Zweig: Picking the Right Countries (Start at Market Weights)

[iceport]

In his latest WSJ article, Jason Zweig makes the case (however briefly) for using the market weighting of stock styles for your US equity allocation, and the world market weightings of countries for your total equity allocation among world regions. He specifically mentions the MSCI All Country World index as a window on the global equity market allocation by country.

If you were investing from scratch in the U.S. market, how would you parcel out your money among different kinds of stocks? The logical starting point: Ask how other investors have already allocated their money. Small stocks make up less than 10% of the U.S. market, midsized stocks 20% and large stocks at least 70%. And the market is split just about evenly between rapidly expanding "growth" stocks and cheaper "value" companies. You would deviate from those levels only if you had strong evidence that most other investors had missed something.

You should follow the same principle when you spread your investment dollars across the globe, says Frank Nielsen, a director of index research at MSCI Barra. The weights within MSCI's All Country World index approximate how all the world's investors already have placed their bets: 42% in the U.S., 45% in developed foreign markets, 13% in emerging markets.

Take those numbers as your base line. If you keep more than that in the U.S. and less in developed foreign markets, your bets are skewed. What insights do you possess into the global economy that hundreds of millions of other investors have somehow overlooked?

[Emphases added.]

Placing Your Investing Chips in the Right Countries


As an adherent, in general, to the use of market weightings as a starting point for portfolio allocations, these direct challenges resonate with me. They also got me curious.

Does anyone have easy access to the MSCI ACWI market weight breakdown by country?

Also, does anyone have access to the global market breakdown by asset class? (Why stop at just stock styles or world regions?)

Thanks,
--Pete

[Robert T]

.
Vanguard Total World Stock ETF gives a reasonable breakdown: https://personal.vanguard.com/us/funds/ ... IntExt=INT

IMO personal circumstance also matters in global allocation decisions. http://www.stanford.edu/~wfsharpe/art/t ... esting.htm

The global market portfolio might be a good choice for a truly international investor, who lives in hotels and on airlines, pays taxes everywhere, consumes goods from all over the world, is of average age and risk tolerance, and so on. Of course this is not likely to describe anyone in this room. But the global market portfolio is a good place for you to start, tilting each of your investment positions in a direction that makes sense, based on the differences between your characteristics and those of this fictional global investor.

Robert
.

[Lucio]

In his latest WSJ article, Jason Zweig makes the case (however briefly) for using the market weighting of stock styles for your US equity allocation, and the world market weightings of countries for your total equity allocation among world regions. He specifically mentions the MSCI All Country World index as a window on the global equity market allocation by country.

To me, this smacks of recency bias. Only in the last thirty years or so has it become reasonably safe to let your precious capital venture beyond your native place. This applies just as well to the UK and France as it does to markets considered more risky nowadays. Remember the nationalizations undertaken in the UK in the 70s, much less in France (the Rothschilds' experience with Francois Mitterrand comes to mind).

Lucio

[alec]

In his latest WSJ article, Jason Zweig makes the case (however briefly) for using the market weighting of stock styles for your US equity allocation, and the world market weightings of countries for your total equity allocation among world regions. He specifically mentions the MSCI All Country World index as a window on the global equity market allocation by country.

To me, this smacks of recency bias. Only in the last thirty years or so has it become reasonably safe to let your precious capital venture beyond your native place. This applies just as well to the UK and France as it does to markets considered more risky nowadays. Remember the nationalizations undertaken in the UK in the 70s, much less in France (the Rothschilds' experience with Francois Mitterrand comes to mind).

Lucio

Meh, IMO, not really that much safer. Remember the S&L nationalizations in the US in the 1980s, or Swedish banks in the 1990s, or for that matter nationalizations of banking institutions when banking crises hit lots of countries in the last 30 years.

I think the lesson is not let put any capital that is precious into risky investments like stocks anywhere.

[bb]

William Bernstein's latest book does not advocate an allocation that
mirrors a world index. The reasons he gave:

(1) Currency risk
(2) Foreign stock riskier
(3) Foreign stock more expensive to own

[alec]

William Bernstein's latest book does not advocate an allocation that
mirrors a world index. The reasons he gave:

(1) Currency risk
(2) Foreign stock riskier
(3) Foreign stock more expensive to own

Those are reasons against international investing in general, not a world index allocation.

I think a major reason we in the US aren't all that helped by investing overseas is that our economy appears to be more diversified than a lot of other countries.

[Gekko]

i'll stick with Bogle and the VFIAX.

[Kenster1]

William Bernstein's latest book does not advocate an allocation that
mirrors a world index. The reasons he gave:

(1) Currency risk
(2) Foreign stock riskier
(3) Foreign stock more expensive to own

But don't forget that he has a slight US tilt --- he personally has 50% international equities as someone mentioned about his statement during the last Diehard's meeting.

Same thing with Bill of the Coffeehouse Portfolio --- it is hard to espouse or swallow a high international allocation for most investors. But Bill personally has stated that he is globally diversified with 50% international allocation.

It's OK not to own the Global marketcap -- that's just a simple consideration to start with that even Malkiel has mentioned in his new book but Yes - 30, 40 or 50% International is still US tilting but at least you've got some decent global diversification and so don't get too hung up on whether that's the exact global equities weighting or not.

[grabiner]

William Bernstein's latest book does not advocate an allocation that
mirrors a world index. The reasons he gave:

(1) Currency risk
(2) Foreign stock riskier
(3) Foreign stock more expensive to own

Those are reasons against international investing in general, not a world index allocation.

I would see them as reasons to own less foreign stock than the world allocation. It is entirely rational for a US investor to own more US stock than European stock, and a European investor to own more European stock than US stock, because the US investor has more risk and higher costs in European stock investments, and vice versa.

However, it makes sense for a US investor to weight Europe and Japan according to their relative market caps, as the risks and costs are similar. (Emerging markets are another matter; they have higher risks and costs for everyone, but they also have higher expected returns.)

[sscritic]

Why do you trust other investors in other countries to get it right? I assume there is home bias everywhere. African investors will invest more in Africa, Japanese investors will invest more in Japan, and US investors will invest more in the US.

Suppose these are the only 3 regions in the world. Since there is a lot more money in the US to invest than there is in Africa, the total effect of the home bias is heavily weighted to the US bias. Thus, the world market at 42% US is already overweighted to the US because of the bias effect.

I am just thinking out loud, and I have no intention of investing following my own thoughts, but if you really believed, you would only invest say 35% or 38% in the US. Given that more people are investing in international, we can expect the home country bias to decline, and as money flows to other countries, the US will become a smaller portion of the pie. You therefore should beat the rush and reduce your US holdings now.

[Lucio]

Meh, IMO, not really that much safer. Remember the S&L nationalizations in the US in the 1980s, or Swedish banks in the 1990s, or for that matter nationalizations of banking institutions when banking crises hit lots of countries in the last 30 years.

I disagree strongly. The nationalizations that I referred to had nothing to do with banking crises or bailouts. When the government of France, for example, decides that your nickel mining company is a strategic national resource and then demands majority control, you have lost a great deal. This is exactly what happened to the Rothschild bank and its shareholders, when France expropriated their nickel mining concern (Société Le Nickel) in 1974. Seven years later, Mitterrand took the rest by nationalizing the bank.

I do not mean to disparage France in particular. Sovereigns will do whatever they want, whenever they want.

Lucio

[alec]

I do not mean to disparage France in particular. Sovereigns will do whatever they want, whenever they want.

Lucio

Good points, but what's to stop the US gov't from doing the same in the future? Seems like spreading stock holdings across a lot of governments would reduce the chances of mass nationalizations destroying your portolio - kind of like buying a national muni bond fund or corp bond fund with thousands of bonds to diversify risks.

[Lucio]

I do not mean to disparage France in particular. Sovereigns will do whatever they want, whenever they want.

Lucio

Good points, but what's to stop the US gov't from doing the same in the future? Seems like spreading stock holdings across a lot of governments would reduce the chances of mass nationalizations destroying your portolio - kind of like buying a national muni bond fund or corp bond fund with thousands of bonds to diversify risks.

I know what you mean. However, the going will get tough at some point in the future, as it has periodically throughout financial history, so I prefer to own less than the world market capitalization-weighted portfolio outside of my home economy for two reasons:
1) Better the devil that I know
and
2) A long history of respect for private property rights and ownership claims combined with a mostly independent judicial system.

The second point cannot be claimed by many extant countries. The USA holds up to that criterium well enough, excepting perhaps the outlawing of private gold ownership, the gifting of rights-of-way to the railroad companies and the abolition of slavery (nasty, but true).

Lucio

[stratton]

.
Vanguard Total World Stock ETF gives a reasonable breakdown: https://personal.vanguard.com/us/funds/ ... IntExt=INT

IMO personal circumstance also matters in global allocation decisions. http://www.stanford.edu/~wfsharpe/art/t ... esting.htm

The global market portfolio might be a good choice for a truly international investor, who lives in hotels and on airlines, pays taxes everywhere, consumes goods from all over the world, is of average age and risk tolerance, and so on. Of course this is not likely to describe anyone in this room. But the global market portfolio is a good place for you to start, tilting each of your investment positions in a direction that makes sense, based on the differences between your characteristics and those of this fictional global investor.

Robert
.

Live in a really tiny country like Iceland and you'd probably want global weighting for your equities too.

You can see Vanguard's thoughts on a medium sized coutnry by looking at the Vanguard Australia Diversified fund

Asset allocation targets are:

Income assets 30%

Cash 2%
Australian fixed interest 11%
International fixed interest (hedged) 17%

Growth assets 70%

Australian shares 34%
International shares 23%
Australian and international property securities (hedged) 8%
Emerging markets 2%
International small companies (hedged) 3%

Equity is split about 50/50 Australia/International. Remember Australia is not a reserve currency, but it is a "commodity" producer currency.

Paul

[dumbmoney]

MSCI All Country World Investable Market Index:

http://www.mscibarra.com/products/indic ... tsheet.pdf

[iceport]

MSCI All Country World Investable Market Index:

http://www.mscibarra.com/products/indic ... tsheet.pdf

Thanks dumbmoney and Robert T for the links. Very interesting. I couldn't even find the MSCI ACWI sheet. From the sheet:

MSCI ACWI IMI can be used for:
Asset Allocation — MSCI ACWI IMI can assist with
asset allocation decisions by helping to:

capture the full spectrum of equity diversification opportunities;

identify implied bets;

and quantify any home bias in your equity allocation.

Does a global market breakdown by asset class even exist? Is the US public market still roughly 60/40 equity/fixed income? Does that ratio hold for the global public market? Are the private markets almost as large as the public markets? Do the same allocations hold in the public and private markets?

How would someone go about answering these questions?

The only place I've come across the US public and private AA breakdowns is in a 2007 Vanguard paper, Commercial Equity Real Estate: A Framework for Analysis, p. 9, supporting a REIT allocation by showing the value of privately held real estate:



There seems to be well reasoned justification for tilting away from market weights, but it still seems to provide a useful perspective to at least identify the market weights, and thus the magnitude of the tilt.

Would the 60/40 equity/fixed income market weight be just as useful a default AA as an age-based (as in "age in bonds") default? Is that the logical extension of the concept advocated by Zweig in the article?

--Pete

[foodnerd]

Hey guys, I wrote an email to Jason to get further clarification on what he meant and to ask to compare his column to what Dr. Bernstein says (~ 30% International) and what Saint Jack writes (~ 20% International in new updated Common Sense on Investing). Jason responsed back to me this morning. Here is his response:

I didn’t exactly say you should be “keeping your portfolios” at global market weights. I said you should 1) take those cap-weightings as your starting point and 2) deviate from them to the extent that you have empirical evidence justifying a difference. Someone who believes he or she has a convincing reason to move away from those cap weightings should feel free to do so. The numbers typically thrown about – between 10% and 30% -- seem to be based on rules of thumb or perhaps a belief that U.S. investors are xenophobic. There’s a theoretical argument that your [current] savings units should be in the same denomination as your [future] consumption units; in other words, most of your financial assets should be in dollars today because most of your retirement spending will need to be in dollars tomorrow. I don’t find that very persuasive. If it’s true for us, it should be true in other countries. But my reading of history suggests that it is false. Would I have wanted to be a British citizen with most of my assets invested in the U.K. from, say, 1945 through 1980? Certainly not. Nor would I want to have been a Russian with most of my portfolio in the St. Petersburg stock exchange in 1913, or a citizen of Weimar Germany with a domestic-heavy stock portfolio in the 1920s, or a Japanese with a Japan-heavy portfolio in 1989. I don’t really see why a domestic tilt is guaranteed to be a better idea for an American today than it was for those folks then. It might be; but, then again, it might not. I don’t believe anybody even knows how to calculate the uncertainty of that, which makes it sound like a 50-50 coin flip to me. Since the global market weights are fairly close to 50-50 domestic/international, I’m comfortable running my own portfolio like that. Other people are welcome to differ, but I do think they should be able to articulate a sound reason for deviating from the benchmark. So far as I can tell, not everyone does.

Best wishes,

Jason Zweig

Thought I'd share that with the group.

Thanks,

FN

[conundrum]

Thanks foodnerd for passing along that info.

Drum

[Karamatsu]

Personally I find the "What insights do you possess into the global economy that hundreds of millions of other investors have somehow overlooked?" rationale pretty lame. People who index (which includes me) don't claim to know anything at all about what components of the market are going to do. We just throw our money into a fund that promises to do more or less what everyone else is doing. That's not "insight" into the global economy. It's punting.

It's only the people who don't index, the ones doing value investing or looking at magic candlestick patterns on the bottom of teacups who are making investment decisions based on some particular (real or imagined) insight, and they (the evidence suggests) are generally wrong!

I don't think the "insights" that people attribute to the hundreds of millions of other investors are really worth much, and so I figure... pick an allocation that makes some sort of intuitive sense, is unlikely to be 100% wrong, is easy to work with, then stay the course and enjoy the ride. Personally I'm 40% US, 40% developed world, 20% EM. These days, this is accidentally close enough to global weighting that I can feel virtuous (it wasn't when I started), yet provides nice round numbers to work with.

[TJAJ9]

Since the global market weights are fairly close to 50-50 domestic/international, I’m comfortable running my own portfolio like that. Other people are welcome to differ, but I do think they should be able to articulate a sound reason for deviating from the benchmark. So far as I can tell, not everyone does.

Best wishes,

Jason Zweig

I agree with him 100% on his 50-50 approach.

[iceport]

Hey guys, I wrote an email to Jason to get further clarification on what he meant and to ask to compare his column to what Dr. Bernstein says (~ 30% International) and what Saint Jack writes (~ 20% International in new updated Common Sense on Investing). Jason responsed back to me this morning. Here is his response:

[snip]

Thought I'd share that with the group.

Thanks,

FN

Thanks for thinking of us, FN.

Jason makes a good point. Still, barring an unforeseen catastrophe, I wonder if my 30% vs. Jason's 50% international weighting will make a huge difference over the long term. Though I guess the whole point in broad diversification is precisely to mitigate the effects of a catastrophe. :undecided

--Pete

[foodnerd]

Petrico, I agree. And after reading the Vanguard White Paper on International Stocks and how if their correlation to Domestic stocks increases, that the diversification benefit shrinks. And seeing the news today about the fear of Euro Countries, I am also hestitant to make the 50% leap. I am trying to get my allocation to 25% right now and then I'll keep studying.

FN

[CyberBob]

Petrico, I agree. And after reading the Vanguard White Paper on International Stocks and how if their correlation to Domestic stocks increases, that the diversification benefit shrinks. And seeing the news today about the fear of Euro Countries, I am also hestitant to make the 50% leap. I am trying to get my allocation to 25% right now and then I'll keep studying.

FN

Take careful notice that the Vanguard White Paper you are referring to only has developed markets as their international allocation. They did not include emerging markets. But if you include emerging markets in your international, it seems to point towards a higher allocation from a correlation standpoint.

Bob

[foodnerd]

Petrico, I agree. And after reading the Vanguard White Paper on International Stocks and how if their correlation to Domestic stocks increases, that the diversification benefit shrinks. And seeing the news today about the fear of Euro Countries, I am also hestitant to make the 50% leap. I am trying to get my allocation to 25% right now and then I'll keep studying.

FN

Take careful notice that the Vanguard White Paper you are referring to only has developed markets as their international allocation. They did not include emerging markets. But if you include emerging markets in your international, it seems to point towards a higher allocation from a correlation standpoint.

Bob

Thanks Cyberbob, I wasn't aware of the emerging market exculsion. I'll re-read that paper.

FN

[matt]

Since the global market weights are fairly close to 50-50 domestic/international...

Here is the error in Zweig's logic, because the U.S. is the only country that has close to 50% of the world's market value. For the citizens of every other country in the world, his logic would dictate a much smaller allocation. So following the weights of Vanguard Total World Stock ETF, U.S. citizens should have 41% in domestic stocks, U.K. citizens should have 9% in domestic stocks, Japanese citizens should have 8% in domestic stocks, Egyptians should have 0% in domestic stocks. This makes it clear that the global market weight starting point is completely arbitrary and U.S.-centric.

[555]

.

[Opponent Process]

What about other planets?

surely our planet is the best, right?

seriously, echoing Zweig, people should make a conscious effort to eliminate xenophobic emotions from their equity allocation decisions.

[sia]

For me, the thing that is not considered in that Vanguard paper is the risk of a Japan like event. It focuses only the diversification value around volatility, rather than decreased chance of singular really bad outcome. That's the main reason I don't overweight the US.

Also while 50/50 sounds simple, note that the US share of the global market is not static - rather its been in decline for a while - from the 70's down to the 40's today and continuing to trend lower. How comfortable would you feel iw 50% US f in our lifetime the US is in the 30's or even 20's? (BTW this isn't all that unlikely - bc a lot of the reduction in US% is driven by new stock creation in the ROW, and today still a huge amount is private or govt owned outside of the US - so further dilution is quite likely)

I don't like to make too many decisions so letting VT decide my US allocation means that I'll always have the market weight and can sleep very easy w that - anything different and I'd have to constantly re-evaluate.

[jenol]

For me, the thing that is not considered in that Vanguard paper is the risk of a Japan like event.

I agree.

However, the most ironic thing about bogleheads quoting that paper is that they totally dismiss the fact that it's based on backtesting and history of developed stock markets. Normally when people go around making recommendations based on other "research" that's based on history we jump like a flock of hyenas over them. But when Vanguard has a paper it's obviously a good starting point of how to build ones portfolio. Cmon bogleheads, be more critical!

[iceport]

Petrico, I agree. And after reading the Vanguard White Paper on International Stocks and how if their correlation to Domestic stocks increases, that the diversification benefit shrinks. And seeing the news today about the fear of Euro Countries, I am also hestitant to make the 50% leap. I am trying to get my allocation to 25% right now and then I'll keep studying.

FN

Take careful notice that the Vanguard White Paper you are referring to only has developed markets as their international allocation. They did not include emerging markets. But if you include emerging markets in your international, it seems to point towards a higher allocation from a correlation standpoint.

Bob

Thanks Cyberbob, I wasn't aware of the emerging market exculsion. I'll re-read that paper.

FN

Hey FN and/or Bob,

What white paper are you referring to? Was it recent? The one I remember is from 2006: International Equity: Considerations and Recommendations

If I remember correctly, this is the paper that helped me to justify increasing my international allocation from 25 to 30%. This one does include emerging markets.

Throughout this analysis we have evaluated international equities as a single market, combining developed markets and emerging markets at their historical market weights in the MSCI All Country World Index ex USA. But traditionally, many have viewed these two markets as separate asset classes and have assigned specific allocations to them accordingly.

Would be interested to read a more recent paper.

Thanks,
--Pete