Discrepancy in advice for European vs US investors

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FourLights
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Joined: Thu Jan 25, 2018 12:24 pm

Discrepancy in advice for European vs US investors

Post by FourLights » Sat Oct 05, 2019 4:32 am

Why is it that the general advice for European investors is to go for global stocks and bonds while US investors typically have a much heavier US bias?

E.g. the typical recommendation for EU based investors is: MSCI World + MSCI EM + some global bond fund. I almost never see a MSCI World recommendation for US based investors, but rather VTI/VOO etc. Same for bond funds.

Schlabba
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Re: Discrepancy in advice for European vs US investors

Post by Schlabba » Sat Oct 05, 2019 4:42 am

The reason is the size of market. If you live in a tiny European country would you want to over weigh it as much as Americans over weigh their market?

If you live in a country which consists of 55% of the world market, and you take a 60%-40% split between local market vs international, you're not too far off from market weights.

Another reason is currency risk. If you live in a tiny European country there is no way around it, if you live in the US you can control how much currency risk you want to take.
IWDA: MSCI World | EMIM: MSCI Emerging Markets | AGGH: Global Aggregate Bond Hedged to €

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Peculiar_Investor
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Re: Discrepancy in advice for European vs US investors

Post by Peculiar_Investor » Sat Oct 05, 2019 7:33 am

FourLights wrote:
Sat Oct 05, 2019 4:32 am
Why is it that the general advice for European investors is to go for global stocks and bonds while US investors typically have a much heavier US bias?

E.g. the typical recommendation for EU based investors is: MSCI World + MSCI EM + some global bond fund. I almost never see a MSCI World recommendation for US based investors, but rather VTI/VOO etc. Same for bond funds.
Home country bias.

Since this is the Bogleheads, Why Jack Bogle Doesn't Own Non-U.S. Stocks | Morningstar has a lot to do with US investors and their choices.

There are lots and lots of topics here on the BH that discuss it ad nauseum, generally without conclusion, i.e. https://www.google.ca/search?q=home+cou ... eheads.org

An often referred to Vanguard paper, recently updated, is Global equity investing: The benefits of diversification and sizing your allocation
Vanguard paper wrote:
  • Regardless of where they live, investors have a significant opportunity to diversify their equity portfolios by investing outside their home market. Despite this opportunity, investors on average have maintained allocations to their home country that have been significantly larger than the country’s market-capitalization weight in a globally diversified equity index.
  • In each market we examined, our analysis indicated that volatility was reduced most with an allocation to international equities of between 40% and 50%. While this observation may help investors determine the appropriate mix of domestic and international equities, volatility reduction is not the only factor to consider.
  • This paper concludes that although no one answer fits all investors, global market capitalization weight serves as a helpful starting point in determining the appropriate allocation between domestic and international equities. In practice, many investors will consider an allocation to international equities well below global market-capitalization weight based on their sensitivity to a number of considerations, including volatility reduction, implementation costs, taxes, regulation, and their own preferences.
I recently posted into another similar topic my thoughts on this paper and the framework it provides,
Peculiar_Investor wrote:
Fri Oct 04, 2019 8:09 am
JoMoney wrote:
Thu Oct 03, 2019 7:49 am
Risks, expenses, tax considerations...
https://personal.vanguard.com/pdf/icrrhb.pdf
Image
... Although there may be many rational reasons for home bias, we present certain metrics that investors can use to help determine an appropriate allocation to foreign securities. Generally speaking, our framework suggests that U.S. investors may have some quantitative justification for a home bias, and investors in other countries might consider increasing their global diversification. We provide an example of how our framework can be used; however, it or any systematic evaluation process must also be individualized. ...
As a Canadian investor, I found the linked Vanguard paper is an excellent framework to examine the question and understand the impact of home country bias. Once you understand there are some valid reasons to have some extra home country bias, it becomes easier to design an asset allocation that works for your circumstances and biases.

I'm well aware that Canada represents about 3-4% of global equity market capitalization and is another example of sector concentration in a small number of sectors, financial and energy are the top 2. My asset allocation to Canadian equities isn't quite that low mostly because of local taxation and spending (now and future) patterns that will mostly be in Canadian dollars.

I don't agree with Bogle and many others who preach the notion of buying the whole haystack, i.e. a broad-based index, but somehow limit their haystack selection to just the US haystack. I see no reason this shouldn't be extended to the global haystack.
Normal people… believe that if it ain’t broke, don’t fix it. Engineers believe that if it ain’t broke, it doesn’t have enough features yet. – Scott Adams

Ferdinand2014
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Re: Discrepancy in advice for European vs US investors

Post by Ferdinand2014 » Sun Oct 06, 2019 8:22 pm

A good article that helps define the unique characteristics of the U.S. stock market which allows a U.S. investor to ‘get away’ with a home country bias.

https://awealthofcommonsense.com/2018/0 ... is-unique/
“You only find out who is swimming naked when the tide goes out.“ — Warren Buffett

Valuethinker
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Re: Discrepancy in advice for European vs US investors

Post by Valuethinker » Fri Oct 11, 2019 6:15 am

FourLights wrote:
Sat Oct 05, 2019 4:32 am
Why is it that the general advice for European investors is to go for global stocks and bonds while US investors typically have a much heavier US bias?

E.g. the typical recommendation for EU based investors is: MSCI World + MSCI EM + some global bond fund. I almost never see a MSCI World recommendation for US based investors, but rather VTI/VOO etc. Same for bond funds.
Equities you have your answer. You want diversification. And you definitely want to own Microsoft Apple Google Facebook Amazon - these are some of the world's largest companies by market capitalisation. For the same reason you want to own Nestle and Royal Dutch Shell (the largest European companies by market cap, I believe). Not to mention JP Morgan (world's largest bank last time I checked).

Bonds the problem is Eurozone specific. Germany is a relatively small part of the Eurozone government bond market (number 3 or 4?). With the European Central Bank owning so many bonds in Quantitative Easing (roughly 1/3rd of each country's issue) it's a very small market.

The largest bond market in the Eurozone in terms of value of issued bonds is Italy. The difference in yield between Italian 10 year government bond and German (say 2.5% ? I have not checked in a wild) tells you that roughly speaking, the market thinks there is a 2.5% greater chance per annum that Italy will default than Germany.

Now would you play Russian Roulette with a machine gun that 2.5 in 100 barrels (5 in 200) were loaded, pointed at your well being in retirement? Pulling that trigger for one shot every year between now and retirement (and beyond?).

Of course it would be a domino. If Italy really were in danger of default it would exit the Euro, but the Spanish and Portugese government bond markets (at least) would also price in that likelihood. And northern European countries like France and Belgium (especially the latter) would come into question given their budgetary and demographic problems.

(it's much more complex than that, because the market would also assume that a 100% write off of Italian debt would not happen - investors in Greece got in the 2nd bailout roughly 50% of present value on the bonds, I vaguely recall. There's also other factors like bond liquidity, quantitative easing (ECB owning government bonds) etc).

So the solution many have advocated here is:

- a global government bond fund dilutes Italy down to something like 7% (developed world, investment grade government bonds). That's an acceptable level of risk

- by hedging the fund back into Euros, the cost of hedging lowers or raises the average yield to about that of the Eurozone - ie negative for a risk-free German govt bond. However it is a bit better than that - the credit risk of global government bonds is above what the market puts on German govt bonds

In short, you can't do much about low Eurozone interest rates, but you can diversify in terms of issuers and thus credit risk - reducing the impact of Italy and France and Germany and adding the impact of USA, Japan, UK, Australia, Canada. Note that almost all international government bond indices and funds seem to cap Japan at 20% - as it is by a big margin the largest govt debt load (I think if you included US mortgage backed securities backed by US government financial institutions like FNMA, FMAC, GNMA the US might be bigger).

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