Good argument for underweighting international stocks?

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rca1824
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Good argument for underweighting international stocks?

Post by rca1824 »

Assumptions:
1. International volatility is inflated by current risk
2. Vanguard charges 9 basis points more for international versus domestic equity funds.

Given both of these reasons, is it rational to deviate from cap-weights and tilt towards domestic? Maybe Vanguard was right all along, with only a 40% allocate to international instead of the theoretically optimal cap weight of 48% (inferred from VT).

Although historical returns don't prove anything, 60/40 has had better risk and return than 50/50. The max return was 65/35 and the min risk was 80/20, implying optimal international allocation was only 20-35%. (1972-2014)

On the other hand, our career fortunes are more closely tied to domestic markets, so maybe it's prudent to underweight domestic so that if the USA economy tanks and we lose our jobs, at least our international allocation will do better.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
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LAlearning
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Re: Good argument for underweighting international stocks?

Post by LAlearning »

its not rational but its what people do.
I know nothing!
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rca1824
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Re: Good argument for underweighting international stocks?

Post by rca1824 »

LAlearning wrote:its not rational but its what people do.
Why is it not rational?
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
asif408
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Re: Good argument for underweighting international stocks?

Post by asif408 »

If you want to underweight for those reasons that seems fine, though for me the cost is the most compelling reason of any.

FWIW, I changed the ending point by two years from 2014 to 2012 and the ideal allocation from 1972-2012 (a 40 yr period) is 70% international/30% US, so now I am leaning more towards an international bias. :wink:
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Re: Good argument for underweighting international stocks?

Post by JonnyDVM »

I'll keep my equity allocation at 40% international and you can keep yours at 20% or whatever. In 15 years we can post here (under the watchful eye of our Chinese overlords of course) and we'll see whose portfolio did better.
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Re: Good argument for underweighting international stocks?

Post by Twins Fan »

I don't think the cost/ER difference is even worth mentioning anymore. Maybe way back when the international index cost quite a bit more? But, nowadays a 9 basis point difference isn't even going to be noticeable in the big picture.

Also, it can't really be said Vanguard had it right all along since they only recently changed to having 40% of equities in international in the target retirement/life strategy funds. It used to be about 30%. So, all along... we know they change their minds about that part. :happy
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rca1824
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Re: Good argument for underweighting international stocks?

Post by rca1824 »

JonnyDVM wrote:I'll keep my equity allocation at 40% international and you can keep yours at 20% or whatever. In 15 years we can post here (under the watchful eye of our Chinese overlords of course) and we'll see whose portfolio did better.
That sounds like confusing strategy with outcome.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
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rca1824
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Re: Good argument for underweighting international stocks?

Post by rca1824 »

Twins Fan wrote:I don't think the cost/ER difference is even worth mentioning anymore. Maybe way back when the international index cost quite a bit more? But, nowadays a 9 basis point difference isn't even going to be noticeable in the big picture.
After 100 years, that 9 bp fee can bleed 8.6% of a portfolio's value like a thirsty vampire. Jack Bogle calls this phenomenon the "tyranny of compounding costs." Over 500 years, 36%. Over 1000 years, 59%. So I wouldn't call it unnoticeable
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
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Re: Good argument for underweighting international stocks?

Post by jebmke »

rca1824 wrote:
Twins Fan wrote:I don't think the cost/ER difference is even worth mentioning anymore. Maybe way back when the international index cost quite a bit more? But, nowadays a 9 basis point difference isn't even going to be noticeable in the big picture.
After 100 years, that 9 bp fee can bleed 8.6% of a portfolio's value like a thirsty vampire. Jack Bogle calls this phenomenon the "tyranny of compounding costs." Over 500 years, 36%. Over 1000 years, 59%. So I wouldn't call it unnoticeable
You must have good genes.
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rca1824
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Re: Good argument for underweighting international stocks?

Post by rca1824 »

jebmke wrote:
rca1824 wrote:
Twins Fan wrote:I don't think the cost/ER difference is even worth mentioning anymore. Maybe way back when the international index cost quite a bit more? But, nowadays a 9 basis point difference isn't even going to be noticeable in the big picture.
After 100 years, that 9 bp fee can bleed 8.6% of a portfolio's value like a thirsty vampire. Jack Bogle calls this phenomenon the "tyranny of compounding costs." Over 500 years, 36%. Over 1000 years, 59%. So I wouldn't call it unnoticeable
You must have good genes.
To be capable of having children? I didn't know that was an exceptional achievement.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
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Re: Good argument for underweighting international stocks?

Post by Twins Fan »

Yep, you got me there, rca.... sure, over a million years 9 basis points could add up. How did I miss that?? :wink:
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Re: Good argument for underweighting international stocks?

Post by gks »

Rca

Oh boy, have you opened a can of worms. I can't reliably suggest a search of just this website for US/International stock ratios, but there are a multitude out here.

On 4-29-96 Vanguard opened VTIAX, (Total International). Comparing 19 years of total returns, Total Stock Market outperformed Total International $47,165 to $23,867. (courtesy Morningstar) Will this continue? Who knows. There a lot of folks here, and the US government mandate to mutual funds, who state:

“Keep in mind that the Fund’s past performance does not indicate how the Fund will perform in the future.”

Remember, this is 19 years. Is you investment horizon more than 19 years. If you don't have international, maybe this is the time to buy, since there is a 19 year under-performance. Maybe the next 19 years will be kinder to International than US, but personally, I don't have that long of an investment time frame to wait and see, and I also believe in US exceptionalism.

There is a thread on this site that indicates that US companies receive ~46ish% of their income from international operations. That supports Mr. Bogle's contention that international is not necessary. From another thread, Coke receives 50% of its income from international sources, so why is it necessary to own an international soda company?

Finally, Wellington Management Company, advisers to the Wellesly and Wellington funds, seem to think that 6ish% of international for those two funds is an appropriate level.

There are many others on this site who will disagree with my view, but it is offered as a personal response to your question.

Greg
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rca1824
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Re: Good argument for underweighting international stocks?

Post by rca1824 »

gks wrote:Rca

Oh boy, have you opened a can of worms. I can't reliably suggest a search of just this website for US/International stock ratios, but there are a multitude out here.

On 4-29-96 Vanguard opened VTIAX, (Total International). Comparing 19 years of total returns, Total Stock Market outperformed Total International $47,165 to $23,867. (courtesy Morningstar) Will this continue? Who knows. There a lot of folks here, and the US government mandate to mutual funds, who state:

“Keep in mind that the Fund’s past performance does not indicate how the Fund will perform in the future.”

Remember, this is 19 years. Is you investment horizon more than 19 years. If you don't have international, maybe this is the time to buy, since there is a 19 year under-performance. Maybe the next 19 years will be kinder to International than US, but personally, I don't have that long of an investment time frame to wait and see, and I also believe in US exceptionalism.

There is a thread on this site that indicates that US companies receive ~46ish% of their income from international operations. That supports Mr. Bogle's contention that international is not necessary. From another thread, Coke receives 50% of its income from international sources, so why is it necessary to own an international soda company?

Finally, Wellington Management Company, advisers to the Wellesly and Wellington funds, seem to think that 6ish% of international for those two funds is an appropriate level.

There are many others on this site who will disagree with my view, but it is offered as a personal response to your question.

Greg
I am not going by past returns, focusing more on sound facts and forward-looking returns based on currency risk and fees, which are objective and indisputable. But if you want to go by past returns, it seems like it's still optimal to add a small slice of international, 20-35% based on 1972-2014 numbers, to both increase returns and decrease risk. Even if the correlation is strong, there's still some uncorrelation that can be diversified. I don't think you can just ignore 50% of the global equity market. I don't think it's optimal to hold 0% international, but I am now rethinking my cap-weight 48% holding and moving to 35-40%.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
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Re: Good argument for underweighting international stocks?

Post by columbia »

rca1824 wrote:
Twins Fan wrote:I don't think the cost/ER difference is even worth mentioning anymore. Maybe way back when the international index cost quite a bit more? But, nowadays a 9 basis point difference isn't even going to be noticeable in the big picture.
After 100 years, that 9 bp fee can bleed 8.6% of a portfolio's value like a thirsty vampire. Jack Bogle calls this phenomenon the "tyranny of compounding costs." Over 500 years, 36%. Over 1000 years, 59%. So I wouldn't call it unnoticeable

I'll possibly be dead in less than 30 years.
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Re: Good argument for underweighting international stocks?

Post by Maynard F. Speer »

They've found if you inject mice with young mouse blood, it seems to reverse aging at the cellular level

Who knows, in a few years we might all be stockpiling blood - take a 4% draw-down every year for your annual blood transfusion

In which case we've got about 4 billion years till the Andromeda galaxy collides with us .. Those 9 bp could buy you a deep space mining operation or a star system before long
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Re: Good argument for underweighting international stocks?

Post by z3r0c00l »

The uptick in posts against international may be a good argument for going overweight at this time.
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Re: Good argument for underweighting international stocks?

Post by Twins Fan »

Remember earlier this year when so many posts were out about being happy to have international and wanting to add more... How quickly things change...
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Re: Good argument for underweighting international stocks?

Post by bigred77 »

What are the chances of a long bear market depression, war, or other "very bad event" that occurs in the US over the next 100 years?

I don't know the answer to that but I would prefer to have a substantial allocation to international markets in that scenario. I acknowledge that in the past over weighting the US market significantly has outperformed.

Full disclosure: I'm close to 50/50 US and international on the equity side. I'm 1005 US on the fixed income side.
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Re: Good argument for underweighting international stocks?

Post by rca1824 »

Twins Fan wrote:Remember earlier this year when so many posts were out about being happy to have international and wanting to add more... How quickly things change...
Just to be clear, I am not basing my argument on news or recent returns. It is based purely on the inherent and indisputable nature of both currency risk and higher fees.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
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Re: Good argument for underweighting international stocks?

Post by rca1824 »

bigred77 wrote:What are the chances of a long bear market depression, war, or other "very bad event" that occurs in the US over the next 100 years?

I don't know the answer to that but I would prefer to have a substantial allocation to international markets in that scenario. I acknowledge that in the past over weighting the US market significantly has outperformed.

Full disclosure: I'm close to 50/50 US and international on the equity side. I'm 1005 US on the fixed income side.
To be clear, I am not arguing it is optimal to NOT have a substantial allocation to international. Just wondering if it is optimal to dial back from the cap-weight of 48% to say 40% in light of very real currency risk and costs.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
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Re: Good argument for underweighting international stocks?

Post by Twins Fan »

rca1824 wrote:
Twins Fan wrote:Remember earlier this year when so many posts were out about being happy to have international and wanting to add more... How quickly things change...
Just to be clear, I am not basing my argument on news or recent returns. It is based purely on the inherent and indisputable nature of both currency risk and higher fees.
No worries... that was just a general comment after z3r0c00l's comment. Wasn't meant to be directed to you.
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Re: Good argument for underweighting international stocks?

Post by bigred77 »

rca1824 wrote:
bigred77 wrote:What are the chances of a long bear market depression, war, or other "very bad event" that occurs in the US over the next 100 years?

I don't know the answer to that but I would prefer to have a substantial allocation to international markets in that scenario. I acknowledge that in the past over weighting the US market significantly has outperformed.

Full disclosure: I'm close to 50/50 US and international on the equity side. I'm 1005 US on the fixed income side.
To be clear, I am not arguing it is optimal to NOT have a substantial allocation to international. Just wondering if it is optimal to dial back from the cap-weight of 48% to say 40% in light of very real currency risk and costs.
That's fair. I don't have a good answer or argument one way or the other in terms of 40% - 48% International. I suspect the impact of that decision is small enough that it gets lost in the noise 95% of the time.
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Re: Good argument for underweighting international stocks?

Post by JoMoney »

The additional expenses for the ER is just a drop in the bucket. Remember that ER does not encompass all the costs of a mutual fund, only a few explicit items. Other trading/brokerage expenses impact as well, which are typically higher in foreign markets. On top of that there are foreign tax withholdings that can easily amount to another .35% or more. There's probably a basis point or two in expenses for the intermediary banks that hold the stocks for benefit of some foreign investor - you don't have the legal rights to own stock in many foreign places, you have to do it through a series of derivative agreements with banks that are allowed to operate in both countries, and they extract fees for this service.

To get an idea about the foreign tax impact, over the past 15 years, the MSCI ACWI ex US Gross Return (before foreign tax withholding) achieved .54% higher annualized return than the MSCI ACWI ex US Net Return (including foreign tax withholding).
(Morningstar Chart)

EDIT to add- Here's another MStar Chart including the ACWX iShares ETF that tracks this index.
Over the past 7 years, ACWX grew $10,000 to $11,339.13
and the MSCI ACWI ex US GR grew to $12,195.90
over a 7 year period that amounts to a difference to an annualized 1.05% per year
Last edited by JoMoney on Tue Aug 18, 2015 6:58 pm, edited 1 time in total.
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Re: Good argument for underweighting international stocks?

Post by DVMResident »

Wanting to overweight the US today would be chasing returns.

Looking at international fundamentals. Than look at the US.
rca1824 wrote:
Twins Fan wrote:I don't think the cost/ER difference is even worth mentioning anymore. Maybe way back when the international index cost quite a bit more? But, nowadays a 9 basis point difference isn't even going to be noticeable in the big picture.
After 100 years, that 9 bp fee can bleed 8.6% of a portfolio's value like a thirsty vampire. Jack Bogle calls this phenomenon the "tyranny of compounding costs." Over 500 years, 36%. Over 1000 years, 59%. So I wouldn't call it unnoticeable
Will "international" even be a thing in a 1000 years?
By then the BH forum will be debating the optimal earth:emerging mars colony ratio :wink:
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Re: Good argument for underweighting international stocks?

Post by rca1824 »

JoMoney wrote:The additional expenses for the ER is just a drop in the bucket. Remember that ER does not encompass all the costs of a mutual fund, only a few explicit items. Other trading/brokerage expenses impact as well, which are typically higher in foreign markets. On top of that there are foreign tax withholdings that can easily amount to another .35% or more. There's probably a basis point or two in expenses for the intermediary banks that hold the stocks for benefit of some foreign investor - you don't have the legal rights to own stock in many foreign places, you have to do it through a series of derivative agreements with banks that are allowed to operate in both countries, and they extract fees for this service.

To get an idea about the foreign tax impact, over the past 15 years, the MSCI ACWI ex US Gross Return (before foreign tax withholding) achieved .54% higher annualized return than the MSCI ACWI ex US Net Return (including foreign tax withholding).
(Morningstar Chart)
Thanks for this extra information. That 0.54% drag is way more than thought, it's actually quite shocking. Do you have comparable numbers for US equity? Do you hold any international yourself?
DVMResident wrote: Wanting to overweight the US today would be chasing returns.
Actually it wouldn't because I'm not chasing historical returns, I'm just optimizing with respect to indisputable currency risk and fees. Even if you assume the gross returns of US and international are equal and perfectly uncorrelated, there would still exist a Pareto improvement over cap-weight because it would be optimal to trade-off a little bit of diversification for guaranteed less currency risk and fees.
Looking at international fundamentals. Than look at the US.
Is this even a Boglehead principle? I thought PE market timing models were killed already. The market price already ought to embed all present public knowledge about future risk-adjusted earnings. If PE of some foreign countries is low, it's because either have low expected growth or high uncertainty (political regime uncertainty for one). Like Russia.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
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Re: Good argument for underweighting international stocks?

Post by rca1824 »

JoMoney wrote:The additional expenses for the ER is just a drop in the bucket. Remember that ER does not encompass all the costs of a mutual fund, only a few explicit items. Other trading/brokerage expenses impact as well, which are typically higher in foreign markets. On top of that there are foreign tax withholdings that can easily amount to another .35% or more. There's probably a basis point or two in expenses for the intermediary banks that hold the stocks for benefit of some foreign investor - you don't have the legal rights to own stock in many foreign places, you have to do it through a series of derivative agreements with banks that are allowed to operate in both countries, and they extract fees for this service.

To get an idea about the foreign tax impact, over the past 15 years, the MSCI ACWI ex US Gross Return (before foreign tax withholding) achieved .54% higher annualized return than the MSCI ACWI ex US Net Return (including foreign tax withholding).
(Morningstar Chart)
Thanks for this extra information. That 0.54% drag is way more than thought, it's actually quite shocking. Do you have comparable numbers for US equity? Do you hold any international yourself?
DVMResident wrote: Wanting to overweight the US today would be chasing returns.
Actually it wouldn't because I'm not chasing historical returns, I'm just optimizing with respect to indisputable currency risk and fees. Even if you assume the gross returns of US and international are equal and perfectly uncorrelated, there would still exist a Pareto improvement over cap-weight because it would be optimal to trade-off a little bit of diversification for guaranteed less currency risk and fees.
Looking at international fundamentals. Than look at the US.
Is this even a Boglehead principle? I thought PE market timing models were killed already. The market price already ought to embed all present public knowledge about future risk-adjusted earnings. If PE of some foreign countries is low, it's because either have low expected growth or high uncertainty (political regime uncertainty for one). Like Russia.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
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Re: Good argument for underweighting international stocks?

Post by alex_686 »

rca1824 wrote:Assumptions:
1. International volatility is inflated by current risk
Over a period of 3 years currency risk basically falls to zero.
rca1824 wrote: 2. Vanguard charges 9 basis points more for international versus domestic equity funds.
This statement is meaningless by itself. It needs to be put into a risk / return framework.
Does adding international increase your expected risk / return? If so, how much value does this diversification add?
Once you have figured out the value of the diversification effects, then you can consider if the extra cost is worth it.
rca1824 wrote:Although historical returns don't prove anything, 60/40 has had better risk and return than 50/50. The max return was 65/35 and the min risk was 80/20, implying optimal international allocation was only 20-35%. (1972-2014)
Probably not a good time span to use. Big developed markets have gone from a level of about 40% integration with the US in the 70s to about 80% in 2010. This is going to seriously throw off any numbers you get.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
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JoMoney
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Re: Good argument for underweighting international stocks?

Post by JoMoney »

rca1824 wrote:...That 0.54% drag is way more than thought, it's actually quite shocking. Do you have comparable numbers for US equity? Do you hold any international yourself? ...
U.S. citizens don't have foreign tax withholding on U.S. stocks :confused , foreign investors do but I don't have details, and might vary from country to country based on different country agreements treaties etc..

FWIW, after all fees and expenses Vanguard's Institutional class index actually beats the S&P500 index when combined with the income earned with securities lending. The VFIAX Admiral class 500 fund was only short .02% of the index, which is significantly less then the the ER would imply.
MStar Chart

The 'Vanguard Total Market' index similarly has net expenses lower then what is implied by the ER net of securities lending, but the only way I know to show this is to look at the annual reports and look at the returns of the fund vs the benchmark shown in the annual report.

I don't own any stocks traded on non-U.S. exchanges. Most all of my investments are in S&P500 funds... which may contain some international depending on how you want to define 'international' - (i.e. some of companies are in Vanguard's International Index fund) - but they're all traded on a U.S. exchange (and have to comply with the SEC regulations)
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Re: Good argument for underweighting international stocks?

Post by stlutz »

If I was 22 and starting brand new today, I think I would go with market weight as that best reflects the world we live in.

However, I've personally been 1/3 international for about 20 years now and decided once again not to change although I thought about it earlier in the year based on the discussion in this thread: viewtopic.php?f=10&t=154400.

As has been noted, there are some additional costs (though not huge) with international investing. I also think international markets are in general currently more risky than US ones--and the market seems to agree with me based on the relative prices of each. Since I'm in the minority here and do think that one must expect that extra risk will be compensated, I don't agree with those who forecast international outperformance in the future.

I generally argue that staying the course is more important than finding the optimal allocation, so I'm sticking with 1/3 international even though I'm very sympathetic with the market-weight approach.
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Re: Good argument for underweighting international stocks?

Post by rca1824 »

alex_686 wrote:
rca1824 wrote: 2. Vanguard charges 9 basis points more for international versus domestic equity funds.
This statement is meaningless by itself. It needs to be put into a risk / return framework.
I don't think this is meaningless in itself. If a fund has higher fees, then it means it should be optimal to tilt away from cap-weight. We can exaggerate the math and suppose the fee is 5% for international. I probably wouldn't hold ANY at that price. Ergo, it is straightforward that if the fee is higher than US, it is optimal to tilt slightly away from the cap weight of 48%. The optimal solution will be somewhere between 1-47%.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
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Re: Good argument for underweighting international stocks?

Post by Browser »

At the end of the day, it doesn't make any difference how much you allocate to foreign equity because you won't stick with that allocation for the 20+ years it will take to find out how it would have turned out. Nobody will. Pick a number. :mrgreen:
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Re: Good argument for underweighting international stocks?

Post by vitaflo »

Twins Fan wrote:Remember earlier this year when so many posts were out about being happy to have international and wanting to add more... How quickly things change...
Remember a year ago when people were asking "why international at all?" because it had underperformed for so long? We've come full circle! :sharebeer
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Re: Good argument for underweighting international stocks?

Post by Twins Fan »

rca, I believe in a few threads you mention "optimal" when it comes to portfolios, strategies, tilts, or whatever. You realize it's about impossible to know now what will be optimal for the next 20 years or whatever.

What if international outperforms TSM by 5% (random there) over the next decade... would you have an issue paying an extra 9 basis points for that?

For those that hold TSM but tilt to hold more than market weight in SCV, REITs, or whatever, how does the extra expense figure in for them since their going over weight?

Talking of optimal holdings for most of the Vanguard low ER <.20 index type fund based on a few basis points is just spinning one's wheels. IMO

What's the saying about the quest for the perfect plan while passing up a perfectly fine plan again?? :wink: :D
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Re: Good argument for underweighting international stocks?

Post by Maynard F. Speer »

It shows doesn't it - the basic behavioural sways of the market never really change

No matter how much we read about CAPE ratios, and the importance of diversification and buying at fair value, the heaving centre mass of the market is always doomed to performance-chasing
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Re: Good argument for underweighting international stocks?

Post by patrick »

The arguments for underweighting non-US stocks seem rather weak (though not completely negated) to me for these reasons:

1) 9 basis points is not very much.

2) The extra foreign taxes can be regained by a tax credit if you are investing in a taxable account.

3) Movements in exchange rates should be correlated to inflation (though unfortunately they aren't very strongly correlated) so losses from currency risk would tend to happen in period of low inflation (when you don't need so much gains anyway) while gains from currency risk would tend to happen in period of high inflation (when you really do need a lot of gains).

4) Foreign stocks don't represent a specific amount of a foreign currency, but rather a fraction of a company. Major companies usually have suppliers, customers, and employees in many different countries and using many different currencies. Thus the value of the company will, measured in it's home currency, will tend to vary depending on currency movements, so the currency effect on the stocks price in US dollars isn't simply a matter of the change in the exchange rate between the US dollar and the company's home currency.

There are also a couple of reasons for overweighting non-US stocks:

5) Your ability to earn income from the US depends on the US economy. This includes not only income you would get by working (already noted in the original post) but also retirement benefits.

6) Just as you wouldn't want to have too much money in one single stock, you also might want to avoid too much in any one country.

How to do you weight these together? It's hard to assign precise weights to all of them, so you might as well just take a simple approach such as either cap weighting or perhaps 50/50 which comes out about the same right now.
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Re: Good argument for underweighting international stocks?

Post by rca1824 »

patrick wrote:The arguments for underweighting non-US stocks seem rather weak (though not completely negated) to me for these reasons:

1) 9 basis points is not very much.

2) The extra foreign taxes can be regained by a tax credit if you are investing in a taxable account.

3) Movements in exchange rates should be correlated to inflation (though unfortunately they aren't very strongly correlated) so losses from currency risk would tend to happen in period of low inflation (when you don't need so much gains anyway) while gains from currency risk would tend to happen in period of high inflation (when you really do need a lot of gains).

4) Foreign stocks don't represent a specific amount of a foreign currency, but rather a fraction of a company. Major companies usually have suppliers, customers, and employees in many different countries and using many different currencies. Thus the value of the company will, measured in it's home currency, will tend to vary depending on currency movements, so the currency effect on the stocks price in US dollars isn't simply a matter of the change in the exchange rate between the US dollar and the company's home currency.

There are also a couple of reasons for overweighting non-US stocks:

5) Your ability to earn income from the US depends on the US economy. This includes not only income you would get by working (already noted in the original post) but also retirement benefits.

6) Just as you wouldn't want to have too much money in one single stock, you also might want to avoid too much in any one country.

How to do you weight these together? It's hard to assign precise weights to all of them, so you might as well just take a simple approach such as either cap weighting or perhaps 50/50 which comes out about the same right now.
I see what you mean, compared to all those factors 9 points is not much.

But JoMoney says it's closer to a 54 point drag. That's 6x higher than the spread in costs alone. At that much drag, I am seriously reconsidering my international stake. I'm already about to pull VSS because I think 19 bp is too much to pay for an index fund.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
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Re: Good argument for underweighting international stocks?

Post by patrick »

rca1824 wrote:I see what you mean, compared to all those factors 9 points is not much.

But JoMoney says it's closer to a 54 point drag. That's 6x higher than the spread in costs alone. At that much drag, I am seriously reconsidering my international stake. I'm already about to pull VSS because I think 19 bp is too much to pay for an index fund.
The 54 basis point drag is not quite the same as an expense ratio -- it is the taxes withheld by foreign governments on the dividend payments. This is only a loss to you if you hold the fund in a tax-advantaged account since you (usually) get to claim a tax credit for this if you are investing in a taxable account.
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Re: Good argument for underweighting international stocks?

Post by grabiner »

JoMoney wrote:The additional expenses for the ER is just a drop in the bucket. Remember that ER does not encompass all the costs of a mutual fund, only a few explicit items. Other trading/brokerage expenses impact as well, which are typically higher in foreign markets. On top of that there are foreign tax withholdings that can easily amount to another .35% or more. There's probably a basis point or two in expenses for the intermediary banks that hold the stocks for benefit of some foreign investor - you don't have the legal rights to own stock in many foreign places, you have to do it through a series of derivative agreements with banks that are allowed to operate in both countries, and they extract fees for this service.

To get an idea about the foreign tax impact, over the past 15 years, the MSCI ACWI ex US Gross Return (before foreign tax withholding) achieved .54% higher annualized return than the MSCI ACWI ex US Net Return (including foreign tax withholding).
You can get the foreign tax withholding back if you hold your international stock in a taxable account. There is still a tax loss because international funds do not have 100% qualified dividends. If your international fund has 70% qualified dividends taxed at 15% and 30% non-qualified taxed at 25%, and a typical 7% withholding rate, the effective tax rate is 11% of the dividend yield, versus 15% for a US fund with 100% qualified dividends. (International may still be worse because international funds have had higher dividend yields than US funds since 2009.)
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Re: Good argument for underweighting international stocks?

Post by rca1824 »

Twins Fan wrote:rca, I believe in a few threads you mention "optimal" when it comes to portfolios, strategies, tilts, or whatever. You realize it's about impossible to know now what will be optimal for the next 20 years or whatever.
It's impossible to know what will optimal ex-post. But that's confusing strategy with outcome. We can only optimize ex-ante. Assume a utility function, and a probability distribution of outcomes, and there ALWAYS exists an optimal strategy (I think -- might need some other set theoretical assumptions like the outcome space is finite-dimensioned, bounded, complete, etc.) that will maximize expected utility.

The problem is then just pinning down the assumptions on the probability distributions. Once that's done, you can derive a simple function that maps a utility function to an optimal asset allocation.
Twins Fan wrote:What if international outperforms TSM by 5% (random there) over the next decade... would you have an issue paying an extra 9 basis points for that?
If I knew ex-ante what the ex-post returns would be, then sure. If I knew ex-ante than TISM was expected to return more net of fees than TSM, then also yes. Cap-weight theories says you can't subdivide the market and tilt towards one sector or segment to boost returns, so I assume TSM and TISM have equal gross expected returns. Then it's just a matter of looking at costs to derive net returns. If gross returns are equal and costs are higher in TISM then net returns must be lower, by humble arithmetic.

Imagine you're at a casino and there are two roulette wheels, one has 0 and 00 spots but the other only has 0. You must play once. You go to the one with only 0 and bet red. It comes up as black, but red on the other wheel. Do you regret your decision? No because you maximized expected utility.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
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Re: Good argument for underweighting international stocks?

Post by czeckers »

P/E ratios for international, and emerging markets in particular, are much more attractive right now than US equity. I certainly would not be decreasing my international exposure right now.

Pick an international allocation and stick with it anywhere between 20-50% of equity is reasonable. The optimal allocation won't be known except in retrospect so no point in trying to nail down the perfect percentage.
The Espresso portfolio: | | 20% US TSM, 20% Small Value, 10% US REIT, 10% Dev Int'l, 10% EM, 10% Commodities, 20% Inter-term US Treas | | "A journey of a thousand miles begins with a single step."
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Re: Good argument for underweighting international stocks?

Post by Northern Flicker »

81.5% vtmgx at 9 basis pts ER and 18.5% vemax at 15 basis pts gives an implementation of total int'l for about 10 basis pts/yr of ER. The real added expense of int'l stocks for a US investor, especially EM stocks, is the higher transaction costs from more expensive commissions and wider bid-ask spreads, neither of which are included in ER.

I don't know of any imperitive for US investors to weight US and int'l equities by cap weights. Even VG's recommendation of 40% int'l is probably too much currency exposure for investors in a withdrawal phase with liabilities denominated in USD.

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Re: Good argument for underweighting international stocks?

Post by Twins Fan »

rca1824 wrote:If I knew ex-ante what the ex-post returns would be, then sure. If I knew ex-ante than TISM was expected to return more net of fees than TSM, then also yes. Cap-weight theories says you can't subdivide the market and tilt towards one sector or segment to boost returns, so I assume TSM and TISM have equal gross expected returns. Then it's just a matter of looking at costs to derive net returns. If gross returns are equal and costs are higher in TISM then net returns must be lower, by humble arithmetic.
Okay, I at least see where you're coming from now. I would call that an exercise on futility though. We can be almost certain the returns will not be exactly equal... and again, we're talking 9 basis points.

Also, the cap weight of the world market does not stay the same. Do you adjust your AA every decade or whenever for that, or....
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Re: Good argument for underweighting international stocks?

Post by grabiner »

jalbert wrote:81.5% vtmgx at 9 basis pts ER and 18.5% vemax at 15 basis pts gives an implementation of total int'l for about 10 basis pts/yr of ER. The real added expense of int'l stocks for a US investor, especially EM stocks, is the higher transaction costs from more expensive commissions and wider bid-ask spreads, neither of which are included in ER.
This is not a major cost for US investors who hold index funds, as the funds don't pay the spreads and commissions very often. Total International has 3% turnover. Even FTSE All-World Ex-US Small-Cap had only 13% turnover last year.
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Re: Good argument for underweighting international stocks?

Post by whaleknives »

Having lived in countries considered emerging markets, there are some personal experiences with currency black markets, government employee corruption, and political unrest that strongly reinforce some of Vanguard's warnings about international risk.
  • "Vanguard Total International Stock Index Fund Admiral Shares (VTIAX) Portfolio & Management:
    Country/regional risk: The chance that world events—such as political upheaval, financial troubles, or natural disasters—will adversely affect the value of securities issued by companies in foreign countries or regions.
    Currency risk: The chance that the value of a foreign investment, measured in U.S. dollars, will decrease because of unfavorable changes in currency exchange rates.
    Emerging markets risk: The chance the stocks of companies located in emerging markets will be substantially more volatile, and substantially less liquid, than the stocks of companies located in more developed foreign markets."
I'm comfortable with my 30% of stocks international.
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Re: Good argument for underweighting international stocks?

Post by rca1824 »

Twins Fan wrote:
Okay, I at least see where you're coming from now. I would call that an exercise on futility though. We can be almost certain the returns will not be exactly equal... and again, we're talking 9 basis points.
Correction: 54 now. And you keep confusing strategy with outcome. If you roll two equal dice they will likely come up as different numbers 5 out of 6 times but each die had the same expected value. Cap weight theory says you can't boost expected returns by tilting because if you could investors would have already done so thus bidding down any excess returns. If you believe in efficient markets. That's one of my assumptions. Thus we assume all markets have identical ex-ante gross returns, no?
Also, the cap weight of the world market does not stay the same. Do you adjust your AA every decade or whenever for that, or....
Right, look up cap weight when rebalancing. And I don't consider adjusting the domestic/international split in response to real changes in market caps to be adjusting AA. AA should be defined in terms of stocks and bonds, and within stocks, how much you tilt relative to cap weight. If cap weight changes from 48% to 55% and you adjust your allocation from 48% to 55% then you didn't really change your allocation in principle, you just tracked the cap weight. People who hold a static domestic: equity split ignoring cap weights are actually not tracking the global cap-weight index. If you do a tilt, say you hold 30% international when cap-weight is 48%, then you've essentially divided your portfolio into two allocations: 62.5% in a global cap-weight fund and 37.5% in domestic equity. Thus is the international cap weight shifts from 48% to 55% you should continue holding 62.5% global / 37.5% domestic thus your new international allocation should be 34.375% to be consistent with your relative tilt. If you DON'T adjust your asset allocation then you've actually shifted your high-level AA to 54.5% global / 45.5% domestic so you no longer have the same portfolio.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
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Re: Good argument for underweighting international stocks?

Post by lack_ey »

rca1824 wrote:
Twins Fan wrote:
Okay, I at least see where you're coming from now. I would call that an exercise on futility though. We can be almost certain the returns will not be exactly equal... and again, we're talking 9 basis points.
Correction: 54 now. And you keep confusing strategy with outcome. If you roll two equal dice they will likely come up as different numbers 5 out of 6 times but each die had the same expected value. Cap weight theory says you can't boost expected returns by tilting because if you could investors would have already done so thus bidding down any excess returns. If you believe in efficient markets. That's one of my assumptions. Thus we assume all markets have identical ex-ante gross returns, no?
No, or at least maybe not.

Even if you suppose that cap weighting gets you maximum risk-adjusted return, the risks of different markets are not the same. Based on the sheer number of stocks available (higher means more diversification in some nontrivial sense), sector representation, breadth of economic output, stability of institutions like governments, shareholder and legal protections, liquidity, etc., you shouldn't expect different markets to be equally risky. Empirically, the volatility of large developed markets tends to be lower.

Because there is still some extra risk in some sets of countries even after diversifying, it would not be a stretch to assume the baseline long-run expected return to be unequal as a result. And they probably shouldn't have the same risk-adjusted returns. You can't expect 1% of the global float-adjusted equity market (say India) to have the same risk-adjusted return as say 50% of it (the US).


Also, in practice market efficiency depends on free flow of information and capital. It is limited in practice by costs of arbitrage and the amount of money spent to make things efficient. Because of language and other barriers, time zones, investor preferences for home country investing, differing transaction costs all around, etc. the conditions for market efficiency are a little weaker in the global equity market as compared to the smaller subset of the US market. In any case, given that investors face currency headwinds investing anywhere outside, can the global market portfolio even be optimal for an investor in Singapore at the same time it is for someone in Nigeria? How does the market find the equilibrium point?
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Re: Good argument for underweighting international stocks?

Post by rca1824 »

lack_ey wrote:[
Even if you suppose that cap weighting gets you maximum risk-adjusted return, the risks of different markets are not the same. Based on the sheer number of stocks available (higher means more diversification in some nontrivial sense), sector representation, breadth of economic output, stability of institutions like governments, shareholder and legal protections, liquidity, etc., you shouldn't expect different markets to be equally risky. Empirically, the volatility of large developed markets tends to be lower.
Okay, if we go with this point then any investor who is less than 100% equity and not seeking higher risk/return is better off with cap-weight. It's still aside to my point, because the assumption I listed above was that cap-weight in efficient and its the ideal portfolio. From this assumptions, we should get this conclusion. Obviously if you use different assumptions like factor investing then you can get a different conclusion.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
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Re: Good argument for underweighting international stocks?

Post by afan »

The high and perhaps still rising correlation suggests that it does not much matter what percent allocation one uses.

The tax drag might or might not overwhelm diversification advantages. It would depend on just how high the correlations turn out to be. At some point, expenses and taxes could be high enough that it is not worth a given level of (unknown) correlation. It is not obvious that a total ER and tax drag of 1 basis point would be enough to rule out international stocks. It seems highly likely that several percent would be high enough to do this.

As many have pointed out, the US market derives a lot of its revenue from foreign countries and many international stocks do a lot of their business exporting to the US. One is invested in the US with international stocks and in international stocks with domestic indexes.

Even for US companies, there are all sorts of tax, regulatory and what we would call graft, extortion and bribery costs to doing business around the world. On the one hand these are drags to be avoided if possible. On the other hand, it is not at all clear that one could identify which companies suffer this most heavily in order to underweight them. Shifts in the distribution of international countries where a company gets its business couid change this effect, as could changes in tax policies across international countries. I assume there are people at major accounting firms and the finance departments of multinational companies whose full time jobs are keeping track of the tax issues. For an individual investor, trying to guess how much total drag there might be on international companies could be effectively impossible.

All things considered, it seems the factors that might influence this decision are too hard to estimate to get a quantitative answer for how much to allocate to international stocks. One could make a case for zero up to 50%, depending on which factors one chooses to give the most weight. Given the high correlations, it may not matter that much.
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Re: Good argument for underweighting international stocks?

Post by afan »

One could argue that the logic is less about efficient markets and correlation of stock returns than about diversifying sovereign risk. For any short to medium term, there is always the chance that the political leaders of a country or a group of countries could make a series of moves that turn out to be financially catastrophic. That could happen in the US, in Europe, China, Brazil, India, where ever.

I would say that it is highly likely this will happen to a series of countries around the world over time, as it has in the past. But it is less likely to happen to a large group of countries all at the same time. It is even less likely that the bad decisions will be the same in these various different markets.

The Europeans have linked their markets to an extent that their outcomes are probably highly correlated with one another. If I were in Europe, I would want to invest some money not only outside my country, but outside Europe. From the US, I think I can moderate my exposure to political risk by investing across a variety of countries.

That does not get me close to calculating an asset allocation, but it does suggest a "significant' non-US component.
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Re: Good argument for underweighting international stocks?

Post by BigJohn »

rca1824 wrote:To be clear, I am not arguing it is optimal to NOT have a substantial allocation to international. Just wondering if it is optimal to dial back from the cap-weight of 48% to say 40% in light of very real currency risk and costs.
rca1824 wrote:Just to be clear, I am not basing my argument on news or recent returns. It is based purely on the inherent and indisputable nature of both currency risk and higher fees.
rca, I have participated in recent threads and seen your comments on making big bets on SCV tilting based on historical analysis. Just like with SCV, if you look at the data on international allocation you can draw almost any conclusion you want depending on period chosen. However, based on what I've read from VG and others I think that anything in the range of 20 - 40% would have yielded very similar overall returns. The results are not static and things have and will continue to change so there is no way to judge what's optimal going forward with any accuracy http://www.vanguard.com/pdf/ISGGEB.pdf.

To me the key is picking an allocation you are comfortable with and then staying the course. Our brains are funny things and what we might think is a well considered strategy change could be motivated by recency bias that we don't even realize is there. To avoid this my process for making any strategy change like moving my AA is to studying it for at least a year. If a year later I'm still fully convinced it's the right thing to do I'll start to make moves in that direction.
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