ASX - Australia - Portfolio review

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Topic Author
Lustang
Posts: 2
Joined: Tue Jan 25, 2022 9:33 pm

ASX - Australia - Portfolio review

Post by Lustang »

Hi bogleheads,

I just wanted to quick double check of my thoughts on a portfolio which seems a little complicated, due to the fact that I do not want to ever sell - so must live with the remnants of former choices that I don't really hold any more (e.g. VAS for australian shares seems less diverse than using VGAD).

While I think that markets are generally efficient and have no interest whatsoever in picking specific companies, I do believe that there is inherit home bias in all countries both by everyday investors and by institutional investors - e.g. super funds need to be accountable to australian's, so they typically have a bunch of australian shares, more than australia's GDP vs the world. So I'm not so convinced that weighting allocation by market cap weighting makes sense, but I am convinced that within a market, cap weighting makes most sense. This makes me question reproducing typical market cap weightings in super funds like-for-like.

I have a long investing horizon (in my 20's) and I believe possible the ability to never sell despite news scares. I'm healthy and don't really foresee needing to draw down on money. I also have high earning potential, currently working in tech and it's looking like demand for programmers will remain high with China's new focus on tech + the big tech companies in the US having enough money to slosh around, bidding up the market. So it's entirely possible I could move to the US if I really needed (don't want to) and earn USD, giving me both AUD and USD potential earnings exposure.

One big question I've been trying to answer is how much Emerging markets should be in my portfolio? I believe this to be a great diversifier, and commonly see advice of 10% weighting. Having read https://www.morganstanley.com/im/en-la/ ... o-own.html and agreeing with some of these metrics, it seems like 10% is certainly too conservative.

My current portfolio aspiration is the following:

20% VAS (australia)
30% VGAD (international developed markets, aud hedged)
13% VGS (international developed markets, not hedged)
15% VGE (emerging markets, not hedged)
13% VAE (asia excluding japan, not hedged)
6.5% DJRE (international real estate, not hedged)
2.5% GOLD (not hedged)

This gives 50-50 AUD/non AUD denominated assets. In future I will move towards 60-40% AUD favoured. Also in future I'd like to minimize VAS, and will do so with buying VGAD.

The more unusual ETF in there is VAE. This is because VAE includes mostly the same countries as VGE, and looking at the MSCI emerging markets index, a bunch of countries have always gone in and out of it. It seems reasonable that at some stage of development, the index will kick out China, and I have a strong belief that China will become the dominant economic power (even in the medium term, less than 20 years). So given that I design the portfolio with the idea of never selling, to maximize compounding before a capital gains tax event, I've split VGE into VGE + VAE. Another significant factor is that it also has less fees than VGE.

I'd be very interested in hearing peoples criticism of the portfolio, things that they would do different, or general disagreement with my assumptions listed.

Cheers
Valuethinker
Posts: 49038
Joined: Fri May 11, 2007 11:07 am

Re: ASX - Australia - Portfolio review

Post by Valuethinker »

Lustang wrote: Tue Jan 25, 2022 10:07 pm Hi bogleheads,

I just wanted to quick double check of my thoughts on a portfolio which seems a little complicated, due to the fact that I do not want to ever sell - so must live with the remnants of former choices that I don't really hold any more (e.g. VAS for australian shares seems less diverse than using VGAD).

While I think that markets are generally efficient and have no interest whatsoever in picking specific companies, I do believe that there is inherit home bias in all countries both by everyday investors and by institutional investors - e.g. super funds need to be accountable to australian's, so they typically have a bunch of australian shares, more than australia's GDP vs the world. So I'm not so convinced that weighting allocation by market cap weighting makes sense, but I am convinced that within a market, cap weighting makes most sense. This makes me question reproducing typical market cap weightings in super funds like-for-like.

I have a long investing horizon (in my 20's) and I believe possible the ability to never sell despite news scares. I'm healthy and don't really foresee needing to draw down on money. I also have high earning potential, currently working in tech and it's looking like demand for programmers will remain high with China's new focus on tech + the big tech companies in the US having enough money to slosh around, bidding up the market. So it's entirely possible I could move to the US if I really needed (don't want to) and earn USD, giving me both AUD and USD potential earnings exposure.

One big question I've been trying to answer is how much Emerging markets should be in my portfolio? I believe this to be a great diversifier, and commonly see advice of 10% weighting. Having read https://www.morganstanley.com/im/en-la/ ... o-own.html and agreeing with some of these metrics, it seems like 10% is certainly too conservative.

My current portfolio aspiration is the following:

20% VAS (australia)
30% VGAD (international developed markets, aud hedged)
13% VGS (international developed markets, not hedged)
15% VGE (emerging markets, not hedged)
13% VAE (asia excluding japan, not hedged)
6.5% DJRE (international real estate, not hedged)
2.5% GOLD (not hedged)

This gives 50-50 AUD/non AUD denominated assets. In future I will move towards 60-40% AUD favoured. Also in future I'd like to minimize VAS, and will do so with buying VGAD.

The more unusual ETF in there is VAE. This is because VAE includes mostly the same countries as VGE, and looking at the MSCI emerging markets index, a bunch of countries have always gone in and out of it. It seems reasonable that at some stage of development, the index will kick out China, and I have a strong belief that China will become the dominant economic power (even in the medium term, less than 20 years). So given that I design the portfolio with the idea of never selling, to maximize compounding before a capital gains tax event, I've split VGE into VGE + VAE. Another significant factor is that it also has less fees than VGE.

I'd be very interested in hearing peoples criticism of the portfolio, things that they would do different, or general disagreement with my assumptions listed.

Cheers
If you are taking a 40 year view I don't see why you would want to hedge AUD exposure. In the long run, Purchasing Power Parity should win out. Why pay for hedging a volatility that you don't need to worry about for another 30 years?

If you want to hedge AUD exposure, a fund investing in Australian Govt Bonds would be better. Or even an Australian Inflation-Linked bond fund (if such a thing exists)-- preserves your purchasing power. I am no expert on Australian tax though - the dividend imputation credit. From what I have read here, the evidence is that yes, it helps domestic investors in Australian companies, but that also means their share prices are higher, so it's basically a wash.

Given Australia is highly linked to the fortunes of East Asian countries, overweighting both Australia and East Asia strikes me as not diversifying risk enough.

I also don't see why you would not want to use world market weights. Say 80% developed, 20% Emerging. Japan comes up on most value screens as being the cheapest major market and with significant events to catalyse that value (changes in corporate governance).

Your market weightings suggest strong prior views you hold, rather than taking what the market says the right weighting should be. I don't imagine many of us thought Tesla would be in the world's 7 largest listed companies by market cap - just as an example of how wrong someone can be*. Or that Apple would go up what, 5x, after Steve Jobs died?

In other words, I hold to Efficient Markets. My guess as to what Russia was going to do next (which has trashed the price of Gazprom, which probably has the largest energy reserves in the world of any company other than Saudi Aramco) was no better than the market's. (I do hold an EM Dividend fund - about as close to get a pure value play in EM as I could find - and it was 20% in Russia, and so it's been a rather painful few days-- both the rouble has crashed and the share prices of the big Russian stocks have crashed).

* so I still think I am right and it's just taking the market a while to come around to my view on Tesla. However since I index, the good news is it doesn't matter if I am right or wrong on this one.
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andrew99999
Posts: 1021
Joined: Fri Jul 13, 2018 8:14 pm

Re: ASX - Australia - Portfolio review

Post by andrew99999 »

I don't think it is necessarily wrong, but it's not my cup of tea.

I wouldn't bother splitting VGE and VAE, but I don't think it's a problem.

Similarly, I wouldn't like so much emerging markets, but again, if you understand the risks, I don't think it's necessarily bad. Although as Valuethinker said, over the last 20 years Australia's stock market and the emerging markets stock market have been quite highly correlated, so that is a consideration. In addition, are you able to continue holding through 10 very long years of crap performance like the last 10?

With a very long time horizon, I agree with Valuethinker that you could leave out VGAD and move it to VGS. I tend to still use it (although with a shorter time horizon until drawdown) in part becuase I can't be bothered trying to time it later when to add it in. I personally don't think keeping it or leaving it out are necessarily wrong.
Topic Author
Lustang
Posts: 2
Joined: Tue Jan 25, 2022 9:33 pm

Re: ASX - Australia - Portfolio review

Post by Lustang »

Thank you both for your replies, I really appreciate it.

Hedging has always been a difficult thing for me to think about, so it's quite possible I'm wrong to hedge. From what I've read (a lot of my opinions formed from Ray Dalio's book, the changing world order), currencies very frequently undergo huge devaluations or even are phased out entirely - over the long term. I'm not sure if the underlying mechanics of hedging would even hold up in these scenarios, but I think the idea of having purchasing power in different currencies is pretty useful in the sense of not having all my eggs in one basket. The hedging cost is 0.03%, which surely may add up over time, but seems to me a smaller issue than if I get the portfolio asset class allocation wrong.

I do agree with overweighting Australia as it's correlated to the emerging markets... in future I'll certainly look towards rebalancing and removing the Australian ETF.

The 80% developed, 20% emerging split sounds fair to me on the surface. But developed markets are made up of 70% USA, ~18% Europe, ~6.5% Japan + small other. This gives a total weight of 56% (assuming 80% developed) to the USA, which seems huge to me. I know that many of the international companies that are listed on the US market operate globally, but they're still subject to the same political risks. If the USA had a civil war, what would happen to these companies? Given the USA is the most unequal developed country, with all time political partisanship, internal conflict is a real possibility in the future.

I think I'm missing something with regards to how the efficient market hypothesis applies for comparisons between markets. People in different countries may be limited in their access to each other's markets - due to political and historical reasons. Wouldn't I only care about what investors in Australia are investing in (given the tax rules vary with country tax treaties etc), and maybe then what the total market caps that are bought from Australia matter? [obviously I can't do this though] Again; I agree that within a market, the market cap weights make sense - you can participate in the market if you buy any individual stock, so it should tend to be efficient.

Doesn't the efficient market hypothesis just say that all markets are fairly priced, in the same way that stocks inside a market are (because the market is made of the stocks in them, which must be fairly priced)? So I don't even know if the idea that buying according to cap weight is necessary (even in a market). If everything is priced fairly, and you don't have enough money to budge the price significantly, then buying everything equally should be consistent with the efficient market hypothesis too, right? I think the problem with this is that if you had a sufficiently large index fund that did weight all stocks equally, then you might actually budge the prices of the cheapest stocks?

It seems a pretty accepted fact too that every country's investors exhibit significant home bias. So wouldn't this be even stronger reason that country market caps aren't too reliable? Countries that have more wealth would exhibit bias, thereby propping up their market cap.

I tried looking into getting some stats for the correlations of Australia and EM + DM. Entering in https://www.asxcorrelations.com/portfolio.php VAS, VGS, and VGE give perhaps surprising results. Note, VGE has no hedged equivalent, so I'm not really sure what to do with the currency risk correlation...

VAS - VGS: 66.81 [australia vs international developed markets]
VAS - VGE: 42.25 [australia vs emerging markets]
VGS - VGE: 48.62 [international developed markets vs emerging markets]
(ranging from -100 to 100)

So Australia is most correlated to international developed markets, LEAST correlated to emerging markets, slightly more so than the rest of the developed world.

Now I'm not really sure about this, the tool is using ASX data apparently but probably only goes back about 10-15 years. It might not be reliable at all - I would have agreed that australia and emerging markets (China) are pretty correlated. But that's just supposition not backed by data.

In addition, are you able to continue holding through 10 very long years of crap performance like the last 10?
Well that's the same as for international markets - they did very well over the last 10 years, but I don't think that's a reason for me to expect them to do any better than emerging markets?
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andrew99999
Posts: 1021
Joined: Fri Jul 13, 2018 8:14 pm

Re: ASX - Australia - Portfolio review

Post by andrew99999 »

I tend to agree that just because it is cap-weighted doesn't make it "right"
Although, I also agree that making a bet on other countries often turns out wrong.
So I quite like cap weighting with the idea of a maximum in any single country, say 40 (or potentially 50%).
Many on here will argue that is making a bet against the US at this current time, but that's not the point — the point is to reduce the concentration risk of so much in one country.
For a similar reason, I don't think it is wrong to hold a little more Australian or emerging market index. The problem comes with tinkering or having so much that you face concentration risk.

As for correlations, do they include magnitude also?
Here is a graph of Aus vs EM vs the US over the last 20 years.
Lustang wrote: Thu Jan 27, 2022 10:52 pm
In addition, are you able to continue holding through 10 very long years of crap performance like the last 10?
Well that's the same as for international markets - they did very well over the last 10 years, but I don't think that's a reason for me to expect them to do any better than emerging markets?
My point is more that .. if you will capitulate after a long period of underperformance of a market segment you overweight, then you will end up worse than if you did not overweight it. If you can not find a plan you can stick to no matter what, cap weighting is likely to be better. So again — you need to be able to continue holding through excruciatingly long periods of underperfomance.
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