demonstration that the markets with the best returns survive, and that those with the worst returns do not—survivorship bias, yet again.
The moral here is that because the most successful societies have the highest stock returns, they become the biggest stock markets...
There is no reason why an investor from one nation should accept as a matter of course poor returns in their own country if they can just as easily invest abroad. If investors think that returns will be higher in Australia than in Belgium, then capital will flow from Belgium to Australia. This will depress prices in Belgium, which in turn will increase future returns. The opposite will occur in Australia. Prices will adjust to the point where the expected returns in both nations will be the same. Assuming that the risks are the same, there is no reason that the future return in any one nation should be higher than another. And to the extent that one nation is perceived to be riskier than another, the nation with the highest perceived risk should have the highest future return, in order to compensate for the extra risk


I think he stresses the general uncertainty about the future. You still need to argue how equal-weighting makes the future less risky. The authors I quoted in my last reply claim it's not possible unless you have more information.
If different markets had different expected returns you should choose a portfolio that is consistent with your risk profile.
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Re: Emerging Markets - Equal Country Weight

Postby G-Money » Fri Jun 28, 2013 11:59 am

AppelSienSapFrietjes wrote:In essence, I fail to understand why it is accepted/common to deviate from the MSCI ACWI IMI index (in the assumption this index covers all equities), but wrong to deviate from the MSCI EM IMI index. In the first index, US is about 50% if I am not mistaken. However, there are a lot of lazy portfolio's which have a smaller or greater exposure to US. In essence, they are are also tilting from/to US. This is accepted/normal.

The vast majority of the members of this forum live, work, and will retire in the US. Holding global market-weight in equities may inject more currency risk and tracking error risk (for those who tend to follow only US stock indexes like S&P 500) than many are willing to tolerate.

Also, the vast majority of the members of this forum use Vanguard funds for some or all of their portfolio. Vanguard published a research paper, which concluded by recommending an allocation between 20%-40% of equities to international, although up to global weight was fine. https://personal.vanguard.com/pdf/icriecr.pdf. Vanguard subsequently published another paper on the role of home country bias in setting asset allocation: https://pressroom.vanguard.com/nonindex ... e_Bias.pdf

AppelSienSapFrietjes wrote:So, why is it wrong to do the same on the level of EM (which might be part of your lazy portfolio)?

"Wrong" is too strong a word. I would use "sub-optimal."

AppelSienSapFrietjes wrote:Why doesn't it make sense to tilt to the smaller EM countries?

I think those reasons have already been provided up-thread: it's more expensive, it does not any independent risk-reward/investment justification, it's an inefficient means of accessing the small-cap stock premium, etc.
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Re: Emerging Markets - Equal Country Weight

Postby Valuethinker » Fri Jun 28, 2013 12:15 pm

AppelSienSapFrietjes wrote:Hi all,

Most investors invest in the emerging markets through an ETF which covers a broad index, such as MSCI Emerging Markets.

Does it make any sense to invest in each country separately and equally weighted, instead of in the broad index? For example, if you want to invest 20K (this is just a number):
c
...

This list might not be complete, but I assume the example is clear.

What is your opinion? Thanks.


Because of high rebalancing costs, Equal Weighting Funds normally impose a huge performance penalty over market capitalization funds. A fund like VG Total Stock Market has extremely low turnover-- one of the reasons it outperforms. By deviating from 'pure' index management, DFA manages to get even lower market impact costs-- vital in investing in illiquid assets.

So therefore this one is likely to blow up in your face.

John Bogle, btw, had a fund like this equal weighted in large cap US stocks, I believe. Early in the days of Vanguard. The trading costs killed it.
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Re: Emerging Markets - Equal Country Weight

Postby boggler » Fri Jun 28, 2013 1:42 pm

AppelSienSapFrietjes wrote:
hafius500 wrote:What you suggest is called "naive diversification". According to Behavioral Finance investors equal-weight investments if they do not possess more information.
Thus it is an uninformed decision and, on averge, you cannot expect any improvement. IOW, any choice is not better or worse than any other choice.[*]

Instead of equal-weighting countries you could equal-weight global sector funds, regional funds, factor-tilted global (large-small, value-growth) funds, socialistic and capitalistic countries, countries with and without harbors, and...

OTOH, you could have a strategy that selects a few portfolios (e.g., countries). You could equal-weight these portfolios if you don't have additional information. (And such funds exist)
BTW, what would be the transaction costs of an equal-weighted portfolio?

[*]See the papers by Arnott, Perold and Kaplan I quoted here in a thread that discusses (among other things) equal-weighting.

Other threads Equal weighting or market cap weighting?

50 biggest companies dominate the S&P 500


Thanks a lot for your insight and information. I will make to sure to read it and come back to it.

In essence, I fail to understand why it is accepted/common to deviate from the MSCI ACWI IMI index (in the assumption this index covers all equities), but wrong to deviate from the MSCI EM IMI index. In the first index, US is about 50% if I am not mistaken. However, there are a lot of lazy portfolio's which have a smaller or greater exposure to US. In essence, they are are also tilting from/to US. This is accepted/normal.

So, why is it wrong to do the same on the level of EM (which might be part of your lazy portfolio)? Why doesn't it make sense to tilt to the smaller EM countries?
Why should we see the EM index as one single block, while we don't see the world as one single block?


I would also like an answer to this. For this reason, I have decided to invest in the total world stock fund rather than splitting US/international.
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Re: Emerging Markets - Equal Country Weight

Postby Noobvestor » Fri Jun 28, 2013 2:21 pm

Valuethinker wrote:
AppelSienSapFrietjes wrote:Hi all,

Most investors invest in the emerging markets through an ETF which covers a broad index, such as MSCI Emerging Markets.

Does it make any sense to invest in each country separately and equally weighted, instead of in the broad index? For example, if you want to invest 20K (this is just a number):
c
...

This list might not be complete, but I assume the example is clear.

What is your opinion? Thanks.


Because of high rebalancing costs, Equal Weighting Funds normally impose a huge performance penalty over market capitalization funds. A fund like VG Total Stock Market has extremely low turnover-- one of the reasons it outperforms. By deviating from 'pure' index management, DFA manages to get even lower market impact costs-- vital in investing in illiquid assets.

So therefore this one is likely to blow up in your face.

John Bogle, btw, had a fund like this equal weighted in large cap US stocks, I believe. Early in the days of Vanguard. The trading costs killed it.


Precisely. It is about cost. In theory rebalancing individual national markets sounds great. - In practice, costs/taxes/headaches ... maybe slice as fine as EU/Pac/EM but leave it at that, particularly if investing in taxable.

Surprised no one has linked this in this thread yet: http://www.efficientfrontier.com/ef/400/rebal400.htm

I like the geographic diversification I get from tilting EM within Intl, but slicing finer than an EM fund (to individual national markets within EM) just isn't efficient.
"In the absence of clarity, diversification is the only logical strategy" -= Larry Swedroe
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Re: Emerging Markets - Equal Country Weight

Postby Drain » Fri Jun 28, 2013 2:41 pm

I'm surprised by the uniformity of the reaction. As far as I know, DFA has been more-or-less equally weighting its original EM fund forever. A very brief search turned up this old post:

viewtopic.php?p=24681#p24681

As for why someone might dare to deviate from cap weighting or GDP weighting...well, in addition to SmallHi's points, you might also want to emphasize markets that correlate more weakly with the domestic market. I'm not sure that equal weights help achieve this objective, but they might.
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Re: Emerging Markets - Equal Country Weight

Postby newbie001 » Fri Jun 28, 2013 2:46 pm

Appelsien,

I am in a bit of a rush right now and don't have time to track it down, but I saw a study a year or two back examining exactly what you propose, with (I think) annual re-balancing. The portfolio's performance was extremely impressive compared to one using market-weighted EM. I can't remember what the details of the study's methodology were, but I will try to post a link o the study later if and when I find it.
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Re: Emerging Markets - Equal Country Weight

Postby AppelSienSapFrietjes » Fri Jun 28, 2013 3:00 pm

Hi all,

Thanks a lot for replies. I am busy in the next two days, but will certainly come back to this. I am glad that this isn't a stupid question after call. FWIW, I like thinking out of the box of conventional wisdom. I am glad this initiates interesting discussions.

Thanks.
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Re: Emerging Markets - Equal Country Weight

Postby AppelSienSapFrietjes » Fri Jun 28, 2013 3:06 pm

About costs and spreads/liquidity, one small remark for now.

Instead of investing in each country separately, a trade-off might be to invest X1% in Latin Am, X2% in emerging EU, X3% in Africa and X5% in Asia. Here, maybe X1=X2=X3=X4=25.
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Re: Emerging Markets - Equal Country Weight

Postby AppelSienSapFrietjes » Fri Jun 28, 2013 3:15 pm

Noobvestor wrote:
Valuethinker wrote:
AppelSienSapFrietjes wrote:Hi all,

Most investors invest in the emerging markets through an ETF which covers a broad index, such as MSCI Emerging Markets.

Does it make any sense to invest in each country separately and equally weighted, instead of in the broad index? For example, if you want to invest 20K (this is just a number):
c
...

This list might not be complete, but I assume the example is clear.

What is your opinion? Thanks.


Because of high rebalancing costs, Equal Weighting Funds normally impose a huge performance penalty over market capitalization funds. A fund like VG Total Stock Market has extremely low turnover-- one of the reasons it outperforms. By deviating from 'pure' index management, DFA manages to get even lower market impact costs-- vital in investing in illiquid assets.

So therefore this one is likely to blow up in your face.

John Bogle, btw, had a fund like this equal weighted in large cap US stocks, I believe. Early in the days of Vanguard. The trading costs killed it.


Precisely. It is about cost. In theory rebalancing individual national markets sounds great. - In practice, costs/taxes/headaches ... maybe slice as fine as EU/Pac/EM but leave it at that, particularly if investing in taxable.

Surprised no one has linked this in this thread yet: http://www.efficientfrontier.com/ef/400/rebal400.htm

I like the geographic diversification I get from tilting EM within Intl, but slicing finer than an EM fund (to individual national markets within EM) just isn't efficient.


This article is very interesting. It says:

"Why the difference in rebalancing effects between the emerging and developed markets? First, the volatility of the emerging markets is much higher than the developed markets, with SDs averaging about 50%. Since the rebalancing bonus is proportional to the variance of the asset, a doubling of SD results in a quadrupling of variance, and thus of rebalancing benefit. Second, correlations are much lower in the emerging markets arena—typically about half of those in the developed world, providing yet another margin of benefit."

The author did an investigation from 89 to 99 and returns are (much) higher, 5.7% annually. See above for my calculation for 2003 to 2012. It was also (much) higher, 3% annually.

Emerging markets are much less correlated to each other than developing markets.
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Re: Emerging Markets - Equal Country Weight

Postby Simplegift » Fri Jun 28, 2013 3:16 pm

One thing to consider is that, due to increasing globalization, the stock markets in individual emerging market countries and regions are much more correlated than they were fifteen years ago (red line in chart below). As a result, much of the backtesting of the equal-weighted strategy (for example, Bernstein's article linked by Noobvestor above) doesn't reflect the current world.

I expect you'd still get some diversification benefit from individual emerging countries or regions, but the advantage is shrinking fast. Best to own the whole, cap-weighted asset class and accept what it gives you, in my view.

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Re: Emerging Markets - Equal Country Weight

Postby AppelSienSapFrietjes » Fri Jun 28, 2013 3:28 pm

Simplegift wrote:One thing to consider is that, due to increasing globalization, the stock markets in individual emerging market countries and regions are much more correlated than they were fifteen years ago (red line in chart below). As a result, much of the backtesting of the equal-weighted strategy (for example, Bernstein's article linked by Noobvestor above) doesn't reflect the current world.

I expect you'd still get some diversification benefit from individual emerging countries or regions, but the advantage is shrinking fast. Best to own the whole, cap-weighted asset class and accept what it gives you, in my view.

Image
Source: Financial Sense


I might be very wrong here, but I believe that higher correlations are to be expected when the the developed markets (US, EU, (Japan?)) are in a secular bear. I think, but that is just a thought, that these correlations between EM countries will lower again once (if ever) DM countries reach a secular bull and/or EM countries reach a secular bear. Of course, globalization is a fact, and will for sure remain so from now on.

Just my gut feeling.
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Re: Emerging Markets - Equal Country Weight

Postby G-Money » Fri Jun 28, 2013 4:24 pm

AppelSienSapFrietjes wrote:About costs and spreads/liquidity, one small remark for now.

Instead of investing in each country separately, a trade-off might be to invest X1% in Latin Am, X2% in emerging EU, X3% in Africa and X5% in Asia. Here, maybe X1=X2=X3=X4=25.

My guess (and it's only a guess) is that this approach would close some of the gap with costs. But I think you still will have significant problems with liquidity.

For example, the SPDR® S&P® Emerging Middle East & Africa ETF (GAF)--I didn't know this existed until a minute ago, when I did a search for "emerging market africa etf"--has an ER of 0.59%. Not terrible, given how specialized an ETF it is, but pretty lousy compared to the 0.18% of VWO. According to Fidelity, an average of 8,500 shares trade per day, which is about $500,000. That's incredibly small. Not surprisingly, the bid/ask spread for GAF is $0.43, or about 0.70% of the market price. That's a pretty steep spread, IMO. In contrast, VWO has a spread of $0.02, or about 0.05% of market price, and about $750,000,000 is traded per day. Even a less liquid fund like VSS (Vanguard's FTSE Global ex-US Small Cap ETF) only has a spread of $0.20, or 0.2% of market price, and has an average volume of about $6,500,000. I think there are several folks here that wouldn't consider trading any ETF less liquid than VSS.

I don't use ETFs, but if I did, that low level of liquidity would make GAF a non-starter. Perhaps there are better alternatives, but I think this would be a problem you'd face with most of these country/regional slices of EM. IMO, the costs will provide a significant drag on any outperformance you might expect from this approach.

Not worth the trouble, IMO, but I'm a simpleton.
Don't assume I know what I'm talking about.
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Re: Emerging Markets - Equal Country Weight

Postby HurdyGurdy » Fri Jun 28, 2013 7:43 pm

I may have seen a Vanguard research paper showing the sector concentration on national stock markets. If in many of those countries, 30% of their stock market is in oil or mining, you are taking significant sector risk, made worse if the oil company is partially owned by the state.

How about using some other weights, like how free is the economy of that country, or how educated/productive its citizenry.
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Re: Emerging Markets - Equal Country Weight

Postby grayfox » Sat Jun 29, 2013 9:22 am

AppelSienSapFrietjes wrote:Hi all,

Most investors invest in the emerging markets through an ETF which covers a broad index, such as MSCI Emerging Markets.

Does it make any sense to invest in each country separately and equally weighted, instead of in the broad index? For example, if you want to invest 20K (this is just a number):

...

What is your opinion? Thanks.


You are talking about an alternative index construction method. There was a paper from Cass Business School

An evaluation of alternative equity indices
Part 1: Heuristic and optimised weighting schemes

that looked into alternative index construction methods. This was done for individual U.S. stocks and not Emerging Market ETFs. Equal-weighted was not the best, but it was about in the middle of the distribution, meaning that it performed about the same as the average stock-picking monkey. They found that Market-Cap Weighted was the worst of all methods, worse than 99.9% of all monkeys. See Figure 5 in the paper.

I don't know if the same results would be observed with EM stock ETFs, but it is an interesting question.

You can find an article with links to the papers here
http://www.cassknowledge.com/research/a ... -knowledge
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Re: Emerging Markets - Equal Country Weight

Postby hafius500 » Sat Jun 29, 2013 3:24 pm

Drain wrote:I'm surprised by the uniformity of the reaction. As far as I know, DFA has been more-or-less equally weighting its original EM fund forever. A very brief search turned up this old post:

viewtopic.php?p=24681#p24681

As for why someone might dare to deviate from cap weighting or GDP weighting...well, in addition to SmallHi's points, you might also want to emphasize markets that correlate more weakly with the domestic market. I'm not sure that equal weights help achieve this objective, but they might.


Do DFA funds equal-weight Emerging Markets?

Country allocations of the DFA Emerging Markets Portfolio (I) according to the factsheet:

China 14.86
South Korea 14.62
Brazil 12.75
Taiwan 11.84
India 7.54
South Africa 7.24
Mexico 6.41
Russia 4.60
Malaysia 3.95
Indonesia 3.62
Thailand 3.15
...

Vanguard (VEMAX) EM Fund:
China 20.0%
Brazil 14.4%
Taiwan 12.6%
India 8.9%
South Africa 8,3%
Russia 6.3%
Mexico 5.6%
Malaysia 4.8%
Indonesia 3.3%
Thailand 3.1%

P.S.:With regard to South Korea: The MSCI EM Index (iShares) may be more similar to the DFA portfolio.
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Re: Emerging Markets - Equal Country Weight

Postby hafius500 » Sat Jun 29, 2013 3:47 pm

AppelSienSapFrietjes wrote:In essence, I fail to understand why it is accepted/common to deviate from the MSCI ACWI IMI index (in the assumption this index covers all equities), but wrong to deviate from the MSCI EM IMI index. In the first index, US is about 50% if I am not mistaken. However, there are a lot of lazy portfolio's which have a smaller or greater exposure to US. In essence, they are are also tilting from/to US. This is accepted/normal.


Obviously there is no agreement. Some investors overweight, some investors underweight or cap-weight domestic/international markets.
It is not a valid comparison.
The World Index includes domestic assets. Investors may choose to overweight domestic assets and to deviate from cap-weighting because of the currency risk.
The Emerging Markets or EAFE Indexes are international indexes for US investors.
AppelSienSapFrietjes wrote:So, why is it wrong to do the same on the level of EM (which might be part of your lazy portfolio)? Why doesn't it make sense to tilt to the smaller EM countries?
Why should we see the EM index as one single block, while we don't see the world as one single block?


If you want to diversify away the 'country risk', or the sector or stock risks, an equal-weighted portfolio may be as good as a cap-weighted portfolio if the cap-weighted portfolio isn't 'too concentrated'. Is there any evidence that the MSCI EM or EAFE indexes are unreasonably concentrated (for an US investor)? The stock markets of individual emerging markets can be very concentrated. Thus it is theoretically possible that an equal-weighted portfolio of country indexes is less diversified than the cap-weighted portfolio if the largest market is much more diversified than the smaller ones. Unsurprisingly, some investable (regional) indexes are capped.

I'm not sure if equal-weighting is the best option if you want to outperform the cap-weighted global market:
- I don't recall new studies that identified a 'small-country premium' that equal-weighted strategies could have captured.
- Back-tested strategies that allegedly outperformed a global cap-weighted market:
- overweighted small or value stocks (experts, including Fama Sr., are not sure about a small-cap effect)
- overweighted stocks that outperformed/ underperformed over the last x years (momentum/ winner-loser reversals)
- overweighted countries (total market indexes) that had low valuations (PE10, Price/Book, dividend yield) or that had outperformed/ underperformed over the last x years.

Three different approaches to pursue such strategies:
1- throw all global stocks into one basket and select the stocks that have the desirable characteristics
2- select the stocks of every single market that have the desirable characteristcs and cap-weight the countries.
Index companies or quants,e.g., DFA choose 1) or 2)
3- select total country markets that have the desirable characteristics.
I don't know many funds that pursue such total-market strategies (which may have lower transaction costs than stock-picking strategies?).
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