Why not allocate across ALL asset classes my market-cap?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Topic Author
lnp
Posts: 166
Joined: Tue Aug 17, 2021 2:33 am

Why not allocate across ALL asset classes my market-cap?

Post by lnp »

When investing in stocks it’s often said that anything that deviates from a market-cap total market fund is active management. If you don’t think you are the 1% that can do better than the market, it’s better to just follow the market.

Why can’t the same thing be said about the allocation to stocks/bonds/crypto/etc.?

Let’s imagine that only stocks and bonds exist. Since the bond market is 3x as large, wouldn’t it make sense to have 25% equity and 75% bonds?

Image

And if the crypto “market” is 20%, wouldn’t it then make sense to also invest 20% in crypto? (20% crypto, 60% bonds, 20% equity)

So why shouldn’t we allocate to all asset classes based on market-cap and then to get our desired risk/return we could either hold cash or apply leverage?
Valuethinker
Posts: 48944
Joined: Fri May 11, 2007 11:07 am

Re: Why not allocate across ALL asset classes my market-cap?

Post by Valuethinker »

larsnyborgpedersen wrote: Tue Oct 26, 2021 9:27 am When investing in stocks it’s often said that anything that deviates from a market-cap total market fund is active management. If you don’t think you are the 1% that can do better than the market, it’s better to just follow the market.

Why can’t the same thing be said about the allocation to stocks/bonds/crypto/etc.?

Let’s imagine that only stocks and bonds exist. Since the bond market is 3x as large, wouldn’t it make sense to have 25% equity and 75% bonds?

Image

And if the crypto “market” is 20%, wouldn’t it then make sense to also invest 20% in crypto? (20% crypto, 60% bonds, 20% equity)

So why shouldn’t we allocate to all asset classes based on market-cap and then to get our desired risk/return we could either hold cash or apply leverage?
William F Sharpe's Financial Engines portfolio does just that.

It is discussed here, if you do some thread searching.

We cannot discuss crypto here (Forum rules) but I am sure it is not in Sharpe's portfolio.
User avatar
vanbogle59
Posts: 1314
Joined: Wed Mar 10, 2021 7:30 pm

Re: Why not allocate across ALL asset classes my market-cap?

Post by vanbogle59 »

larsnyborgpedersen wrote: Tue Oct 26, 2021 9:27 am why shouldn’t we allocate to all asset classes based on market-cap
Many have answered this with: "That's exactly what I try to do"
I know of a number of practitioners who post on this board.

There are some disclaimers typically thrown in:
only invest in liquid, sufficiently transparent markets (so, not North Korean real estate)
only invest where low-cost vehicles have been created (so, not modern art)
Things like that.


At least one of the "asset classes" you list might fail a screen like: don't invest in Ponzi schemes.
Maybe??? :shock: :sharebeer
Big Dog
Posts: 4588
Joined: Mon Sep 07, 2015 4:12 pm

Re: Why not allocate across ALL asset classes my market-cap?

Post by Big Dog »

if you go that route, you might also consider an extra piece of real estate as some believe RE is under weighted in Total Market. (plenty of threads on RE if you search.)
User avatar
bertilak
Posts: 10711
Joined: Tue Aug 02, 2011 5:23 pm
Location: East of the Pecos, West of the Mississippi

Re: Why not allocate across ALL asset classes my market-cap?

Post by bertilak »

larsnyborgpedersen wrote: Tue Oct 26, 2021 9:27 am When investing in stocks it’s often said that anything that deviates from a market-cap total market fund is active management. If you don’t think you are the 1% that can do better than the market, it’s better to just follow the market.

Why can’t the same thing be said about the allocation to stocks/bonds/crypto/etc.?

Let’s imagine that only stocks and bonds exist. Since the bond market is 3x as large, wouldn’t it make sense to have 25% equity and 75% bonds?
I guess it all depends on how one defines "market."

I would say that stocks and bonds are not the same market. OK, they are close and have an effect on each other. They are interrelated, but I think the effect is more a matter of returns and risk in one market effecting how one allocates between markets.

Stocks, bonds, crypto, farm land, commodities, currencies, fine art, and others each have their own markets. A market's capitalization of its component assets says something about the efficient allocation within that market. The assumption is (with some logical and theoretical justification) that all the assets within a market are subject to similar forces and are (to varying degrees) fungible. This is less true for inter-market considerations.
May neither drought nor rain nor blizzard disturb the joy juice in your gizzard. -- Squire Omar Barker (aka S.O.B.), the Cowboy Poet
Tamalak
Posts: 1979
Joined: Fri May 06, 2016 2:29 pm

Re: Why not allocate across ALL asset classes my market-cap?

Post by Tamalak »

- Risk tolerance is different depending on the individual. If you're allocating by market-cap across all asset classes, then you're also 'averaging' the risk tolerance of all persons and entities in the world by their size.

- Not everything you listed is an investment. Currencies have an expected average zero return. Their purpose is not to make money, their purpose is to be money - it makes no sense to hold them unless you plan to use them for their purpose (to spend) in the short or medium term.

- Certain kinds of investments are better for large entities than for individuals. An example of this is negative yielding bonds. Large corporations sometimes have to invest in them to store wealth because they can't exactly open a billion dollar bank account. But small fish like us can always get a 0% bond in a savings account, so we should never invest in things that have a worse risk adjusted return than that.
User avatar
watchnerd
Posts: 13609
Joined: Sat Mar 03, 2007 10:18 am
Location: Gig Harbor, WA, USA

Re: Why not allocate across ALL asset classes my market-cap?

Post by watchnerd »

larsnyborgpedersen wrote: Tue Oct 26, 2021 9:27 am When investing in stocks it’s often said that anything that deviates from a market-cap total market fund is active management. If you don’t think you are the 1% that can do better than the market, it’s better to just follow the market.

Why can’t the same thing be said about the allocation to stocks/bonds/crypto/etc.?
I do this.

See signature.
Global stocks, IG/HY bonds, gold & digital assets at market weights 75% / 19% / 6% || LMP: TIPS ladder
Topic Author
lnp
Posts: 166
Joined: Tue Aug 17, 2021 2:33 am

Re: Why not allocate across ALL asset classes my market-cap?

Post by lnp »

Valuethinker wrote: Tue Oct 26, 2021 9:30 am
William F Sharpe's Financial Engines portfolio does just that.
Can't seem to find his exact proposed equity/bond ratio anywhere.
I found a video where he says he invests in stocks and bonds based on market-cap, but I didn't find anything where he says he chooses the allocation BETWEEN stocks and bonds based on how big the stock market and bond market is.
Topic Author
lnp
Posts: 166
Joined: Tue Aug 17, 2021 2:33 am

Re: Why not allocate across ALL asset classes my market-cap?

Post by lnp »

Big Dog wrote: Tue Oct 26, 2021 9:41 am if you go that route, you might also consider an extra piece of real estate as some believe RE is under weighted in Total Market. (plenty of threads on RE if you search.)
Why do they believe that?
Topic Author
lnp
Posts: 166
Joined: Tue Aug 17, 2021 2:33 am

Re: Why not allocate across ALL asset classes my market-cap?

Post by lnp »

bertilak wrote: Tue Oct 26, 2021 9:48 am Stocks, bonds, crypto, farm land, commodities, currencies, fine art, and others each have their own markets. A market's capitalization of its component assets says something about the efficient allocation within that market. The assumption is (with some logical and theoretical justification) that all the assets within a market are subject to similar forces and are (to varying degrees) fungible. This is less true for inter-market considerations.
Why is this less true for inter-market considerations?
luckyducky99
Posts: 415
Joined: Sun Dec 15, 2019 6:47 pm

Re: Why not allocate across ALL asset classes my market-cap?

Post by luckyducky99 »

larsnyborgpedersen wrote: Tue Oct 26, 2021 9:27 am So why shouldn’t we allocate to all asset classes based on market-cap and then to get our desired risk/return we could either hold cash or apply leverage?
Say you have 1M want to be 80/20. How do you leverage up a 25/75 portfolio to get the risk/return of an 80/20 portfolio? More crucially, why would you pay to borrow to do that when you could just hold the allocation you want?

There's nothing magic about the global ratio of existing bonds to stocks. The overall market is not an inherently meaningful analogue to any individual investor's situation.
Topic Author
lnp
Posts: 166
Joined: Tue Aug 17, 2021 2:33 am

Re: Why not allocate across ALL asset classes my market-cap?

Post by lnp »

Tamalak wrote: Tue Oct 26, 2021 9:55 am - Risk tolerance is different depending on the individual. If you're allocating by market-cap across all asset classes, then you're also 'averaging' the risk tolerance of all persons and entities in the world by their size.
But I could just make it match my risk tolerance by leveraging it up or holding cash.
Tamalak wrote: Tue Oct 26, 2021 9:55 am - Certain kinds of investments are better for large entities than for individuals. An example of this is negative yielding bonds. Large corporations sometimes have to invest in them to store wealth because they can't exactly open a billion dollar bank account. But small fish like us can always get a 0% bond in a savings account, so we should never invest in things that have a worse risk adjusted return than that.
This is a very good point!
Topic Author
lnp
Posts: 166
Joined: Tue Aug 17, 2021 2:33 am

Re: Why not allocate across ALL asset classes my market-cap?

Post by lnp »

watchnerd wrote: Tue Oct 26, 2021 10:03 am I do this.

See signature.

Signature:
60% Global Market Stocks (VT,FM) | 38% Global Market Bonds | 2% crypto & securitized gold || LMP TIPS/STRIPS || RSU + ESPP
How many percent do you invest in TIPS?
djm2001
Posts: 382
Joined: Fri May 29, 2020 6:23 am

Re: Why not allocate across ALL asset classes my market-cap?

Post by djm2001 »

larsnyborgpedersen wrote: Tue Oct 26, 2021 10:07 am
Valuethinker wrote: Tue Oct 26, 2021 9:30 am
William F Sharpe's Financial Engines portfolio does just that.
Can't seem to find his exact proposed equity/bond ratio anywhere.
I found a video where he says he invests in stocks and bonds based on market-cap, but I didn't find anything where he says he chooses the allocation BETWEEN stocks and bonds based on how big the stock market and bond market is.
See the Current Allocations section on the World Bond Stock Portfolio wiki page. This gives the current allocation of Sharpe's portfolio in real time. (I update the underlying factsheet snapshot numbers every month, and then the spreadsheet forward-projects the allocations using the ETF prices of VTI, VXUS, BND, BNDX.)

I have some posts in the Bill Sharpe's preferred portfolio thread that outline the methodology. You can trace these backward from here.
Last edited by djm2001 on Tue Oct 26, 2021 10:30 am, edited 1 time in total.
AA = global stocks & bonds @ market weight (~60/40); EF = i-bonds; WR = -PMT(1%, 100-age, 1, 0, 1)
User avatar
steve r
Posts: 1299
Joined: Mon Feb 13, 2012 7:34 pm
Location: Connecticut

Re: Why not allocate across ALL asset classes my market-cap?

Post by steve r »

watchnerd wrote: Tue Oct 26, 2021 10:03 am
larsnyborgpedersen wrote: Tue Oct 26, 2021 9:27 am When investing in stocks it’s often said that anything that deviates from a market-cap total market fund is active management. If you don’t think you are the 1% that can do better than the market, it’s better to just follow the market.

Why can’t the same thing be said about the allocation to stocks/bonds/crypto/etc.?
I do this.

See signature.
I think your portfolio is solid and understand crypto/gold based on this logic. That said, I do not follow how you bond allocation corresponds with to the market cap of bonds versus stocks. The OP claims 3X more market cap for bonds than stocks. Doing so would change your portfolio dramatically.

More generally, are people really 75 percent bonds and 25 percent stocks (+/- a little to add alt investments)
"Owning the stock market over the long term is a winner's game. Attempting to beat the market is a loser's game. ..Don't look for the needle in the haystack. Just buy the haystack." Jack Bogle
Maverick3320
Posts: 1102
Joined: Tue May 12, 2015 2:59 pm

Re: Why not allocate across ALL asset classes my market-cap?

Post by Maverick3320 »

larsnyborgpedersen wrote: Tue Oct 26, 2021 9:27 am When investing in stocks it’s often said that anything that deviates from a market-cap total market fund is active management. If you don’t think you are the 1% that can do better than the market, it’s better to just follow the market.

Why can’t the same thing be said about the allocation to stocks/bonds/crypto/etc.?

Let’s imagine that only stocks and bonds exist. Since the bond market is 3x as large, wouldn’t it make sense to have 25% equity and 75% bonds?

Image

And if the crypto “market” is 20%, wouldn’t it then make sense to also invest 20% in crypto? (20% crypto, 60% bonds, 20% equity)

So why shouldn’t we allocate to all asset classes based on market-cap and then to get our desired risk/return we could either hold cash or apply leverage?
By your logic, will you be investing in baseball cards? Art? Farmland? NFTs?
User avatar
watchnerd
Posts: 13609
Joined: Sat Mar 03, 2007 10:18 am
Location: Gig Harbor, WA, USA

Re: Why not allocate across ALL asset classes my market-cap?

Post by watchnerd »

steve r wrote: Tue Oct 26, 2021 10:29 am
watchnerd wrote: Tue Oct 26, 2021 10:03 am
larsnyborgpedersen wrote: Tue Oct 26, 2021 9:27 am When investing in stocks it’s often said that anything that deviates from a market-cap total market fund is active management. If you don’t think you are the 1% that can do better than the market, it’s better to just follow the market.

Why can’t the same thing be said about the allocation to stocks/bonds/crypto/etc.?
I do this.

See signature.
I think your portfolio is solid and understand crypto/gold based on this logic. That said, I do not follow how you bond allocation corresponds with to the market cap of bonds versus stocks. The OP claims 3X more market cap for bonds than stocks. Doing so would change your portfolio dramatically.

More generally, are people really 75 percent bonds and 25 percent stocks (+/- a little to add alt investments)
I agree with OP's concept, not his data.

See:

https://docs.google.com/spreadsheets/d/ ... g_/pubhtml#

Also suggest reading the Sharpe portfolio threads.
Global stocks, IG/HY bonds, gold & digital assets at market weights 75% / 19% / 6% || LMP: TIPS ladder
User avatar
bertilak
Posts: 10711
Joined: Tue Aug 02, 2011 5:23 pm
Location: East of the Pecos, West of the Mississippi

Re: Why not allocate across ALL asset classes my market-cap?

Post by bertilak »

larsnyborgpedersen wrote: Tue Oct 26, 2021 10:10 am
bertilak wrote: Tue Oct 26, 2021 9:48 am Stocks, bonds, crypto, farm land, commodities, currencies, fine art, and others each have their own markets. A market's capitalization of its component assets says something about the efficient allocation within that market. The assumption is (with some logical and theoretical justification) that all the assets within a market are subject to similar forces and are (to varying degrees) fungible. This is less true for inter-market considerations.
Why is this less true for inter-market considerations?
It is a matter of degree. That's why I said "less" true and not "untrue."

I do agree with you in one way: If you have enough money where liquidity is not an issue, it is probably OK, and maybe even a good idea, to put some of it into fine art or farm land. But it is not something that can be, for example, readily rebalanced to tune up your asset allocation, and "allocation" is a key word in the name of this topic.

Using fine art as an example ...

Market forces for fine arts are not the same as market forces for stocks so should not be expected to have similar behavior. Perhaps the biggest difference is that you can't look up the day's closing price for Picasso. Picasso is just not in that kind of market. Can I invest a given amount of money in Picasso?

Fine art is more like crypto than it is like stocks in one way: It's value is based on popularity, kind of like tulip bulbs.
May neither drought nor rain nor blizzard disturb the joy juice in your gizzard. -- Squire Omar Barker (aka S.O.B.), the Cowboy Poet
djm2001
Posts: 382
Joined: Fri May 29, 2020 6:23 am

Re: Why not allocate across ALL asset classes my market-cap?

Post by djm2001 »

steve r wrote: Tue Oct 26, 2021 10:29 am
watchnerd wrote: Tue Oct 26, 2021 10:03 am
larsnyborgpedersen wrote: Tue Oct 26, 2021 9:27 am When investing in stocks it’s often said that anything that deviates from a market-cap total market fund is active management. If you don’t think you are the 1% that can do better than the market, it’s better to just follow the market.

Why can’t the same thing be said about the allocation to stocks/bonds/crypto/etc.?
I do this.

See signature.
I think your portfolio is solid and understand crypto/gold based on this logic. That said, I do not follow how you bond allocation corresponds with to the market cap of bonds versus stocks. The OP claims 3X more market cap for bonds than stocks. Doing so would change your portfolio dramatically.

More generally, are people really 75 percent bonds and 25 percent stocks (+/- a little to add alt investments)
The numbers one commonly finds by doing a web search are typically from SIFMA data or something similar. There are some problems with using this data directly to construct an index fund portfolio:
  1. We should buy what we measure, and measure what we buy. For example, if I wanted to build a portfolio of oranges and potatoes, it would not be ideal to use the ratio of fruits to vegetables. I'd rather use the ratio of oranges to potatoes. The raw aggregate market caps of "bonds" and "equity" include things like private equity, private placement bonds, etc. which aren't part of what you can easily invest in using the usual index funds. Including private equity in my stock / bond ratio will screw up my allocation if I'm not actually investing in private equity since private equity has different characteristics (e.g., less competitively priced) than public equity.
  2. We should use free-float market caps rather than raw market caps. Free-float adjustment removes the portion of assets that aren't available to the "public" market. This removes restricted shares, Treasury bonds bought at auction by the Federal Reserve, etc., and thus eliminates a lot of distortion, leaving the resulting numbers much more applicable to the "average investor" than the raw numbers.
The more correct way of determining market caps is by looking up the factsheets for the (free-float) indexes that are tracked by the index funds that you intend to buy. That's what William Sharpe suggests in his free RISMAT book (see Chapter 7), and is the methodology I use for the WBS tracker spreadsheet linked in the WBS wiki page.
AA = global stocks & bonds @ market weight (~60/40); EF = i-bonds; WR = -PMT(1%, 100-age, 1, 0, 1)
djm2001
Posts: 382
Joined: Fri May 29, 2020 6:23 am

Re: Why not allocate across ALL asset classes my market-cap?

Post by djm2001 »

Valuethinker wrote: Tue Oct 26, 2021 9:30 am
larsnyborgpedersen wrote: Tue Oct 26, 2021 9:27 am When investing in stocks it’s often said that anything that deviates from a market-cap total market fund is active management. If you don’t think you are the 1% that can do better than the market, it’s better to just follow the market.

Why can’t the same thing be said about the allocation to stocks/bonds/crypto/etc.?

Let’s imagine that only stocks and bonds exist. Since the bond market is 3x as large, wouldn’t it make sense to have 25% equity and 75% bonds?

Image

And if the crypto “market” is 20%, wouldn’t it then make sense to also invest 20% in crypto? (20% crypto, 60% bonds, 20% equity)

So why shouldn’t we allocate to all asset classes based on market-cap and then to get our desired risk/return we could either hold cash or apply leverage?
William F Sharpe's Financial Engines portfolio does just that.

It is discussed here, if you do some thread searching.

We cannot discuss crypto here (Forum rules) but I am sure it is not in Sharpe's portfolio.
An extension to Sharpe's portfolio that includes free-float market-cap weight gold (and... that other thing you mentioned) is discussed here. There is also further discuss about free-float adjustment later in that thread.
AA = global stocks & bonds @ market weight (~60/40); EF = i-bonds; WR = -PMT(1%, 100-age, 1, 0, 1)
djm2001
Posts: 382
Joined: Fri May 29, 2020 6:23 am

Re: Why not allocate across ALL asset classes my market-cap?

Post by djm2001 »

larsnyborgpedersen wrote: Tue Oct 26, 2021 9:27 am When investing in stocks it’s often said that anything that deviates from a market-cap total market fund is active management. If you don’t think you are the 1% that can do better than the market, it’s better to just follow the market.

Why can’t the same thing be said about the allocation to stocks/bonds/crypto/etc.?
In theory, the same thing can indeed be said about all other publicly- and competitively-traded assets. But it's important to note that this gives the ideal portfolio for the average investor. If you know how you are different from average, then you can (and probably should) deviate from this central "market portfolio" in principled ways. E.g., hold fewer bonds to offset future salary earning if you are early in your career. That said, if know that you are average or if you don't know how you are different from average, the free-float market cap weighted portfolio is a sound default portfolio.

Here's a list of further resources (including recommendations by some Nobel laureates) on the topic of allocating stocks vs. bonds vs. etc. by market weight.
AA = global stocks & bonds @ market weight (~60/40); EF = i-bonds; WR = -PMT(1%, 100-age, 1, 0, 1)
tibbitts
Posts: 23588
Joined: Tue Feb 27, 2007 5:50 pm

Re: Why not allocate across ALL asset classes my market-cap?

Post by tibbitts »

larsnyborgpedersen wrote: Tue Oct 26, 2021 10:08 am
Big Dog wrote: Tue Oct 26, 2021 9:41 am if you go that route, you might also consider an extra piece of real estate as some believe RE is under weighted in Total Market. (plenty of threads on RE if you search.)
Why do they believe that?
Because of the amount of real estate held outside of public equity markets. Some on the other hand argue that public equity real estate ownership of, for businesses like, for example, Walmart (for store properties) isn't adequately accounted for.
User avatar
willthrill81
Posts: 32250
Joined: Thu Jan 26, 2017 2:17 pm
Location: USA
Contact:

Re: Why not allocate across ALL asset classes my market-cap?

Post by willthrill81 »

Why would I want the same allocation to assets as that of the entire globe? Does the entire globe have the same risk tolerance, investment goals, financial needs, time frame, etc., as I do?
The Sensible Steward
djm2001
Posts: 382
Joined: Fri May 29, 2020 6:23 am

Re: Why not allocate across ALL asset classes my market-cap?

Post by djm2001 »

larsnyborgpedersen wrote: Tue Oct 26, 2021 10:23 am
watchnerd wrote: Tue Oct 26, 2021 10:03 am I do this.

See signature.

Signature:
60% Global Market Stocks (VT,FM) | 38% Global Market Bonds | 2% crypto & securitized gold || LMP TIPS/STRIPS || RSU + ESPP
How many percent do you invest in TIPS?

I believe watchnerd might be using TIPS solely for liability matching (they mentioned building non-rolling ladder of individual TIPS) and perhaps does not also include it as part of their market portfolio. Thus a percentage allocation is not appropriate in that case.

Within the market portfolio, you might be surprised to find that the market weight of TIPS is very small -- only about 1% of a market-weighted stock-and-bond portfolio (e.g., VT + BNDW + TIP). Here's an unsubstantiated guess as to why.

TIPS are a little tricky to allocate because they can be used for liability matching to offset future real (i.e., inflation-adjusted) liabilities, while at the same time they are also part of the market portfolio. To resolve this conundrum, it's best to think of your TIPS allocation as being in two buckets:
  • the first bucket of TIPS is a broad TIPS index fund at free-float market cap weight and is part of your main market portfolio. Recall that the market portfolio is ideal for the average investor and is used to fund the average investor's consumption stream.
  • the second bucket consists of individual TIPS bought specifically to duration-match your personal liabilities that are in excess of the average investor's consumption stream.
The idea is that the second bucket of TIPS neutralizes your non-average consumption, thus transforming you into the average investor... for which the market portfolio (which contains the first bucket of TIPS) is ideal.

Note that I-bonds are even better than TIPS for real liability matching, but you're limited to buying at most $10k per year.

This is also covered in the Sharpe thread here.
AA = global stocks & bonds @ market weight (~60/40); EF = i-bonds; WR = -PMT(1%, 100-age, 1, 0, 1)
bs010101
Posts: 303
Joined: Thu Feb 13, 2014 11:08 am

Re: Why not allocate across ALL asset classes my market-cap?

Post by bs010101 »

Why stop there? The global real estate market is $326B, way more than stocks and bonds combined. You can probably try and figure out how much all the commodities in the world are worth as well. But I don't think these things are comparable across asset classes, so I don't think there is a reason to allocate proportionally.
afan
Posts: 8169
Joined: Sun Jul 25, 2010 4:01 pm

Re: Why not allocate across ALL asset classes my market-cap?

Post by afan »

If you ignore the higher moments of risk, then theory says that the expected mean variance return of the market is optimal. The theory also assumes you can borrow at ghe risk free rate. Since individuals cannot do this, we have go adjust our variance by changing weights, rather than by borrowing.

Since at least Roll's critique, everyone has recognized that the "market" includes all investable assets. The you get into which things available for sale qualify? Do you need to invest in commodities? How about derivatives based on stocks and bonds? Huge amounts of money are bet in T bond futures and foreign exchange. Should those count separately as part of the market? Or are they just different ways of investing in bonds?

Theory also assumes informationaly efficient open liquid markets. True of stocks and widely traded bonds. Not true of many private investments, real estate, art, collectibles... Where do they fit in?

One could at least try to build a portfolio of world stocks and bonds, ignore the rest, and leverage to get to the desired volatility. But it might be difficult to get a broker to lend you enough money and you could be wiped out by margin calls in a down market.

Consequently, many people accept that they cannot practically do a total market portfolio. Instead they adjust the stock/bond ratio, maybe add in real estate, and hope that is close enough.

The answers are not trivial. As others have noted, there has been a lot of work in this area but no answers that resolve the questions and are readily implemented by individuals.

The global real estate market is way more than $326B. There are medium sized cities worth more than that.
Last edited by afan on Tue Oct 26, 2021 1:59 pm, edited 1 time in total.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama
Topic Author
lnp
Posts: 166
Joined: Tue Aug 17, 2021 2:33 am

Re: Why not allocate across ALL asset classes my market-cap?

Post by lnp »

djm2001 wrote: Tue Oct 26, 2021 10:29 am See the Current Allocations section on the World Bond Stock Portfolio wiki page. This gives the current allocation of Sharpe's portfolio in real time.
Thanks!

Funny that it's 62.4/37.6 equity/bond ratio, which is VERY close to the classic 60/40 equity/bond portfolio!

Is this where the idea from the 60/40 portfolio came from?
skierincolorado
Posts: 2377
Joined: Sat Mar 21, 2020 10:56 am

Re: Why not allocate across ALL asset classes my market-cap?

Post by skierincolorado »

This is what I do and there are a number of threads devoted to versions of this. Leverage up or down to desired risk. Crypto is not an investment so it is excluded, although crypto companies could be. Also crypto market cap is equal to Tesla market cap so cap weighted it would be trivial.
User avatar
Tyler9000
Posts: 739
Joined: Fri Aug 21, 2015 11:57 am

Re: Why not allocate across ALL asset classes my market-cap?

Post by Tyler9000 »

larsnyborgpedersen wrote: Tue Oct 26, 2021 9:27 am So why shouldn’t we allocate to all asset classes based on market-cap
If you like this idea, check out the Global Market Portfolio. It tracks the total investable global market in just a few index funds. You can also read the underlying academic research for a lot more detail on the exact historical asset breakdowns.
User avatar
nisiprius
Advisory Board
Posts: 52105
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Why not allocate across ALL asset classes my market-cap?

Post by nisiprius »

A couple of points.

First of all, there's an (imperfect, idealized, oversimplified) mathematical result in financial economics that leads to the result that a cap-weighted portfolio has the optimum risk-adjusted return. However, it only applies to a single market and participants trading frictionlessly within that market. Stocks and bonds don't both trade together within a single market. And there isn't any actual "global stock market," only a collection of about two dozen important national stocks markets. Therefore the arguments for cap-weighting within a single market do not apply to global stocks or to stocks + bonds or to stocks + bonds + rare postage stamps. It might or might not matter a lot. Technically I believe there are actually thirteen US stock markets, but the electronic paths between them are pretty frictionless. Can the same thing be said of "the" US bond market? Of the US stock and bond markets combined?

Second, yeah, there IS quite a lot of evidence that the optimum risk-adjusted return is obtained in portfolios that are much more bond-heavy than 60/40. One way to look at risk parity portfolios is that they increase the amount of bonds relative to stocks to get closer to that optimum, but that has the side-effect of creating a portfolio that does not have "enough" risk or return to satisfy their taste, so the whole things is then levered up to restore the return.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
User avatar
watchnerd
Posts: 13609
Joined: Sat Mar 03, 2007 10:18 am
Location: Gig Harbor, WA, USA

Re: Why not allocate across ALL asset classes my market-cap?

Post by watchnerd »

djm2001 wrote: Tue Oct 26, 2021 11:46 am
I believe watchnerd might be using TIPS solely for liability matching (they mentioned building non-rolling ladder of individual TIPS) and perhaps does not also include it as part of their market portfolio. Thus a percentage allocation is not appropriate in that case.
Correct, I use a non-rolling ladder of TIPS as part of my LMP.

I don't bother normalizing it vs global bonds because it's a) very small at global market weight b) the TIPS ladder is not part of the risk portfolio, anyway.
Global stocks, IG/HY bonds, gold & digital assets at market weights 75% / 19% / 6% || LMP: TIPS ladder
User avatar
watchnerd
Posts: 13609
Joined: Sat Mar 03, 2007 10:18 am
Location: Gig Harbor, WA, USA

Re: Why not allocate across ALL asset classes my market-cap?

Post by watchnerd »

larsnyborgpedersen wrote: Tue Oct 26, 2021 12:11 pm [

Funny that it's 62.4/37.6 equity/bond ratio, which is VERY close to the classic 60/40 equity/bond portfolio!

Is this where the idea from the 60/40 portfolio came from?
From what I've read of the history of the 60/40 allocation, it's just coincidence and may not have been true at the time 60/40 was popularized.
Global stocks, IG/HY bonds, gold & digital assets at market weights 75% / 19% / 6% || LMP: TIPS ladder
Topic Author
lnp
Posts: 166
Joined: Tue Aug 17, 2021 2:33 am

Re: Why not allocate across ALL asset classes my market-cap?

Post by lnp »

willthrill81 wrote: Tue Oct 26, 2021 11:22 am Why would I want the same allocation to assets as that of the entire globe? Does the entire globe have the same risk tolerance, investment goals, financial needs, time frame, etc., as I do?
The portfolio could be adjusted to your risk tolerance, investment goals, financial needs, time frame and so on by either holding cash or leveraging up :)

But I think the same thing could be said about investing in stocks by market cap!
Some stocks are more inherently more volatile (for example "small-cap value") while others are less volatile, and investing in them by market-cap is also like investing in them by market-cap.

If investing in stocks by market-cap makes sense, why doesn't it make sense to invest across assets by market cap?
User avatar
watchnerd
Posts: 13609
Joined: Sat Mar 03, 2007 10:18 am
Location: Gig Harbor, WA, USA

Re: Why not allocate across ALL asset classes my market-cap?

Post by watchnerd »

larsnyborgpedersen wrote: Tue Oct 26, 2021 10:23 am
watchnerd wrote: Tue Oct 26, 2021 10:03 am I do this.

See signature.

Signature:
60% Global Market Stocks (VT,FM) | 38% Global Market Bonds | 2% crypto & securitized gold || LMP TIPS/STRIPS || RSU + ESPP
How many percent do you invest in TIPS?
My non-rolling TIPS ladder is part of my Liability Matching Portfolio (LMP in the sig), and not part of my Risk Portfolio.

My Risk Portfolio is a minor tweak of the Sharpe / Global Stock + Bond port.
Global stocks, IG/HY bonds, gold & digital assets at market weights 75% / 19% / 6% || LMP: TIPS ladder
Topic Author
lnp
Posts: 166
Joined: Tue Aug 17, 2021 2:33 am

Re: Why not allocate across ALL asset classes my market-cap?

Post by lnp »

afan wrote: Tue Oct 26, 2021 12:08 pm If you ignore the higher moments of risk, then theory says that the expected mean variance return of the market is optimal.
Which theory says this?
Topic Author
lnp
Posts: 166
Joined: Tue Aug 17, 2021 2:33 am

Re: Why not allocate across ALL asset classes my market-cap?

Post by lnp »

nisiprius wrote: Tue Oct 26, 2021 12:18 pm Stocks and bonds don't both trade together within a single market.
What do you mean? Me and many other people can choose whether we invest in stocks or bonds at our broker.
nisiprius wrote: Tue Oct 26, 2021 12:18 pm Second, yeah, there IS quite a lot of evidence that the optimum risk-adjusted return is obtained in portfolios that are much more bond-heavy than 60/40. One way to look at risk parity portfolios is that they increase the amount of bonds relative to stocks to get closer to that optimum, but that has the side-effect of creating a portfolio that does not have "enough" risk or return to satisfy their taste, so the whole things is then levered up to restore the return.
I'm also very interested in the risk-parity approach. The only thing I'm afraid of, is that the cost of the leverage will bring down the expected return too much.

Can you point to some of the best evidence that risk-parity provides the optimum risk-adjusted return?
djm2001
Posts: 382
Joined: Fri May 29, 2020 6:23 am

Re: Why not allocate across ALL asset classes my market-cap?

Post by djm2001 »

larsnyborgpedersen wrote: Tue Oct 26, 2021 12:11 pm
djm2001 wrote: Tue Oct 26, 2021 10:29 am See the Current Allocations section on the World Bond Stock Portfolio wiki page. This gives the current allocation of Sharpe's portfolio in real time.
Thanks!

Funny that it's 62.4/37.6 equity/bond ratio, which is VERY close to the classic 60/40 equity/bond portfolio!

Is this where the idea from the 60/40 portfolio came from?
I wondered the same. Though I'd love to believe that this is where the 60/40 advice originated, I have some doubts given that "60 / 40" is most often thrown around in the US-only portfolio context... where the ratio is not 60/40.

Sharpe's portfolio has been at roughly 60/40 for several months, but it did dip below 55/45 during the first few months of COVID -- not a wholly unreasonable response to the high uncertainty. Watching the allocations remain pretty sensible over time even during that crisis has really strengthened my confidence in using Sharpe's portfolio as my default portfolio -- it's the "anchor" portfolio from which I then make a couple of adjustments for personal circumstance (e.g., overweighting muni bonds based on tax rate and state).
AA = global stocks & bonds @ market weight (~60/40); EF = i-bonds; WR = -PMT(1%, 100-age, 1, 0, 1)
Northern Flicker
Posts: 15288
Joined: Fri Apr 10, 2015 12:29 am

Re: Why not allocate across ALL asset classes my market-cap?

Post by Northern Flicker »

Bill Sharpe has argued that the global market cap of publicly available securities is the optimal portfolio. I believe his argument is based on balancing supply and demand and price equilibrium for assets.

You can read about his position in Chapter 7 here:

https://web.stanford.edu/~wfsharpe/RISMAT/

I agree with him that this is the most effecient way to implement most (though not all) asset classes, but I do not consider market cap weighting of asset classes in asset allocation to be optimal for me.
Last edited by Northern Flicker on Tue Oct 26, 2021 1:00 pm, edited 1 time in total.
User avatar
willthrill81
Posts: 32250
Joined: Thu Jan 26, 2017 2:17 pm
Location: USA
Contact:

Re: Why not allocate across ALL asset classes my market-cap?

Post by willthrill81 »

larsnyborgpedersen wrote: Tue Oct 26, 2021 12:30 pm
willthrill81 wrote: Tue Oct 26, 2021 11:22 am Why would I want the same allocation to assets as that of the entire globe? Does the entire globe have the same risk tolerance, investment goals, financial needs, time frame, etc., as I do?
The portfolio could be adjusted to your risk tolerance, investment goals, financial needs, time frame and so on by either holding cash or leveraging up :)
But leverage comes with higher expenses. It's less costly to just increase or decrease one's stock exposure.
The Sensible Steward
MarkRoulo
Posts: 1192
Joined: Mon Jun 22, 2015 10:25 am

Re: Why not allocate across ALL asset classes my market-cap?

Post by MarkRoulo »

larsnyborgpedersen wrote: Tue Oct 26, 2021 12:39 pm
afan wrote: Tue Oct 26, 2021 12:08 pm If you ignore the higher moments of risk, then theory says that the expected mean variance return of the market is optimal.
Which theory says this?
I believe CAPM (Capital Asset Pricing Model).

You can start there and also here: https://en.wikipedia.org/wiki/Capital_market_line

Note that these make assumptions that can be sorta/mostly true for large banks
and hedge funds, but will not be true for individual investors (specifically, you
probably can't borrow at the 'risk free' rate).
djm2001
Posts: 382
Joined: Fri May 29, 2020 6:23 am

Re: Why not allocate across ALL asset classes my market-cap?

Post by djm2001 »

MarkRoulo wrote: Tue Oct 26, 2021 12:58 pm
larsnyborgpedersen wrote: Tue Oct 26, 2021 12:39 pm
afan wrote: Tue Oct 26, 2021 12:08 pm If you ignore the higher moments of risk, then theory says that the expected mean variance return of the market is optimal.
Which theory says this?
I believe CAPM (Capital Asset Pricing Model).

You can start there and also here: https://en.wikipedia.org/wiki/Capital_market_line

Note that these make assumptions that can be sorta/mostly true for large banks
and hedge funds, but will not be true for individual investors (specifically, you
probably can't borrow at the 'risk free' rate).
I am not an expert, but I believe that CAPM is not necessary to show that the market portfolio is efficient. We just need the basic Modern Portfolio Theory (MPT) framework + Tobin's Separation Theorem + an argument that if everyone were rational, then the market portfolio must be on the efficient frontier (if it weren't, then a rational investor would be incentivized to make a trade to get it back on the efficient frontier). Julian Boralli has a fairly accessible explanation of all of this. John Cochrane has a paper called Portfolio Advice for a Multi-factor World that describes how this (i.e., that the market portfolio is efficient) is true even beyond the simplistic mean-variance model.
AA = global stocks & bonds @ market weight (~60/40); EF = i-bonds; WR = -PMT(1%, 100-age, 1, 0, 1)
User avatar
watchnerd
Posts: 13609
Joined: Sat Mar 03, 2007 10:18 am
Location: Gig Harbor, WA, USA

Re: Why not allocate across ALL asset classes my market-cap?

Post by watchnerd »

willthrill81 wrote: Tue Oct 26, 2021 12:57 pm

But leverage comes with higher expenses. It's less costly to just increase or decrease one's stock exposure.
The philosophical / academic / purist critique is that any tilt away from the market port is an "active" investing decision.

How much one actually cares about that niggle is probably just a matter of subjective preference.

Pragmatism regarding one's financial goals should probably take priority over dogma for most people.
Global stocks, IG/HY bonds, gold & digital assets at market weights 75% / 19% / 6% || LMP: TIPS ladder
aristotelian
Posts: 12262
Joined: Wed Jan 11, 2017 7:05 pm

Re: Why not allocate across ALL asset classes my market-cap?

Post by aristotelian »

IMO allocation is about managing market risk and inflation risk versus expected return. That is one of the fundamental choices in investing and it varies from situation to situation. As a late accumulation investor, my exposure to market risk and inflation risk is completely different from a new investor early in accumulation, a retiree with a short timeframe, or an institutional investor with an infinite timeframe.

Weighting is a technique to eliminate behavioral risk of choosing within a particular asset class. I don't see behavioral risk as a particular problem when making an asset allocation decision. Moreover, I don't see why my exposure to market risk or inflation risk should be the same as the market. I have particular goals and risks that do not have to be the same as the aggregate of all market participants.
Last edited by aristotelian on Tue Oct 26, 2021 1:28 pm, edited 1 time in total.
hoofaman
Posts: 958
Joined: Tue Jul 14, 2020 3:39 pm

Re: Why not allocate across ALL asset classes my market-cap?

Post by hoofaman »

Such a portfolio would be 99.99% real estate
Northern Flicker
Posts: 15288
Joined: Fri Apr 10, 2015 12:29 am

Re: Why not allocate across ALL asset classes my market-cap?

Post by Northern Flicker »

I have alot of sympathy with the notion of holding everything at cap weight, but I have some issues with the strategy.

1. It may create a mis-alignment with an individual's consumption need. I believe that my personal inflation risk is mitigated significantly by holding equities of companies whose production is reasonably well aligned with my consumption. I of course don't know what that optimal mix is, but I'm pretty sure that residential real estate in Tokyo is not a part of it.

2. Just because there is an efficient market for bonds of some country doesn't mean I must participate in that market. I in fact only can if there are fund products for doing so. Moreover, hedged international bonds and international bonds have different performance characteristics. They cannot both be optimal implementations of the asset class.

3. I believe that some asset classes have inefficiencies that may be exploited by active management. Real estate is the classic example. But there are examples among traded securities. For instance, there is fair evidence that active managers of GNMA portfolios have a track record of beating the GNMA index if costs are low. The iShares GNMA index ETF has only been around 8 or 9 years, so this is not alot of data (and the evidence goes back further but I don't have access to data), but the Vanguard GNMA fund has consisistently outperformed it:

https://www.portfoliovisualizer.com/bac ... ion2_2=100

So I don't consider it as a given that every asset class is best implemented by market cap weighting, though I believe that most are.
Northern Flicker
Posts: 15288
Joined: Fri Apr 10, 2015 12:29 am

Re: Why not allocate across ALL asset classes my market-cap?

Post by Northern Flicker »

larsnyborgpedersen wrote: Tue Oct 26, 2021 12:47 pm
nisiprius wrote: Tue Oct 26, 2021 12:18 pm Stocks and bonds don't both trade together within a single market.
What do you mean? Me and many other people can choose whether we invest in stocks or bonds at our broker.
nisiprius wrote: Tue Oct 26, 2021 12:18 pm Second, yeah, there IS quite a lot of evidence that the optimum risk-adjusted return is obtained in portfolios that are much more bond-heavy than 60/40. One way to look at risk parity portfolios is that they increase the amount of bonds relative to stocks to get closer to that optimum, but that has the side-effect of creating a portfolio that does not have "enough" risk or return to satisfy their taste, so the whole things is then levered up to restore the return.
I'm also very interested in the risk-parity approach. The only thing I'm afraid of, is that the cost of the leverage will bring down the expected return too much.

Can you point to some of the best evidence that risk-parity provides the optimum risk-adjusted return?
Doubtful that such evidence exists because risk parity portfolios most likely are not the optimal portfolio based on expected risk-adjusted returns. (Actual risk-adjusted returns are realized in the future and are unknown in the present).

The following authors argue that a risk-parity portfolio is the optimal portfolio among those you reasonably can construct or hold. I am not familiar with the mathematical result that the authors of the first article reference.

http://gersteinfisher.com/wp-content/up ... Parity.pdf

Here is a more detailed article:

https://jayscholar.etown.edu/busstu/21/

I believe that a 2-asset-class risk parity portfolio optimizes the diversification ratio metric for the portfolio, but this does not generalize to portfolios with more than two asset classes.
Last edited by Northern Flicker on Tue Oct 26, 2021 2:32 pm, edited 1 time in total.
secondopinion
Posts: 6008
Joined: Wed Dec 02, 2020 12:18 pm

Re: Why not allocate across ALL asset classes my market-cap?

Post by secondopinion »

larsnyborgpedersen wrote: Tue Oct 26, 2021 9:27 am When investing in stocks it’s often said that anything that deviates from a market-cap total market fund is active management. If you don’t think you are the 1% that can do better than the market, it’s better to just follow the market.

Why can’t the same thing be said about the allocation to stocks/bonds/crypto/etc.?
There may be merit in market capping it all, but is this optimal for a person seeking retirement and not much more? The objectives met by the all market cap portfolio are drastically different than the average person; I do not think many investors of any kind do or should hold the market cap on everything. Remember, we are dealing with other investors than individual investors. For all intent and purpose, one should be investing market cap according to the average of those investors with similar circumstances to avoid trying to outwit the division (because supposedly their portion of market activity is optimal [otherwise, they would adjust in theory]).

Strange notion, but average money does not equal every investor.
Passive investing: not about making big bucks but making profits. Active investing: not about beating the market but meeting goals. Speculation: not about timing the market but taking profitable risks.
User avatar
watchnerd
Posts: 13609
Joined: Sat Mar 03, 2007 10:18 am
Location: Gig Harbor, WA, USA

Re: Why not allocate across ALL asset classes my market-cap?

Post by watchnerd »

larsnyborgpedersen wrote: Tue Oct 26, 2021 9:27 am
And if the crypto “market” is 20%, wouldn’t it then make sense to also invest 20% in crypto? (20% crypto, 60% bonds, 20% equity)
FWIW, the crypto market is only $2.6-2.7T right now, so it's low single digital percentages vs stocks/bonds.
Global stocks, IG/HY bonds, gold & digital assets at market weights 75% / 19% / 6% || LMP: TIPS ladder
secondopinion
Posts: 6008
Joined: Wed Dec 02, 2020 12:18 pm

Re: Why not allocate across ALL asset classes my market-cap?

Post by secondopinion »

bs010101 wrote: Tue Oct 26, 2021 11:55 am Why stop there? The global real estate market is $326B, way more than stocks and bonds combined. You can probably try and figure out how much all the commodities in the world are worth as well. But I don't think these things are comparable across asset classes, so I don't think there is a reason to allocate proportionally.
Commodities are consumable and some are perishable; I imagine one cannot market cap avocados and get anything meaningful.

Nor can we really take derivatives as a meaningful asset either.

Essentially, asset expiration is dangerous and we really have to exclude such assets. But I guess one could use derivatives to synthesize holding such assets. But that opens another problem itself to manage it.
Passive investing: not about making big bucks but making profits. Active investing: not about beating the market but meeting goals. Speculation: not about timing the market but taking profitable risks.
User avatar
watchnerd
Posts: 13609
Joined: Sat Mar 03, 2007 10:18 am
Location: Gig Harbor, WA, USA

Re: Why not allocate across ALL asset classes my market-cap?

Post by watchnerd »

secondopinion wrote: Tue Oct 26, 2021 3:15 pm
bs010101 wrote: Tue Oct 26, 2021 11:55 am Why stop there? The global real estate market is $326B, way more than stocks and bonds combined. You can probably try and figure out how much all the commodities in the world are worth as well. But I don't think these things are comparable across asset classes, so I don't think there is a reason to allocate proportionally.
Commodities are consumable and some are perishable; I imagine one cannot market cap avocados and get anything meaningful.

Nor can we really take derivatives as a meaningful asset either.

Essentially, asset expiration is dangerous and we really have to exclude such assets. But I guess one could use derivatives to synthesize holding such assets. But that opens another problem itself to manage it.
If people want to get into the thinking behind the port, Sharpe lays out in the RISMAT series why he picks securitized assets and where he draws the boundaries.

https://web.stanford.edu/~wfsharpe/RISMAT/RISMAT-7.pdf
Global stocks, IG/HY bonds, gold & digital assets at market weights 75% / 19% / 6% || LMP: TIPS ladder
Post Reply