Aggressive portfolio: most weight to emerging markets

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Tjiftjaf
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Aggressive portfolio: most weight to emerging markets

Post by Tjiftjaf » Thu Oct 05, 2017 12:55 am

Hi folks,

I was just wondering why most 'aggressive' funds still allocate most of the money to the more safe indexes like Total Stock Market or MSCI World instead of emerging markets. This is where the highest returns are in the long-run, right?

Your ideas?

Tjiftjaf :sharebeer

Mors
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Re: Aggressive portfolio: most weight to emerging markets

Post by Mors » Thu Oct 05, 2017 7:02 am

Hello. This statement is supported mainly thanks to the better valuations of the EM market. You have to understand that a lot more factors play important role on the returns of the market. An EM tilting can be justified as a sensible way to increase returns with added risk. A massive EM overweight is similar to gambling, and long term investing strategies do not bode well with gambling.

retiredjg
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Re: Aggressive portfolio: most weight to emerging markets

Post by retiredjg » Thu Oct 05, 2017 7:29 am

Tjiftjaf wrote:
Thu Oct 05, 2017 12:55 am
I was just wondering why most 'aggressive' funds still allocate most of the money to the more safe indexes like Total Stock Market or MSCI World instead of emerging markets. This is where the highest returns are in the long-run, right?
Because putting very high allocations into emerging markets would be a poor investing idea. Diversification across many asset classes and sectors is a better idea.

Consider if you were a track coach and you have several good long distance runners in your group. The fastest one is prone to injury and lame about 2/3rds of the season. The others run well and are rarely out of commission due to injury.

Is the fastest runner the one you bet your entire season on? Probably not. The fastest runner can maybe bring in 1 or 2 track meets for you, but it is the others who will determine if your season is successful or not.

JBTX
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Re: Aggressive portfolio: most weight to emerging markets

Post by JBTX » Thu Oct 05, 2017 11:17 am

Tjiftjaf wrote:
Thu Oct 05, 2017 12:55 am
Hi folks,

I was just wondering why most 'aggressive' funds still allocate most of the money to the more safe indexes like Total Stock Market or MSCI World instead of emerging markets. This is where the highest returns are in the long-run, right?

Your ideas?

Tjiftjaf :sharebeer
When they say aggressive it is usually more geared to the equity vs bond allocation and less to the higher weighting of more risky slices of the equity markets.

There are some famous investors who think emerging markets are more reasonably valued for the long term than US and other internationals so they have overweighted EM in their portfolios. However even they will admit that there is risk in doing so and if the US crashes emerging markets will crash worse, regardless of relative valuations. Also emerging markets are somewhat of a commodities play, in that their economies are overweighted in the commodities sector.

My take is modestly overweighting EM has some theoretical merit, but if you do so go in with your eyes open because it does increase the risk of your portfolio.

ralph124cf
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Re: Aggressive portfolio: most weight to emerging markets

Post by ralph124cf » Thu Oct 05, 2017 11:37 am

Emerging markets have had a good run so far this year, but the ten year look back is pretty dismal with a significantly greater drawdown in EM than in the S&P during 2008-2009.

Does anybody happen to know the percentage weighting of EM in the total international stock market index?

Ralph

JohnM
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Re: Aggressive portfolio: most weight to emerging markets

Post by JohnM » Thu Oct 05, 2017 12:01 pm

ralph124cf wrote:
Thu Oct 05, 2017 11:37 am
Emerging markets have had a good run so far this year, but the ten year look back is pretty dismal with a significantly greater drawdown in EM than in the S&P during 2008-2009.

Does anybody happen to know the percentage weighting of EM in the total international stock market index?

Ralph
I looked recently at Vanguard Int' indexes and EM was 20% of total. I believe this has dropped slightly over the last few years. I base my portfolio allocation off of this and at one point I had 25% in my calculation (might have been my error though).

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nisiprius
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Re: Aggressive portfolio: most weight to emerging markets

Post by nisiprius » Fri Oct 06, 2017 7:24 am

Tjiftjaf wrote:
Thu Oct 05, 2017 12:55 am
...This is where the highest returns are in the long-run, right?...
First, when comparing investments, all investors need to take risk into account, by some measure, in some way. To look at return without looking at risk at all is a mistake, an obvious mistake--and hundreds of articles and presentations that talk only about return, like the 1-3-5-10 return tables presented in 401(k) plans are misleading.
To state the obvious, investing in the S&P 500 with 10:1 leverage has expected returns in the long run that are exactly ten times as high as investing in the S&P 500 without leverage. Should we, then, invest in the S&P 500 with 10:1 leverage because "this is where the highest returns are in the long run?"
To put it bluntly, if you look only at return, you are setting yourself up to be exploited by people with products to sell and stories to tell.
The risks of emerging markets historically have justified the return, but the risks are real. For example, what do you think of a 40% drop over a period of less than sixty days?
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Before you say too quickly that U.S. stocks have dropped more than 40% twice within the last twenty years, look more closely: this isn't stocks, this is emerging markets bonds; the blue line is the Fidelity New Markets Income Fund, FNMIX. It's curious to me how much love there is for emerging markets bonds recently; my theory is that people have either forgotten 1998, which is now outside the ten-year window, or else they have written it off as a completely unique one-time event that shouldn't "count" because they don't think anything like it could happen again.
Second, who says "this is where the highest returns are in the long-run, right?" How do you know? And what do you mean by "the long run?" It is practically a truism that the fastest growing economies do not necessarily have the highest stock market returns. As with everything in investing, you'll see conflicting views and contradictory charts, depending on what people choose to look at, what period of time they look at, and what measures are used, and most of them are trying to prove a point, but here's one random chart that popped up in a Google search:
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The reason, of course, is that you are not the only person ever to think that emerging markets have more room for growth. (The jump from "have more room for growth" to "therefore, will grow faster and grow more" is a big leap; recognize that it's a big leap; it might be true and then again maybe now). The prices of stocks are set by investors striking their own balance between the perceived risk and the perceived return. If everyone thinks that the likely return of emerging markets more than compensates for their extra risk, then the price will be bid up until not everybody thinks so.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

livesoft
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Re: Aggressive portfolio: most weight to emerging markets

Post by livesoft » Fri Oct 06, 2017 7:51 am

Tjiftjaf wrote:
Thu Oct 05, 2017 12:55 am
Hi folks,

I was just wondering why most 'aggressive' funds still allocate most of the money to the more safe indexes like Total Stock Market or MSCI World instead of emerging markets. This is where the highest returns are in the long-run, right?

Your ideas?
One only needs to look at the so-called Periodic Table of Investment Returns usually produced by Callan and see where the asset class composed of EM stocks fits on that table. Here is a bogleheads wiki article with one version of the Table: https://www.bogleheads.org/wiki/Callan_ ... nt_returns

Let me ask you this question: Of the years shown in that Table, how many years were EM stocks the worst or second worst performing asset class?
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nisiprius
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Re: Aggressive portfolio: most weight to emerging markets

Post by nisiprius » Fri Oct 06, 2017 7:54 am

To take a quick look at the obvious, let's simply compare the data for the Vanguard Total [U.S.] Stock Market Index Fund, VTSMX, with that for the Vanguard Emerging Markets Stock Index Fund (VEIEX), using all data available to PortfolioVisualizer, which seems to go back to inception for VEIEX. Blue, portfolio 1, is 100% VTSMX (U.S.). Red, portfolio 2, is 100% VEIEX (Emerging markets). Notice that VEIEX was worse in every way; not only did it have lower return, it had a higher standard deviation = a measure of volatility = a form of risk, and thus had a far lower Sharpe ratio, a measure of risk-adjusted return.
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Here's the interesting thing. Let's suppose we intentionally cherry-pick the data. Let's suppose that we decide that the last six years shouldn't count--U.S. stocks were anomalously high, or emerging markets' near-flat returns were some kind of fluke. I can't see any rational way to justify either of these, but for the sake of argument let's do it, and throw out all of the data after December, 2010. Notice what we've done. We've intentionally thrown out the recent period when emerging markets far underperformed the U.S., but we've intentionally kept the period 2003-2007 when emerging markets was going gangbusters. I think it was 2003-2007 that spurred a lot of interest in emerging markets.
So, over this time period the two mutual funds are almost tied in total return--emerging markets wins, but only by a nose. However, it has far higher standard deviation/volatility/risk. More risk, same return. Even after keeping i's best period and throwing out its worst period, it was still far inferior to U.S. stocks if we measure by Sharpe ratio, a measure of risk-adjusted return.
Source
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Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

Rob Bertram
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Re: Aggressive portfolio: most weight to emerging markets

Post by Rob Bertram » Fri Oct 06, 2017 12:50 pm

I completely agree with all the posters that concentrating risk in a volatile asset is a terrible approach for increasing returns and that looking at return without considering risk is also a poor plan.

So if an investor like the OP is willing to increase his risk for a reasonable expected increase in return, what suggestions can we give? My personal favorite is leverage. Are there other options that the community can offer?

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