Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

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simplesauce
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Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by simplesauce » Tue May 19, 2020 7:42 am

I am hoping Bogleheads can help explain this topic to me, as I find it confusing. Dr. Burton Malkiel wrote the below statement in one of his books. He discusses that the Total World Index only has about a 2 percent China weighting, however this is a major flaw according to him. He says:

Most indexes are “float” weighted. If some of a company’s shares are not traded freely, they are not counted in the company’s weight in the index. Float weighting means China gets underweighted for two reasons. First, none of the shares traded in the local Chinese stock markets in Shanghai and Shenzhen get counted, because these shares are available only to Chinese citizens (with minor exceptions.) Only the freely tradable shares of Chinese companies listed in Hong Kong or New York are counted in the index.

A second reason China gets underweighted is that the Chinese government owns a huge portion of the shares of many companies, and those shares are not counted in the float. As a result, China gets only about 2 percent of the weight in the world indexes, whereas, adjusted for purchasing power parity, China’s GDP is about 13 percent of the world’s GDP and is growing rapidly.

Hence, I believe that investors need to put more China into their portfolios than is available in general world or emerging market index funds. I am, however, true to my indexing beliefs and think the best way to do it is to buy a broad based index fund of Chinese companies
.” A Random Walk Down Wall Street

Has anyone considered adding a China ETF to their portfolios based on this flaw presented by Dr. Malkiel? Or is it just not as necessary as he makes it out to be?

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by TwoIdenticalIndexes » Tue May 19, 2020 7:52 am

1. Sounds like the same problem that causes the Middle East to essentially not exist in world market caps. It vexes me.
2. I looked into it, but the funds all have absurd ERs, because "China." I decided not to and ex-post justified it to myself on the basis that China's fraud and taxes gave it lower expected returns for me than other options. If it weren't for recent Chinese under-performance I probably would have decided differently, tbh.

The only remotely reasonable expense ratio I found was with FLCH.
Last edited by TwoIdenticalIndexes on Tue May 19, 2020 12:11 pm, edited 1 time in total.

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by JoMoney » Tue May 19, 2020 7:56 am

I saw him use the word "hence" , but none of the stuff before that explains why or for what purpose it would be good to hold more China. If anything, the fact that those shares aren't available to non-US persons would be a reason NOT to, and the correlation between a countries GDP growth and stock market growth isn't very strong.
Further, there are unique risks when investing internationally, maybe especially in China for a U.S. person, especially in the current time period with threats of trade issues and potentially retaliatory financial and embargo issues.
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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by nisiprius » Tue May 19, 2020 8:22 am

Burton Malkiel was a director of the Vanguard Group for 28 years, but left Vanguard in 2005China is what it is, but I do not give recommendations about China any extra weight just because they come from Burton Malkiel. He's been a China permabull since 2007, when he published From Wall Street to the Great Wall: How Investors Can Profit from China's Booming Economy.

Image

The title of his famous book, A Random Walk Down Wall Street, in my opinion is to be interpreted as a play on words; that is, it is an eclectic collection of his thoughts on investing. When first published in 1973, Fama's ideas about the efficient market, random walks, and the idea of indexing were stunning. This was the book that introduced these ideas to many people, and they made more of an impression than his chapter on how to pick stocks.

I used to treat A Random Walk Down Wall Street as a sacred text. My faith was shaken in 2008-2009.

He was, and I think still is, a vigorous proponent of REITs, recommending REITs as 10% of portfolio for young investors and 15% for retirees. Around 2007 that led me to buy a small amount of the Vanguard REIT Index Fund, VGSIX, with the idea of slowly ramping it up to 10% through automated monthly purchases. At the time I couldn't figure out why Vanguard's LifeStrategy and Target Retirement funds didn't match Malkiel's recommended allocations. Malkiel is not responsible for my actions, but I did lose confidence in his specific recommendations in 2008-2009.

Whether he is right or wrong, many of his recent views no longer align with my own.

In 2010 he and Charles Ellis published a book for beginners called The Element of Investing, which advocated something like the standard Bogleheads/Taylor Larimore three-fund portfolio. They said it was a "timeless" approach. Then n 2013, the book was revised to suggest replacing Total Bond with a "bond surrogate" allocation of one-half dividend stocks and one-half emerging markets bonds. I have a problem with a "timeless" approach with a shelf life of only three years.

He became Chief Investment Officer at Wealthfront, where he started by creating fairly Bogleheadish portfolios of low-cost index ETFs. Then Wealthfront suddenly decided to commit 20% of their clients' portfolios to a new Wealthfront risk parity mutual fund, and it bothered me that Burton Malkiel appears to be endorsing that approach, since I can't remember his ever saying anything about about risk parity in A Random Walk Down Wall Street. (I don't have the most recent edition--does he say anything about it there?)

He also did a near-reversal on "smart beta." For years he had big sections in the book expressing strong skepticism about the size and value factors, and at one point a scathing attack specifically on "smart beta." In 2014 he attacked it in an article in the Journal of Portfolio Management entitled "Is Smart Beta Really Smart?" But he then endorsed Wealthfront's version of it in 2017, in An Optimal Approach to Smart Beta.

Advocates of investing in emerging markets constantly point to the difference in global weighting between emerging market stocks and emerging market economies. Usually, the reader is encouraged to draw an inference that our portfolio ought to match the economy rather than the market, yet this is rarely stated in so many words, much less supported. In fact it is almost proverbial that booming economy does not automatically mean good stock investment. To put it another way, booming economy does not imply undervalued stock.
Last edited by nisiprius on Tue May 19, 2020 8:48 am, edited 6 times in total.
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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by Anon9001 » Tue May 19, 2020 8:37 am

I would be very careful of putting money into a country that both political parties in your country (am assuming USA) dislike. They could suddenly restrict inflows to that country and your investments will become a sunk cost. It is is not impossible. The rhetoric as a outsider is becoming like Soviet days.

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by SimpleGift » Tue May 19, 2020 8:44 am

simplesauce wrote:
Tue May 19, 2020 7:42 am
Has anyone considered adding a China ETF to their portfolios based on this flaw presented by Dr. Malkiel?
Anyone who has been a passive investor in an emerging markets index fund in recent years (using either MSCI or FTSE indexes) has been automatically adding an increased China exposure to their portfolios, as these indexes gradually reconstitute to include more mainland China A-shares in their makeup (chart below).
China is currently over 40% of Vanguard's Emerging Markets Stock Index — and with the addition of more mainland A-shares in the years to come, it will one day soon be over 50% of the index. For many investors, that's more than enough China exposure, depending on their portfolio allocation to an emerging markets index.

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by jhsu802701 » Tue May 19, 2020 9:07 am

I think it would be better to just invest more heavily in emerging markets in general, which I am very bullish on due to undervaluation. My favorite emerging markets funds are WisdomTree Emerging Markets Quality Dividend Growth Fund (DGRE) and WisdomTree Emerging Markets SmallCap Dividend Fund (DGS).

I've considered single-country China funds but didn't find any that I liked. While the price/book ratios were low, all of the China-specific funds had one or more deal-breaking flaws:
1. Not enough diversification: A common issue with single-country funds (other than US-only and Japan-only funds) is having too much of the portfolio in a single stock. Unless the fund specializes in high-quality stocks (like dividend growth or economic moats), I insist that the largest position in the fund be no more than 2% of the portfolio.
2. Too small: The smaller the ETF, the greater the risk that it will close. $50 million of assets under management is considered to be the cutoff. Funds bigger than this almost never close. Funds that fall substantially short of this threshold are at high risk of closing. While an ETF that closes isn't a disaster, it is a forced liquidation (and taxable event). I'd rather liquidate on MY terms.

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by Slowtraveler » Tue May 19, 2020 9:17 am

Way too much accounting risk. The majority of the gdp is fraudulent. The government resorts to building imminently collapsing empty ghost towns where mostly squatters live so investors have some feeling of growth. There are no independent audits. I wouldn't touch with a 10 foot pole.

If you want China buy an emerging markets fund. I want developed markets with less corruption. I still don't get why Taiwan and South Korea are called emerging markets. They are highly developed but aside from those 2 countries, I prefer not to have any countries labelled as emerging markets.

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by Anon9001 » Tue May 19, 2020 9:31 am

It does make sense to look at the numbers before making assumptions.:http://pages.stern.nyu.edu/~adamodar/Ne ... yprem.html

The ERP for it is 7.30% compared to 6.01% for USA. The country risk premium is 1.29% for it compared to 0% for USA.

The risks for investing in China is over-exeggerated but they are still high relative to the tiny ERP they offer. The big problem with the Chinese stock market is the amount of State Owned companies there. They are the real losers in terms of performance.
Last edited by Anon9001 on Tue May 19, 2020 10:59 am, edited 2 times in total.

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by Ferdinand2014 » Tue May 19, 2020 9:41 am

simplesauce wrote:
Tue May 19, 2020 7:42 am
I am hoping Bogleheads can help explain this topic to me, as I find it confusing. Dr. Burton Malkiel wrote the below statement in one of his books. He discusses that the Total World Index only has about a 2 percent China weighting, however this is a major flaw according to him. He says:

Most indexes are “float” weighted. If some of a company’s shares are not traded freely, they are not counted in the company’s weight in the index. Float weighting means China gets underweighted for two reasons. First, none of the shares traded in the local Chinese stock markets in Shanghai and Shenzhen get counted, because these shares are available only to Chinese citizens (with minor exceptions.) Only the freely tradable shares of Chinese companies listed in Hong Kong or New York are counted in the index.

A second reason China gets underweighted is that the Chinese government owns a huge portion of the shares of many companies, and those shares are not counted in the float. As a result, China gets only about 2 percent of the weight in the world indexes, whereas, adjusted for purchasing power parity, China’s GDP is about 13 percent of the world’s GDP and is growing rapidly.

Hence, I believe that investors need to put more China into their portfolios than is available in general world or emerging market index funds. I am, however, true to my indexing beliefs and think the best way to do it is to buy a broad based index fund of Chinese companies
.” A Random Walk Down Wall Street

Has anyone considered adding a China ETF to their portfolios based on this flaw presented by Dr. Malkiel? Or is it just not as necessary as he makes it out to be?
I have not considered adding a China ETF to my portfolio. I would never consider this advice with my hard earned money.
“You only find out who is swimming naked when the tide goes out.“ — Warren Buffett

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by Slowtraveler » Tue May 19, 2020 9:41 am

If you've never been there, you can change that. Go see for yourself, I'm serious. It'll teach you a lot. I've been there. Life outside the major cities is extremely different than inside. Also, all companies are legally required to partner with the party.

Research for yourself.

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by abuss368 » Tue May 19, 2020 10:00 am

With respect to Dr. Malkiel, his recommendations and advice appear to have changed and evolved over the years.
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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by apex84 » Tue May 19, 2020 10:11 am

I don't know the details, but when the Japanese stock market had a very large market cap, it dominated stock indices due to a lack of correction for free-float at that time. Index methodology was changed to account for non-tradable shares. I don't think that best practices for index construction have changed.

The current index that Vanguard uses for their emerging markets fund is the "FTSE Emerging Markets All Cap China A Inclusion Index". I leave it to Vanguard to figure out what the best index methodology is. I don't think China is underrepresented in their funds.

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by reln » Tue May 19, 2020 10:11 am

simplesauce wrote:
Tue May 19, 2020 7:42 am
I am hoping Bogleheads can help explain this topic to me, as I find it confusing. Dr. Burton Malkiel wrote the below statement in one of his books. He discusses that the Total World Index only has about a 2 percent China weighting, however this is a major flaw according to him. He says:

Most indexes are “float” weighted. If some of a company’s shares are not traded freely, they are not counted in the company’s weight in the index. Float weighting means China gets underweighted for two reasons. First, none of the shares traded in the local Chinese stock markets in Shanghai and Shenzhen get counted, because these shares are available only to Chinese citizens (with minor exceptions.) Only the freely tradable shares of Chinese companies listed in Hong Kong or New York are counted in the index.

A second reason China gets underweighted is that the Chinese government owns a huge portion of the shares of many companies, and those shares are not counted in the float. As a result, China gets only about 2 percent of the weight in the world indexes, whereas, adjusted for purchasing power parity, China’s GDP is about 13 percent of the world’s GDP and is growing rapidly.

Hence, I believe that investors need to put more China into their portfolios than is available in general world or emerging market index funds. I am, however, true to my indexing beliefs and think the best way to do it is to buy a broad based index fund of Chinese companies
.” A Random Walk Down Wall Street

Has anyone considered adding a China ETF to their portfolios based on this flaw presented by Dr. Malkiel? Or is it just not as necessary as he makes it out to be?
I wouldn't add a China fund for simplicity sake. But I agree with him that the float is not a complete representation of the asset universe.

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by HEDGEFUNDIE » Tue May 19, 2020 10:18 am

An 80/20 stock portfolio with the 20 in China has offered significant diversification benefit over the long run, better than putting the 20 in Total Intl.

Image

https://www.portfoliovisualizer.com/bac ... tion3_2=20


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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by Svensk Anga » Tue May 19, 2020 10:31 am

Anon9001 wrote:
Tue May 19, 2020 9:31 am
It does make sense to look at the numbers before assuming our opinions on a given country we have never been set foot in is correct.:http://pages.stern.nyu.edu/~adamodar/Ne ... yprem.html

The ERP for it is 7.30% compared to 6.01% for USA. The country risk premium is 1.29% for it compared to 0% for USA.

The risks for investing in China is over-exeggerated. The real problem with the Chinese stock market is the amount of State Owned companies there. They are the real losers in terms of performance.
Scanning the list of ERP’s in the reference site, China’s looks relatively modest. If you are going to take emerging market risk, it seems you want to take it where the potential premium is higher. I’ll not be overweighting China.

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by Anon9001 » Tue May 19, 2020 10:34 am

Svensk Anga wrote:
Tue May 19, 2020 10:31 am
Anon9001 wrote:
Tue May 19, 2020 9:31 am
It does make sense to look at the numbers before assuming our opinions on a given country we have never been set foot in is correct.:http://pages.stern.nyu.edu/~adamodar/Ne ... yprem.html

The ERP for it is 7.30% compared to 6.01% for USA. The country risk premium is 1.29% for it compared to 0% for USA.

The risks for investing in China is over-exeggerated. The real problem with the Chinese stock market is the amount of State Owned companies there. They are the real losers in terms of performance.
Scanning the list of ERP’s in the reference site, China’s looks relatively modest. If you are going to take emerging market risk, it seems you want to take it where the potential premium is higher. I’ll not be overweighting China.
Correct the returns are too low for EM. EM bonds are much better if you are investing in EM for diversification. The correlation is very low compared to EM stocks.

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by tadamsmar » Tue May 19, 2020 10:37 am

nisiprius wrote:
Tue May 19, 2020 8:22 am
Burton Malkiel was a director of the Vanguard Group for 28 years, but left Vanguard in 2005China is what it is, but I do not give recommendations about China any extra weight just because they come from Burton Malkiel. He's been a China permabull since 2007, when he published From Wall Street to the Great Wall: How Investors Can Profit from China's Booming Economy.
Bullish since 1999, when he published Global Bargain Hunting. He was big on TDF (Templeton Dragon Fund), but I skimmed a book by the manager of TDF whi was pretty frank about how the government sometimes tampered with publicly traded companies so I did not bite.

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by Fclevz » Tue May 19, 2020 10:37 am

simplesauce wrote:
Tue May 19, 2020 7:42 am
China’s GDP is about 13 percent of the world’s GDP and is growing rapidly.
I've never seen an index fund that weights by GDP.

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by Anon9001 » Tue May 19, 2020 10:55 am

I am fairly confused that Malkiel keeps recommending China yet ignores India. The ERP for India is much higher than China while being safer politically. You also have much lower amount of state owned companies in India's index compared to China's.

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by tea_pirate » Tue May 19, 2020 12:44 pm

abuss368 wrote:
Tue May 19, 2020 10:00 am
With respect to Dr. Malkiel, his recommendations and advice appear to have changed and evolved over the years.
In your current or former profession, do you not change beliefs or best practices based on new information, research, or career experience?

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by nisiprius » Tue May 19, 2020 1:05 pm

tea_pirate wrote:
Tue May 19, 2020 12:44 pm
abuss368 wrote:
Tue May 19, 2020 10:00 am
With respect to Dr. Malkiel, his recommendations and advice appear to have changed and evolved over the years.
In your current or former profession, do you not change beliefs or best practices based on new information, research, or career experience?
This is one of the big questions. It is not obvious that staying the course is the best strategy, or even a good strategy. Most people start out by believing it must obviously be better to keep reviewing and changing their portfolio.

There are no absolutes.

However, I feel that it is dishonest to recommend a strategy on the basis of long-term studies that tell you what would have happened if you had stayed the course for three or four decades, if you yourself are going to recommend strategy changes every few years.

John C. Bogle was reasonably consistent, and I would like to quote his words:
Pillar 2. When All Else Fails, Fall Back on Simplicity.

There are an infinite number of strategies worse than this one: Commit, over a period of a few years, half of your assets to a stock index fund and half to a bond index fund. Ignore interim fluctuations in their net asset values. Hold your positions for as long as you live, subject only to infrequent and marginal adjustments as your circumstances change. When there are multiple solutions to a problem, choose the simplest one.
Notice that there is nothing in this about "new information" or "research." Changes are to be "infrequent," "marginal," and based on your circumstances, not what you think it new information you have about the market.
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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by HomerJ » Tue May 19, 2020 1:25 pm

tea_pirate wrote:
Tue May 19, 2020 12:44 pm
abuss368 wrote:
Tue May 19, 2020 10:00 am
With respect to Dr. Malkiel, his recommendations and advice appear to have changed and evolved over the years.
In your current or former profession, do you not change beliefs or best practices based on new information, research, or career experience?
In his case, however, it sure looks like he's changed his beliefs depending on who is paying him.
A Goldman Sachs associate provided a variety of detailed explanations, but then offered a caveat, “If I’m being dead-### honest, though, nobody knows what’s really going on.”

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by abuss368 » Tue May 19, 2020 1:48 pm

tea_pirate wrote:
Tue May 19, 2020 12:44 pm
abuss368 wrote:
Tue May 19, 2020 10:00 am
With respect to Dr. Malkiel, his recommendations and advice appear to have changed and evolved over the years.
In your current or former profession, do you not change beliefs or best practices based on new information, research, or career experience?
Fair and reasonable. Feels like he has changed his mind a lot in a few years.
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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by michoco911 » Tue May 19, 2020 1:50 pm

It is not 2%
VWRD has 4.6% china exposure. That should be enough i guess.
30% VWRD 30% VUSD 40% AGGG until further notice

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by palanzo » Tue May 19, 2020 1:57 pm

Just buy individual stocks like Luckin Coffee. What could possibly go wrong. :oops:

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by theorist » Tue May 19, 2020 2:00 pm

jhsu802701 wrote:
Tue May 19, 2020 9:07 am
I think it would be better to just invest more heavily in emerging markets in general, which I am very bullish on due to undervaluation. My favorite emerging markets funds are WisdomTree Emerging Markets Quality Dividend Growth Fund (DGRE) and WisdomTree Emerging Markets SmallCap Dividend Fund (DGS).

I've considered single-country China funds but didn't find any that I liked. While the price/book ratios were low, all of the China-specific funds had one or more deal-breaking flaws:
1. Not enough diversification: A common issue with single-country funds (other than US-only and Japan-only funds) is having too much of the portfolio in a single stock. Unless the fund specializes in high-quality stocks (like dividend growth or economic moats), I insist that the largest position in the fund be no more than 2% of the portfolio.
2. Too small: The smaller the ETF, the greater the risk that it will close. $50 million of assets under management is considered to be the cutoff. Funds bigger than this almost never close. Funds that fall substantially short of this threshold are at high risk of closing. While an ETF that closes isn't a disaster, it is a forced liquidation (and taxable event). I'd rather liquidate on MY terms.
I’m just using VEMAX, the emerging markets index. Do you think index investing is particularly bad for emerging markets? Is there evidence to this effect?

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by William Million » Tue May 19, 2020 2:24 pm

VWO, Vanguard's emerging market ETF, holds so much China that it seems to be the easiest way to buy in. Mainland China is 42% and Taiwan another 16%. Expense ratio .1%.

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by SethJane42 » Tue May 19, 2020 2:35 pm

Deleted--I was wrong
Last edited by SethJane42 on Mon Jun 08, 2020 6:51 am, edited 1 time in total.

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by jhsu802701 » Tue May 19, 2020 2:38 pm

theorist wrote:
Tue May 19, 2020 2:00 pm
jhsu802701 wrote:
Tue May 19, 2020 9:07 am
I think it would be better to just invest more heavily in emerging markets in general, which I am very bullish on due to undervaluation. My favorite emerging markets funds are WisdomTree Emerging Markets Quality Dividend Growth Fund (DGRE) and WisdomTree Emerging Markets SmallCap Dividend Fund (DGS).

I've considered single-country China funds but didn't find any that I liked. While the price/book ratios were low, all of the China-specific funds had one or more deal-breaking flaws:
1. Not enough diversification: A common issue with single-country funds (other than US-only and Japan-only funds) is having too much of the portfolio in a single stock. Unless the fund specializes in high-quality stocks (like dividend growth or economic moats), I insist that the largest position in the fund be no more than 2% of the portfolio.
2. Too small: The smaller the ETF, the greater the risk that it will close. $50 million of assets under management is considered to be the cutoff. Funds bigger than this almost never close. Funds that fall substantially short of this threshold are at high risk of closing. While an ETF that closes isn't a disaster, it is a forced liquidation (and taxable event). I'd rather liquidate on MY terms.
I’m just using VEMAX, the emerging markets index. Do you think index investing is particularly bad for emerging markets? Is there evidence to this effect?
I'm not particularly for or against index investing. I judge ETFs by valuations.

My reasons for preferring DGRE and DGS over VEMAX are these:
1. VEMAX sells for 1.7 times book value, which makes it slightly more expensive than DGRE and substantially more expensive than DGS. Keep in mind that DGRE specializes in dividend growth stocks, the kind that justify higher multiples. VEMAX doesn't.
2. VEMAX has less diversification. The biggest position is 6.8% of the portfolio, compared to 4.7% for DGRE and 1.0% for DGS.

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by Bill Bernstein » Tue May 19, 2020 2:41 pm

The reason to avoid China's equity markets can be summarized in one word: dilution.

The best estimates are that the Chinese equity markets dilute their share pools on the order of about 20% per year, so even if the country is growing its GDP and corporate profits at slightly less than 10% pa, they can't keep up on a per-share basis.

This is borne out by the MSCI China index, which since 12/31/92 has had a total return of 1.6% in nominal dollar terms, or less than zero in real terms.

The problem, of course, is that if you're indexing Emerging Markets, there's no way to avoid the country's ~30% weighting in most indexes.

Bill

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by bryansmile » Tue May 19, 2020 2:42 pm

palanzo wrote:
Tue May 19, 2020 1:57 pm
Just buy individual stocks like Luckin Coffee. What could possibly go wrong. :oops:
Or Enron... oh wait, it never happens in the US.

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by HEDGEFUNDIE » Tue May 19, 2020 2:52 pm

Bill Bernstein wrote:
Tue May 19, 2020 2:41 pm
The reason to avoid China's equity markets can be summarized in one word: dilution.

The best estimates are that the Chinese equity markets dilute their share pools on the order of about 20% per year, so even if the country is growing its GDP and corporate profits at slightly less than 10% pa, they can't keep up on a per-share basis.

This is borne out by the MSCI China index, which since 12/31/92 has had a total return of 1.6% in nominal dollar terms, or less than zero in real terms.

The problem, of course, is that if you're indexing Emerging Markets, there's no way to avoid the country's ~30% weighting in most indexes.

Bill
With a low enough correlation, even an asset class that returns zero can improve the performance of a US-heavy portfolio.

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by Angst » Tue May 19, 2020 2:58 pm

Bill Bernstein wrote:
Tue May 19, 2020 2:41 pm
The reason to avoid China's equity markets can be summarized in one word: dilution.

The best estimates are that the Chinese equity markets dilute their share pools on the order of about 20% per year, so even if the country is growing its GDP and corporate profits at slightly less than 10% pa, they can't keep up on a per-share basis.

This is borne out by the MSCI China index, which since 12/31/92 has had a total return of 1.6% in nominal dollar terms, or less than zero in real terms.

The problem, of course, is that if you're indexing Emerging Markets, there's no way to avoid the country's ~30% weighting in most indexes.

Bill
Is this one of the things that keeps a country in the "Emerging Markets" category, regardless of the size of its economy?

I gather that generally speaking, the quality of a country's financial regulation and the transparency of it's companies bookkeeping are important criteria for this categorizing.

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by SimpleGift » Tue May 19, 2020 3:02 pm

The 21st century is almost certain to involve a "great power struggle" between the U.S. and China, a conflict that is already well under way. It's easy to make the case that we are transitioning toward an "Asian Century" — if economic growth rates, population dynamics, and share of world consumption are any guide to the future.

But transitions are always complicated, from the ancient struggles between Athens and Sparta to the world wars of the 20th century. The last great power transition, when global leadership shifted from the United Kingdom to the United States, stands out as an unusually peaceful one — mainly because it unfolded gradually over a century and both countries shared a political heritage and common liberal democratic values.

In the years ahead, criticisms of Asia and, in particular, China, will likely continue to grow in the western world, and it can almost be expected that a scenario of constant conflicts becomes the new normal for a while. What this will mean for the investments of U.S. companies in China, and for U.S. investors in emerging markets index funds, I don't have an easy answer. However, we continue to hold our modest overweight to emerging market stocks.

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by nisiprius » Tue May 19, 2020 3:23 pm

HEDGEFUNDIE wrote:
Tue May 19, 2020 2:52 pm
Bill Bernstein wrote:
Tue May 19, 2020 2:41 pm
The reason to avoid China's equity markets can be summarized in one word: dilution.

The best estimates are that the Chinese equity markets dilute their share pools on the order of about 20% per year, so even if the country is growing its GDP and corporate profits at slightly less than 10% pa, they can't keep up on a per-share basis.

This is borne out by the MSCI China index, which since 12/31/92 has had a total return of 1.6% in nominal dollar terms, or less than zero in real terms.

The problem, of course, is that if you're indexing Emerging Markets, there's no way to avoid the country's ~30% weighting in most indexes.

Bill
With a low enough correlation, even an asset class that returns zero can improve the performance of a US-heavy portfolio.
Just to be clear, if an asset class returns less than the riskless return, in order to improve a portfolio the correlation doesn't just need to be "low enough," it needs to be less than zero; it needs to actually be negative. "Negative" can be interpreted as "low enough," of course.

If I type MCHI (iShares MSCI China ETF) and VTI (Vanguard [US] Total Stock Market Index ETF) into PortfolioVisualizer's correlation tool and accept all defaults, it tells me that over [Apr 2011 - Apr 2020] the correlation has been 0.65. That isn't anywhere close to negative correlation, and can't improve a portfolio unless it actually makes money.
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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by LadyGeek » Tue May 19, 2020 4:04 pm

I removed a post and several replies discussing moral arguments for not investing in China (political policy / politics / morality). As a reminder, see: Non-actionable (Trolling) Topics
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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by SteadyOne » Tue May 19, 2020 4:12 pm

SimpleGift wrote:
Tue May 19, 2020 8:44 am
simplesauce wrote:
Tue May 19, 2020 7:42 am
Has anyone considered adding a China ETF to their portfolios based on this flaw presented by Dr. Malkiel?
Anyone who has been a passive investor in an emerging markets index fund in recent years (using either MSCI or FTSE indexes) has been automatically adding an increased China exposure to their portfolios, as these indexes gradually reconstitute to include more mainland China A-shares in their makeup (chart below).
China is currently over 40% of Vanguard's Emerging Markets Stock Index — and with the addition of more mainland A-shares in the years to come, it will one day soon be over 50% of the index. For many investors, that's more than enough China exposure, depending on their portfolio allocation to an emerging markets index.
Why China even is classified as ‘Emerging’ it is presumably second economy in the world? Something is shady about all this.
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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by SimpleGift » Tue May 19, 2020 4:13 pm

HomerJ wrote:
Tue May 19, 2020 3:35 pm
Population dynamics doesn't favor China that much... Their one-child policy means they have a ton of older people compared to the younger generations, and they don't get a lot of immigrants.

Of course, we are currently pushing away immigrants ourselves, so unless that changes, who knows how it will turn out.
Good points. However the argument for an "Asian Century" does include India as well, which will very soon overtake China as the world's most populous country (chart below).
Beyond the sheer size of these Asian populations, they are experiencing an increase in wealth (GDP per capita) that is already driving the large majority of the world's GDP growth today, and will continue to drive global GDP growth in the decades to come.

Which companies will best be able to take advantage of this economic growth in the decades ahead — e.g., local emerging market companies, Japanese or European multinationals, or U.S. firms — is an open question, and a good reason to have at least some portfolio exposure to global stocks, in my view, especially for young investors.

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by HEDGEFUNDIE » Tue May 19, 2020 5:30 pm

nisiprius wrote:
Tue May 19, 2020 3:23 pm
HEDGEFUNDIE wrote:
Tue May 19, 2020 2:52 pm
Bill Bernstein wrote:
Tue May 19, 2020 2:41 pm
The reason to avoid China's equity markets can be summarized in one word: dilution.

The best estimates are that the Chinese equity markets dilute their share pools on the order of about 20% per year, so even if the country is growing its GDP and corporate profits at slightly less than 10% pa, they can't keep up on a per-share basis.

This is borne out by the MSCI China index, which since 12/31/92 has had a total return of 1.6% in nominal dollar terms, or less than zero in real terms.

The problem, of course, is that if you're indexing Emerging Markets, there's no way to avoid the country's ~30% weighting in most indexes.

Bill
With a low enough correlation, even an asset class that returns zero can improve the performance of a US-heavy portfolio.
Just to be clear, if an asset class returns less than the riskless return, in order to improve a portfolio the correlation doesn't just need to be "low enough," it needs to be less than zero; it needs to actually be negative. "Negative" can be interpreted as "low enough," of course.

If I type MCHI (iShares MSCI China ETF) and VTI (Vanguard [US] Total Stock Market Index ETF) into PortfolioVisualizer's correlation tool and accept all defaults, it tells me that over [Apr 2011 - Apr 2020] the correlation has been 0.65. That isn't anywhere close to negative correlation, and can't improve a portfolio unless it actually makes money.
Good thing it has made money then.

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by SimpleGift » Tue May 19, 2020 6:23 pm

SteadyOne wrote:
Tue May 19, 2020 4:12 pm
Why China even is classified as ‘Emerging’ it is presumably second economy in the world? Something is shady about all this.
The definition of a developed country vs. an emerging country is no doubt arbitrary, and different criteria are used by MSCI, FTSE, the World Bank and the IMF — but there isn't necessarily anything shady about one definition or the other.

A common factor in most definitions is GDP-per-capita. Developed countries have GDP-per-capita in the $40,000-$60,000 range today, while emerging markets have GDP-per-capita in the $8,000-$12,000 range (chart below, log scale).
  • Image
    Note: Vertical axis is log scale. Source: OWID
So a country like China can have the second largest economy in the world, but still be classified as developing, since the per-capita wealth of its average citizen is relatively low — though growing rapidly, compared to developed nations.

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by Random Musings » Tue May 19, 2020 6:44 pm

......
Last edited by Random Musings on Tue May 19, 2020 8:38 pm, edited 1 time in total.
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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by SteadyOne » Tue May 19, 2020 7:16 pm

simplesauce wrote:
Tue May 19, 2020 7:42 am
I am hoping Bogleheads can help explain this topic to me, as I find it confusing. Dr. Burton Malkiel wrote the below statement in one of his books. He discusses that the Total World Index only has about a 2 percent China weighting, however this is a major flaw according to him. He says:

Most indexes are “float” weighted. If some of a company’s shares are not traded freely, they are not counted in the company’s weight in the index. Float weighting means China gets underweighted for two reasons. First, none of the shares traded in the local Chinese stock markets in Shanghai and Shenzhen get counted, because these shares are available only to Chinese citizens (with minor exceptions.) Only the freely tradable shares of Chinese companies listed in Hong Kong or New York are counted in the index.

A second reason China gets underweighted is that the Chinese government owns a huge portion of the shares of many companies, and those shares are not counted in the float. As a result, China gets only about 2 percent of the weight in the world indexes, whereas, adjusted for purchasing power parity, China’s GDP is about 13 percent of the world’s GDP and is growing rapidly.

Hence, I believe that investors need to put more China into their portfolios than is available in general world or emerging market index funds. I am, however, true to my indexing beliefs and think the best way to do it is to buy a broad based index fund of Chinese companies
.” A Random Walk Down Wall Street

Has anyone considered adding a China ETF to their portfolios based on this flaw presented by Dr. Malkiel? Or is it just not as necessary as he makes it out to be?
“Chinese government owns a huge portion of the shares of many companies, and those shares are not counted in the float”

So, basically those companies are state enterprises and not necessarily act in the interests of private shareholders. This is my point—these companies’ shares are NOT the same things conceptually and legally as US companies shares. That’s why those valuations are low
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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by garlandwhizzer » Tue May 19, 2020 7:21 pm

HomerJ wrote:

In his case, however, it sure looks like he's changed his beliefs depending on who is paying him.
This is a common practice in the financial industry/literature.

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by Angst » Tue May 19, 2020 7:22 pm

SteadyOne wrote:
Tue May 19, 2020 4:12 pm
Why China even is classified as ‘Emerging’ it is presumably second economy in the world? Something is shady about all this.
Yes indeed, but I think it's you that's in the shade here. 8-) With minimal effort online one can shed some light on the issue by looking for the criteria that the likes of FTSE and MSCI use to break out Frontier, Emerging and Developed markets. There's nothing "shady" going on. Although, one might say that Developed markets are characterized by a lot of sunlight while Emerging markets are partly cloudy, and then those frontier markets... well, they're definitely a bit "shady".

https://www.msci.com/documents/1296102/1330218/MSCI_Market_Classification_Framework.pdf

https://research.ftserussell.com/products/downloads/FTSE_Equity_Country_Classification_Paper.pdf

[EDIT] Here's an excellent FTSE pdf graphic specifically addressing some of the work China has ahead of itself before it has any chance of being considered a Developed market: https://research.ftserussell.com/products/downloads/Asia-Pacific_latest.pdf You'll want to zoom in on some of those red boxes. China has a long way to go.
Last edited by Angst on Tue May 19, 2020 7:49 pm, edited 2 times in total.

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by typical.investor » Tue May 19, 2020 7:33 pm

SteadyOne wrote:
Tue May 19, 2020 4:12 pm

Why China even is classified as ‘Emerging’ it is presumably second economy in the world? Something is shady about all this.
Do you think size negates things like capital controls and legal frameworks? If so, why?

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by garlandwhizzer » Tue May 19, 2020 8:24 pm

Bill Bernstein wrote:

The reason to avoid China's equity markets can be summarized in one word: dilution.

The best estimates are that the Chinese equity markets dilute their share pools on the order of about 20% per year, so even if the country is growing its GDP and corporate profits at slightly less than 10% pa, they can't keep up on a per-share basis.

This is borne out by the MSCI China index, which since 12/31/92 has had a total return of 1.6% in nominal dollar terms, or less than zero in real terms.

The problem, of course, is that if you're indexing Emerging Markets, there's no way to avoid the country's ~30% weighting in most indexes.

Bill
Great point, by the insightful Dr. Bernstein. That goes a long way toward explaining why China and EM in general have hugely lagged US markets in the last decade and a half or so in spite of their rapid growth and cheap valuations. If we look at Vanguard ETFs for emerging versus developed markets versus US over the last 12 years, VWO (EM) and VEA (ex-US DM) performed about the same over those 12 years 4 months 1/2008 thru 4/2020, essentially zero nominal CAGR for VWO and VEA, no growth in the portfolio, both negative real. Over the same period VTI (US) had a 7.9% CAGR and 10K investment in VTI would be worth about 2.5 times as much May 1 as either of the other two.These results are from Portfolio Visualizer.

https://www.portfoliovisualizer.com/bac ... ion3_3=100

Share dilution may explain why EMs growing so much quicker performed so poorly. But why did INTL DM which have property rights, rule of law, less corruption, presumably well regulated financial markets, and without that share dilutions perform so poorly? Was it just fortuitous dates for the US that will soon reverse? Is it because of different government/economic policy and structure--more socialism, less free market capitalism in DMs? Was it due to Japanification of Europe, both victims of negative demographics, cultural differences, and excessive debt more so than the US although we may be heading that way ourselves? Is this likely reversible or is it likely to persist into the future? I know there is no certainty on this question but am interested in others opinions. Does Dr. Bernstein or anyone else have insight into this question that might be actionable to portfolio allocations going forward?

Ultimately I believe in value. Cheap should beat expensive long term. EM and DM have had better valuations throughout this 12 year period, hence they in theory should outperform at some point if value is still a valid strategy. I've held a basically a 50 US/25 EM/25 DM portfolio for many years, more than 12, but I am getting tired of losing money because of the theoretical payoff in return and diversification at some indefinite point that may or may not show up in the future. Personally looking at the world now, I do not see DM or EM skyrocketing ahead of the US anytime in the foreseeable future. I'm still holding on to my INTL but I have started wondering if Bogle and Buffett were right about 80%+ US.

Comments?

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by SteadyOne » Tue May 19, 2020 8:26 pm

HEDGEFUNDIE wrote:
Tue May 19, 2020 2:52 pm
Bill Bernstein wrote:
Tue May 19, 2020 2:41 pm
The reason to avoid China's equity markets can be summarized in one word: dilution.

The best estimates are that the Chinese equity markets dilute their share pools on the order of about 20% per year, so even if the country is growing its GDP and corporate profits at slightly less than 10% pa, they can't keep up on a per-share basis.

This is borne out by the MSCI China index, which since 12/31/92 has had a total return of 1.6% in nominal dollar terms, or less than zero in real terms.

The problem, of course, is that if you're indexing Emerging Markets, there's no way to avoid the country's ~30% weighting in most indexes.

Bill
With a low enough correlation, even an asset class that returns zero can improve the performance of a US-heavy portfolio.
So 1+0=2 ?
“Every de­duc­tion is al­lowed as a mat­ter of leg­isla­tive grace.” US Federal Court

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Re: Dr. Malkiel: “I believe that investors need to put more China into their portfolios“

Post by SteadyOne » Tue May 19, 2020 8:31 pm

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