ram wrote: ↑
Sun May 03, 2020 12:49 pm
Why stop at American exceptionalism. Why not look at Californian exceptionalism (and Silicon valley exceptionalism). If California based companies do much better than US ex California then should we only invest in California based companies.
I will continue to invest in Intt.
This is a great point, and ties into something I've been thinking a lot about lately. My wife and I just recently started considering buying our first home, and in doing research about real estate, both from shelter and investment perspectives, it struck me how leverage was so normalized compared to buying stocks on margin. Now, I don't really want to get into a discussion on whether margin makes sense for stock investors, because there are so many details that play into that, but I did get to thinking that if it's so normal to take on risk in the form of leverage for outsized returns, there should be a similar way to accomplish the same thing with stocks.
So I started looking into those popular lifecycle investment threads that suggest using leverage early in one's career to maximized time diversification, and in doing so, I kind of realized that leverage mostly magnifies the underlying portfolio's returns without modifying its risk characteristics. Just like a home's neighborhood and schools don't get better or worse because of a mortgage, a company isn't more or less likely to go bankrupt because you buy its stock on margin. That makes margin a fairly investment-agnostic way to amplify returns without introducing additional risk (again, I'm ignoring the mechanical risks of margin calls and suboptimal taxation for the sake of the argument).
Additionally, I started challenging my thoughts on global market investing because as a 100% VTWAX investor, I too have been pretty disappointed with the past decade of ex-US returns. But in reading the research papers and articles, time and time again, I kept seeing statements and evidence suggesting that a global cap-weighted equity index returned better risk-adjusted returns over the long run than even an all-US portfolio.
Now, admittedly, I understand all this market stuff at a very basic layman's level, so I don't really understand what goes into calculating risk-adjusted returns, but conceptually, when I put those 2 concepts together in my mind, an epiphany struck me: leverage is for amplifying returns, and diversification is for reducing risk. They are 2 separate things, and they often get conflated. I think perhaps investors have gotten used to treating the US market as the benchmark for stocks over the past decade, but isn't it more precise to say that the overall market beta factor returns were lower than the recent US market returns would suggest, and an all-US portfolio has instead just been a lucky active bet with outsized performance but additional single-country risk? I mean, after all, it's not that hard to imagine scenarios in which an all-US portfolio would turn out terribly. I haven't compared the relative market performances of Italy and Germany in quite a while, but I'm guessing if I were to look now, Germany would have likely outperformed by a significant margin in recent months for reasons having everything to do with disruption due to the pandemic and very little to do with their relative economic prospects from a year ago. So focusing on the cumulative ex-US returns and how they compare to US markets could be missing the point entirely. The point is not to match US returns at all, just like the point of buying an S&P 500 fund is not to match Microsoft returns. If an active bet outperforms a total market index, more power to the people who made that active bet, but active bets are not without additional risk, so you can't compare them apples to apples.
If that's the case, then I think there are 2 cases to consider: 1) for people who are less than 100% allocated to stocks, they may want to consider switching to a global cap-weight portfolio but also increasing their allocation to stocks, because presumably, a bigger global position has a similar risk profile to a smaller all-US position, and 2) for people who are at 100% stocks, they may want to consider switching to a global portfolio and amplifying returns with margin or some other form of leverage. In other words, I think people with an all-US recency bias may be overestimating both returns and risks of stocks globally, and so they can actually afford to reduce risk by diversifying and then bring that risk back up to their risk tolerance by increasing stock allocation or using leverage beyond 100% stocks. The global position is inherently less risky than any bet on a single individual country, and it will always underperform the top individual countries' markets any given year, so a higher stake in globally diversified equities can yield similar returns with less risk. Again, it's kind of missing the point to say that US beat ex-US for the past decade, because if you're something like 50% stocks / 50% bonds, one could also say 75% global cap-weighted stocks / 25% bonds may have beat your portfolio in that same decade with similar levels of risk. You can't really just look at any top-performing market in isolation and call it an optimal investment going forward based on past performance. That goes back to the whole core philosophy of indexing in the first place, the same as it is within the US markets.