How to Global ETFs 'readjust' to reflect market conditions

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Cintrapark
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How to Global ETFs 'readjust' to reflect market conditions

Post by Cintrapark » Sat Mar 03, 2018 2:29 am

Morning Everyone. The main bulk of my stock portfolio is a global ETF (Vanguard FTSE All-World UCITS ETF). Does anyone know how these ETFs work and redistribute? For example over 50% of the shares are US based. If the US' economic dominance were to decline in favour of China in the next 30 years, for example, would the fund automatically rebalance to reflect this? Right now the 10 main holdings are. Would this change?

1 Apple Inc.
2 Microsoft Corp.
3 Alphabet Inc.
4 Amazon.com Inc.
5 Facebook Inc.
6 Berkshire Hathaway Inc.
7 JPMorgan Chase & Co.
8 Johnson & Johnson
9 Exxon Mobil Corp.
10 Tencent Holdings Ltd.

AlohaJoe
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Re: How to Global ETFs 'readjust' to reflect market conditions

Post by AlohaJoe » Sat Mar 03, 2018 2:53 am

Why would there fund need to rebalance?

It doesn't need to do anything at all.

Maybe you could explain with an example to show why the fund would need to rebalance?

Cintrapark
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Re: How to Global ETFs 'readjust' to reflect market conditions

Post by Cintrapark » Sat Mar 03, 2018 3:47 am

Maybe I worded my post incorrectly. My questions is that if the 10 top holdings cease to become the top 10 global holdings, will the fund redistribute in favour of the new order?

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whodidntante
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Re: How to Global ETFs 'readjust' to reflect market conditions

Post by whodidntante » Sat Mar 03, 2018 4:15 am

Cintrapark wrote:
Sat Mar 03, 2018 3:47 am
Maybe I worded my post incorrectly. My questions is that if the 10 top holdings cease to become the top 10 global holdings, will the fund redistribute in favour of the new order?
It wouldn't be necessary. The fund is passively holding the stocks. The fund will trade to reflect adjustments in the index it tracks, although a small aside is that some funds use "sampling" which means they might not actually hold all the stocks in the index, just a representative sample. If Tencent becomes the world's largest company by market float, you'll see it at the top of the list . If Apple goes bankrupt, you'll see it fall off the list once it's dropped from the index or the shares become worthless.

Cintrapark
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Re: How to Global ETFs 'readjust' to reflect market conditions

Post by Cintrapark » Sat Mar 03, 2018 4:19 am

Great - thanks!

lack_ey
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Re: How to Global ETFs 'readjust' to reflect market conditions

Post by lack_ey » Sat Mar 03, 2018 4:47 am

Stock index funds generally only sample for small caps, maybe some illiquid mid caps in some markets. They do full replication of large caps.

Keep in mind that the funds don't even need to trade (rebalance) to keep up with changes in market cap from stock price movement. The price movement increases a rising stock's market cap just as it does the fund's weighting in that stock.

There is trading from portfolio maintenance to keep track of mergers/acquisitions, IPOs, stock issuance and buybacks, dividends, etc.

On another note because China was specifically mentioned, most funds including index funds do not own the A Shares stocks listed on the heavily controlled local Chinese market (in Shanghai and Shenzhen), just the stocks listed in Hong Kong, which is a more typical and open market with the usual international investor base. China restricts and has quotas on foreign investment in the local market. There is some overlap, but a significant percentage of companies are not on the local market but not in Hong Kong.

In general, a country's economic performance is not very much tied to the stock performance over a given period of time. Consider the prevalence of publicly vs. privately owned businesses in a given country, the fact that stock pricing is forward looking, who is benefiting from the underlying economic growth and where the money is going, etc.

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Re: How to Global ETFs 'readjust' to reflect market conditions

Post by Cintrapark » Sat Mar 03, 2018 5:05 am

Interesting - basically aside from market full-on market fluctuations, I'm trying to assess how robust my portfolio is with most of its holdings being US based.

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alpine_boglehead
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Re: How to Global ETFs 'readjust' to reflect market conditions

Post by alpine_boglehead » Sat Mar 03, 2018 5:40 am

Cintrapark wrote:
Sat Mar 03, 2018 5:05 am
Interesting - basically aside from market full-on market fluctuations, I'm trying to assess how robust my portfolio is with most of its holdings being US based.
According to Morningstar, the US makes up 51% of Vanguard FTSE All-World, so that's half of the holdings. That seems to be the market consensus of how investable public companies around the world are valued. That might be wrong of course, like Japan getting too much weight in the late 1980s, but I doubt that the US is currently as overvalued as Japan was back then.

If you think you have more information or different needs than the other market participants, you can sideline your portfolio with tilts to other countries/regions (I keep reading that Emerging Markets and "International" (=developed world without US) have more attractive valuations), but a global market weighted fund like this one seems to be a good starting point.

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Re: How to Global ETFs 'readjust' to reflect market conditions

Post by nisiprius » Sat Mar 03, 2018 7:28 am

Cintrapark wrote:
Sat Mar 03, 2018 2:29 am
Morning Everyone. The main bulk of my stock portfolio is a global ETF (Vanguard FTSE All-World UCITS ETF). Does anyone know how these ETFs work and redistribute? For example over 50% of the shares are US based. If the US' economic dominance were to decline in favour of China in the next 30 years, for example, would the fund automatically rebalance to reflect this? Right now the 10 main holdings are. Would this change?

1 Apple Inc.
2 Microsoft Corp.
3 Alphabet Inc.
4 Amazon.com Inc.
5 Facebook Inc.
6 Berkshire Hathaway Inc.
7 JPMorgan Chase & Co.
8 Johnson & Johnson
9 Exxon Mobil Corp.
10 Tencent Holdings Ltd.
Note that Tencent Holdings Ltd. is a Chinese firm.

In case the answer to your questions still isn't clear, the answer to your question "Would this change?" the answer is "yes." For example, if we imagine that the US declined to be "just another big economic power," like Germany or Japan or Canada or Switzerland, then we might well see only one US company in the top ten.

The reason you're getting mixed answers is that this does not required any "readjustment" or "redistribution."

The question isn't "how do global ETFs 'readjust,'" it is "how do cap-weighted index funds change to reflect their indexes?" And the answer is, "they don't need to, it is an automatic feature of cap-weighting." This is one of the good things about cap-weight indexes and index funds, and one of the reasons their costs are so low. If you don't understand why they don't need to, think about it until you do.

This is very important to understand, because the huge success of Vanguard has led to their rivals attacking it by attacking cap-weighted indexing in general (and the S&P 500 in particular). Much of the competition involves alternative weightings ("fundamental" indexing, "smart beta," Fidelity's "enhanced" indexing, "factor tilts," equal-weighted indexing) and thus they all have a self-interest in arguing against cap-weighted indexing. In the process they say or imply an awful lot of bad nonsense. For example, when MSCI and S&P reclassified REITs as being their own sector instead of being part of the financial sector, a number of writers claimed that this was going to require index funds to buy REITs.

The way in which the ETF would adjust is by doing nothing at all. In your scenario, the stock prices of Chinese firms would gradually rise and rise and rise. (The stocks would eventually need to split, but that doesn't require the ETF to buy or sell anything). The position of Tencent Holdings and other Chinese firms would become higher and higher on the list, and those of US firms lower and lower, not because the ETF had to do anything, but simply because of the natural evolution of the stock prices. Eventually, the ETF would be holding large numbers of shares of Chinese firms due to splits, and the total value of its Chinese shares would come to exceed the total value of its US shares due to price chances and splits.

Unfortunately, transaction costs are not included in the expense ratio and not easily visible. (I think funds keep it a secret). You can tell that they are negligible in index funds simply by observing how closely they succeed in tracking their index. Transaction costs are implied in Morningstar's "turnover" numbers, which seem to be calculated only for mutual funds; for the mutual fund equivalent of VT, VTSWX, it is 10%--only 10% of the portfolio needs to be bought or sold per year. For actively-managed rival T. Rowe Price Global Stock Fund, PRGSX, it is 96%--it does ten times as much buying and selling.
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dumbmoney
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Re: How to Global ETFs 'readjust' to reflect market conditions

Post by dumbmoney » Sat Mar 03, 2018 1:22 pm

nisiprius wrote:
Sat Mar 03, 2018 7:28 am
Unfortunately, transaction costs are not included in the expense ratio and not easily visible. (I think funds keep it a secret). You can tell that they are negligible in index funds simply by observing how closely they succeed in tracking their index.
Not really, because index funds generally trade in sync with the index. This means that the transaction cost of index changes (the implicit cost - trading slippages, as opposed to brokerage fees) is baked into the index.

Transaction costs of fund inflows/outflows would indeed show up as index tracking error. (In the case of ETFs that use in-kind creation/redemption, they are zero anyway).
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