Total world investing - "owning the market"

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boggler
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Total world investing - "owning the market"

Post by boggler »

One of the tenets of passive investing is that you are better off "owning the whole market" than you are trying to play a zero-sum trading game within it. Due to costs, taxes, and additional risks, you often end up ahead by simply buying and holding the entire market.

Problem is, there's no way to hold the entire market directly. I mean holding all asset classes in their market weight -- with the balance between stocks, bonds, real estate, cash, etc. determined by the market, not by a prescripted set of fixed percentages. Since there is no true "Vanguard World Markets" Fund encompassing all asset classes, and only "World Stock", "International Bond", etc., our only option is to separate out stocks from bonds into something like the three-fund portfolio.

The unfortunate results of this is that we are implicitly betting against the market. If we are overweighted in stocks relative to the market, and active investors decide to pull out of stocks and shift towards bonds or real estate, we take an unnecessary hit in our portfolio. Much as we cancel out stock trading in equities by owning a "total stock" fund, wouldn't we be better off holding the world market to capture larger shifts between different asset classes? Is there any practical way to do this?
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cflannagan
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Re: Total world investing - "owning the market"

Post by cflannagan »

boggler wrote:One of the tenets of passive investing is that you are better off "owning the whole market" than you are trying to play a zero-sum trading game within it. Due to costs, taxes, and additional risks, you often end up ahead by simply buying and holding the entire market.

Problem is, there's no way to hold the entire market directly. I mean holding all asset classes in their market weight -- with the balance between stocks, bonds, real estate, cash, etc. determined by the market, not by a prescripted set of fixed percentages. Since there is no true "Vanguard World Markets" Fund encompassing all asset classes, and only "World Stock", "International Bond", etc., our only option is to separate out stocks from bonds into something like the three-fund portfolio.

The unfortunate results of this is that we are implicitly betting against the market. If we are overweighted in stocks relative to the market, and active investors decide to pull out of stocks and shift towards bonds or real estate, we take an unnecessary hit in our portfolio. Much as we cancel out stock trading in equities by owning a "total stock" fund, wouldn't we be better off holding the world market to capture larger shifts between different asset classes? Is there any practical way to do this?
How would internal construction work for stocks vs bonds allocation? I'm curious as to how "total world stock" market capitalization is compared to "total world bond" - maybe that's why it becomes a non-starter, if the capitalizations does not make sense to use.

In any case, I would prefer to own a few funds than have just one fund, because I would have more TLH opportunities, and TLH opportunities can be significant - reducing my taxable income (if I used the correct term) by at least $3,000, with carryover for future years.

Edit: According to Wiki, global bond market is $82 trillion http://en.wikipedia.org/wiki/Bond_market
And stock market is about $36.6 trillion http://en.wikipedia.org/wiki/Stock_market

Are you saying you would like the fund to have 70% of itself invested into global bond markets?
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boggler
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Re: Total world investing - "owning the market"

Post by boggler »

cflannagan wrote:
boggler wrote:One of the tenets of passive investing is that you are better off "owning the whole market" than you are trying to play a zero-sum trading game within it. Due to costs, taxes, and additional risks, you often end up ahead by simply buying and holding the entire market.

Problem is, there's no way to hold the entire market directly. I mean holding all asset classes in their market weight -- with the balance between stocks, bonds, real estate, cash, etc. determined by the market, not by a prescripted set of fixed percentages. Since there is no true "Vanguard World Markets" Fund encompassing all asset classes, and only "World Stock", "International Bond", etc., our only option is to separate out stocks from bonds into something like the three-fund portfolio.

The unfortunate results of this is that we are implicitly betting against the market. If we are overweighted in stocks relative to the market, and active investors decide to pull out of stocks and shift towards bonds or real estate, we take an unnecessary hit in our portfolio. Much as we cancel out stock trading in equities by owning a "total stock" fund, wouldn't we be better off holding the world market to capture larger shifts between different asset classes? Is there any practical way to do this?
How would internal construction work for stocks vs bonds allocation? I'm curious as to how "total world stock" market capitalization is compared to "total world bond" - maybe that's why it becomes a non-starter, if the capitalizations does not make sense to use.

In any case, I would prefer to own a few funds than have just one fund, because I would have more TLH opportunities, and TLH opportunities can be significant - reducing my taxable income (if I used the correct term) by at least $3,000, with carryover for future years.

Edit: According to Wiki, global bond market is $82 trillion http://en.wikipedia.org/wiki/Bond_market
And stock market is about $36.6 trillion http://en.wikipedia.org/wiki/Stock_market

Are you saying you would like the fund to have 70% of itself invested into global bond markets?
Yes, exactly. And then when investors dump stocks and buy bonds, I won't care.

Vanguard had a pie chart in one of their videos showing "global market capitalization", including the breakdown of stocks, bonds, etc. I'm talking about owning that pie, not the slices.
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cflannagan
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Re: Total world investing - "owning the market"

Post by cflannagan »

boggler wrote:
Yes, exactly. And then when investors dump stocks and buy bonds, I won't care.

Vanguard had a pie chart in one of their videos showing "global market capitalization", including the breakdown of stocks, bonds, etc. I'm talking about owning that pie, not the slices.
I'm sure you already thought of this - why not just buy the funds (TSM, TISM, TBM, and International Bonds.. hopefully I didn't miss anything else) with % duplicate the markets? In theory, they would grow and shrink, in step with the markets?
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boggler
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Re: Total world investing - "owning the market"

Post by boggler »

cflannagan wrote:
boggler wrote:
Yes, exactly. And then when investors dump stocks and buy bonds, I won't care.

Vanguard had a pie chart in one of their videos showing "global market capitalization", including the breakdown of stocks, bonds, etc. I'm talking about owning that pie, not the slices.
I'm sure you already thought of this - why not just buy the funds (TSM, TISM, TBM, and International Bonds.. hopefully I didn't miss anything else) with % duplicate the markets? In theory, they would grow and shrink, in step with the markets?
I think there are two issues with this:
1 - This won't work if there are any net inflows or outflows from those four funds. If assets shift from natural resources into stocks, for example, I don't think this will be accounted for. Am I misunderstanding this?
2 - I'd love to cover more than stocks and bonds - would be great to include real estate, cash, etc. Essentially, whatever Vanguard determines to be part of the world asset allocation.
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G-Money
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Re: Total world investing - "owning the market"

Post by G-Money »

If you held TSM, TISM, TBM, and TIBM in their current respective market weights, the market would automatically adjust your portfolio for you. Just like you didn't need to do anything with your TSM when Apple became more valuable than Exxon, then less valuable, then more valuable.

As for the stuff that's not in TSM, TISM, TBM, and TIBM (or in TIPS, HY, munis, etc.), well, it will be rather difficult to invest in it. You can't invest in your neighbor's house, or in your local pizza shop, or in some rural Chinese rice farm, especially at market weights. So you can't invest in the entire economy. You can invest in "total markets," as in, all publicly traded securities available on exchanges, and that is, by and large, what TSM, TISM, TBM, and TIBM do. You can come up with proxies for non-publicly traded securities, or you can shrug your shoulders and ignore them.

And, of course, whether it makes sense to try to invest in the "total economy" is an entirely separate matter. But you didn't ask that, so I won't go there.
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umfundi
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Re: Total world investing - "owning the market"

Post by umfundi »

boggler wrote:
cflannagan wrote:
boggler wrote:
Yes, exactly. And then when investors dump stocks and buy bonds, I won't care.

Vanguard had a pie chart in one of their videos showing "global market capitalization", including the breakdown of stocks, bonds, etc. I'm talking about owning that pie, not the slices.
I'm sure you already thought of this - why not just buy the funds (TSM, TISM, TBM, and International Bonds.. hopefully I didn't miss anything else) with % duplicate the markets? In theory, they would grow and shrink, in step with the markets?
I think there are two issues with this:
1 - This won't work if there are any net inflows or outflows from those four funds. If assets shift from natural resources into stocks, for example, I don't think this will be accounted for. Am I misunderstanding this?
2 - I'd love to cover more than stocks and bonds - would be great to include real estate, cash, etc. Essentially, whatever Vanguard determines to be part of the world asset allocation.
Boggler, you are almost correct, I think.

You can buy the total market to a large degree by buying TSM, TISM, ... in appropriate percentages. Inflows to and from the funds do not matter. If the return on each of the component investments is different, you should rebalance. If the percentage contribution to the global market of any component changes, you should change your Asset Allocation appropriately.

Keith
Last edited by umfundi on Tue Aug 27, 2013 4:22 pm, edited 2 times in total.
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MnD
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Re: Total world investing - "owning the market"

Post by MnD »

My fixed income allocation is simply the portion of my investment portfolio that I opt to not subject to equity ownership risk, but rather seek to lend out to reputable borrowers in the hopes of receiving a return of principal and a modest real return. Cash is the portion of FI that I am not willing to subject to credit and interest risk. Owning the market makes sense on the equity side if one is interested in completion, less correlated equity class returns and not interested in maintaining a home country bias or other geographic tilt in their equity ownership.

What % of the global economic marketplace happens to be in bonds or cash would seem to be completely irrelevant to what percentage one would place in those classes.
Suppose 75% of the global market is bonds. For what reason would you want to mirror that?
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Aptenodytes
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Re: Total world investing - "owning the market"

Post by Aptenodytes »

MnD wrote:My fixed income allocation is simply the portion of my investment portfolio that I opt to not subject to equity ownership risk, but rather seek to lend out to reputable borrowers in the hopes of receiving a return of principal and a modest real return. Cash is the portion of FI that I am not willing to subject to credit and interest risk. Owning the market makes sense on the equity side if one is interested in completion, less correlated equity class returns and not interested in maintaining a home country bias or other geographic tilt in their equity ownership.

What % of the global economic marketplace happens to be in bonds or cash would seem to be completely irrelevant to what percentage one would place in those classes.
Suppose 75% of the global market is bonds. For what reason would you want to mirror that?
I'm with you on this.
The suggestion in the OP comes up here from time to time and it just never makes any sense to me, for the reasons you delineate. It seems to be an example of a little knowledge being a dangerous thing.
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boggler
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Re: Total world investing - "owning the market"

Post by boggler »

MnD wrote:What % of the global economic marketplace happens to be in bonds or cash would seem to be completely irrelevant to what percentage one would place in those classes.
Suppose 75% of the global market is bonds. For what reason would you want to mirror that?
Because any other allocation is basically a tilt away from the market portfolio. The logical extension of "owning the market" in a given asset class is to own the market across the different asset classes as well.
gt4715b
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Re: Total world investing - "owning the market"

Post by gt4715b »

boggler wrote:Because any other allocation is basically a tilt away from the market portfolio. The logical extension of "owning the market" in a given asset class is to own the market across the different asset classes as well.
You're letting the tail wag the dog. We don't invest to hold a market portfolio of investable securities. We invest to meet some financial goal. We know that different types of securities have different risk/reward characteristics. Then we set our asset allocation according to our particular needs.

Holding the total market is an intra-asset class tenet, not an inter-asset class tenet. Again, you allocate across asset class according to your own needs.

You're trying to stretch a sound concept too far. Should I not start a business because I won't be holding a world market weighted portfolio? Of course not.
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JoMoney
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Re: Total world investing - "owning the market"

Post by JoMoney »

It's not a "logical extension of owning the market".
They're different markets. They represent different things.
The bulk of my investments I want to be in things that create value (like businesses). Not in things that depreciate (like the purchasing power of cash/bonds due to inflation or otherwise).
I certainly would not want to trade or buy and hold Pork-bellies even if it was only in market-weighted amounts.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham
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boggler
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Re: Total world investing - "owning the market"

Post by boggler »

gt4715b wrote:
boggler wrote:Because any other allocation is basically a tilt away from the market portfolio. The logical extension of "owning the market" in a given asset class is to own the market across the different asset classes as well.
You're letting the tail wag the dog. We don't invest to hold a market portfolio of investable securities. We invest to meet some financial goal. We know that different types of securities have different risk/reward characteristics. Then we set our asset allocation according to our particular needs.

Holding the total market is an intra-asset class tenet, not an inter-asset class tenet. Again, you allocate across asset class according to your own needs.

You're trying to stretch a sound concept too far. Should I not start a business because I won't be holding a world market weighted portfolio? Of course not.
Then how do you define an asset class? Why not split up Total Stock Market into different sectors, then? Arguably technology has more risk than basic goods, so does that mean we should allocate differently than the market between these areas if it better suits our risk/return goals?
cellige
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Re: Total world investing - "owning the market"

Post by cellige »

I would like to hear an expert response on the last question boggler asked as I am interested in owning the entire market as well. Perhaps it seems foolishly.
AviN
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Re: Total world investing - "owning the market"

Post by AviN »

Tilting towards some sectors more than others could increase expense ratios, trading costs, taxes, and complexity. Aside from those considerations, I don't think it's necessarily a bad thing. Some Bogleheads like tilting towards REIT's, in part due to their somewhat low correlation with the rest of the stock market. But other sectors like healthcare and energy also have a somewhat low correlation to the rest of the stock market.
cellige
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Re: Total world investing - "owning the market"

Post by cellige »

As boggler asked, what makes investing in everything within an asset class any different than investing in the different asset classes?
Rodc
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Re: Total world investing - "owning the market"

Post by Rodc »

Does it really matter?

For example if your 401K does not have a US Total Stock Market, but does have a S&P 500 and the Extended Market fund (which we see from time to time).

You have some options:

A) just use the S&P 500 fund and call it good enough
B) Use both in a fixed allocation of say 75/25 to approximate TSM and call it good enough
C) Use both and rebalance monthly to the precise allocation that matches TSM

I note that historically the difference between A and B has been very small, too small to have a material impact on your retirement (and since S&P has had a tiny bit lower risk and return than TSM, you could just hold an extra couple of percent, as in 63/37 vs a 60/40 and even further close the gap).

The difference between B and C is so small as to be completely irrelevant.

I suspect some situations being discussed are very similar.

Also, unless your risk aversion and needs are the same as pension funds, endowments, the Federal Government and the FED, the Chinese government and other sovereign funds, and hedge funds, all of whom drive the markets in stocks and bonds, not people like us, why do you think you should match your investments to theirs?
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.
staythecourse
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Re: Total world investing - "owning the market"

Post by staythecourse »

This echos a fundamental point that I see many folks not get or refuse to see when they campaign "own the market". NO ONE owns the market. ?chris Jones from financial engines talks about this in his excellent book, something like, "brilliant portfolio" or something like that.

Forget about trying to even own the market most folks on here do not even own the equity markets in normal weight when they can due to home bias and other justifications.

My point as well as Chris Jones is it is okay to not hold the market, but more important to hold an asset allocation that you will stay the course with. Just don't lie to yourself thinking you are a total market approach as you are no different then a slice and dicer. Just less and dice then maybe others.

I would venture to guess if someone was 25% in TSM, ISM, TBM, and a total international bond fund the correlation would be close to the total market approach as the rest (TIPS, real estate, cash) are small % pie pieces.

Good luck.
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afan
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Re: Total world investing - "owning the market"

Post by afan »

The theory of holding all risky assets at market weights assumes you can borrow at the risk free rate if you find the expected return to the market portfolio is too low. You could then use leverage to get farther out in risk and expected return. But you cannot borrow at the risk free rate. Instead, you would be paying more on your margin than you would collect from your bond portfolio. This turns a good idea into a bad one. The alternative that everyone uses is under weighting bonds and overweighting stocks as compared to the market. You get higher risk and higher expected return more efficiently than with leverage.

Most in the US also overweight domestic assets because they suspect the market underestimates the risks of foreign investment. US investors may very well be wrong about this, but for foreign investment one has to worry not only about the market, but about the intermediary costs and risks, which are not priced. So an action by a government, a coup, or an election reversal could hit foreign mutual funds harder than the underlying markets. Governments care about access to capital, so they may treat big banks and sovereign wealth bond buyers better than mutual funds owned by peasants like us. We face risks that JP Morgan does not. But banks like JPN effectively set the prices.

Plus, we have rule of law protections here that are far from universal. When you buy total world markets you assume the world correctly prices these risks. But the biggest risks of war and political turmoil are hard to price. Since they come up rarely, the risks may be underestimated.

In other words, it may make sense to favor US markets, perhaps along with western Europe, Japan and other first world countries with stable democracies. For other countries it is not so clear that the risks are fully rewarded. Most test of performance of emerging markets are hopelessly confounded by survivorship bias.
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ASUGrad
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Re: Total world investing - "owning the market"

Post by ASUGrad »

Could you be taking own the market a bit far here?

If you are going to do this shouldn't you include all the different currencies into that cash position as their % of the market? What about commodities? Wouldn't we need to own all commodities as well? Do you own those commodities as their %s of the total commodity market? What about collectibles?

It doesn't make sense to me. You own different 'types' of investments depending on what your goals are. Stocks provide growth and a high chance of beating inflation, Bonds provide income, etc. You don't try to pick and choose which stock will do the best. And through rebalancing you are benefiting from flows from stocks to bonds and back. But if you need growth and have a high risk tolerance and long time horizon you would still own more stocks than bonds.

And afan hit this a bit, but international markets have different sets of risks than domestic markets. In addition to the risks he highlighted there is also the risk that assets are mispriced because the fundamentals are all make believe. I don't trust 90% of the data that comes out of Chinese companies. I felt this way before issues starting arising with GDP numbers from the government, economists, and all the local governments combined not matching. Years ago a friend of mine who is an accountant went to China to review the books of several companies that a major hedge fund was looking to invest in. When he got back he told me his recommendation was for the fund not to invest in any of the companies. They had no clear accounting practices, and he found a lot of irregularities. For all he knew they were all just making up numbers as they went along. No one is perfect. We had Enron, but we also have a lot of standards, accounting practices, auditing practices, the SEC, etc. in place to make sure that sort of thing is 'rare' as opposed to common.
afan
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Re: Total world investing - "owning the market"

Post by afan »

Good points ASU. One would have to assume the market correctly discounted all those risks. But you are only likely to find out whether that is true when a crisis hits.

Just not worth the risk.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama
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boggler
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Re: Total world investing - "owning the market"

Post by boggler »

afan wrote:Most in the US also overweight domestic assets because they suspect the market underestimates the risks of foreign investment. US investors may very well be wrong about this, but for foreign investment one has to worry not only about the market, but about the intermediary costs and risks, which are not priced. So an action by a government, a coup, or an election reversal could hit foreign mutual funds harder than the underlying markets. Governments care about access to capital, so they may treat big banks and sovereign wealth bond buyers better than mutual funds owned by peasants like us. We face risks that JP Morgan does not. But banks like JPN effectively set the prices.

Plus, we have rule of law protections here that are far from universal. When you buy total world markets you assume the world correctly prices these risks. But the biggest risks of war and political turmoil are hard to price. Since they come up rarely, the risks may be underestimated.

In other words, it may make sense to favor US markets, perhaps along with western Europe, Japan and other first world countries with stable democracies. For other countries it is not so clear that the risks are fully rewarded. Most test of performance of emerging markets are hopelessly confounded by survivorship bias.
Can you explain why this stuff isn't priced in?
afan wrote:Good points ASU. One would have to assume the market correctly discounted all those risks. But you are only likely to find out whether that is true when a crisis hits.

Just not worth the risk.
There's a difference between saying that it's riskier vs. saying that it's not "worth the risk". The latter is arguing that the market is inefficient. Is that what you are arguing in this case?
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james99
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Re: Total world investing - "owning the market"

Post by james99 »

Once someone asked Warren Buffett about the specifics of portfolio / asset allocation etc, he said something about just investing in a simple low cost index fund and 'get back to work'. :D

I think most lazy portfolios will be fine, just pick the one you're most comfortable with (the easy part), and stay the course (hard part).

I myself use VT for the stocks portion. I think most people like VTI+VXUS combination. I use VT to keep myself from tinkering!

Also, something off topic but related to staying the course - I read in the Investor Manifesto something about (don't have the book with me) if you're young, you better get on your knees and pray for a long bear market (so you can buy the stocks cheap.)
enc0re
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Re: Total world investing - "owning the market"

Post by enc0re »

I have asked myself the OP's question as well. Wouldn't owning the global capital market be the ultimate diversification strategy? Any tilt away from it implies an 'activist' bet about the relative risk-adjusted return of an asset class. In other words, doesn't CAPM imply that owning the market portfolio is most efficient?

But here is the rub for me. Equities make up less than 25% of global market capitalization. Is that good asset allocation? Here is the most recent report (executive summary) from McKinsey on global market capitalization. http://www.google.com/url?sa=t&rct=j&q= ... 2U&cad=rja. (Sorry about the insane link. I don't know how to shorten it.)

I think a strong argument could be make that in retirement, the global portfolio is desirable. Perhaps an idea for a future Vanguard product.
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