the effect of performance on Total World Stock vs Total World Bond

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goonie
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the effect of performance on Total World Stock vs Total World Bond

Post by goonie »

I think I'm correct in stating that, in general, when a country's stock market does well, its percentage of the overall global equity market increases. And when its market does poorly, its percentage decreases. Again, just speaking in general.

However, I'm not sure if performance applies to the global bond market. With the global bond market, aren't the market percentages really just about who's issuing the most bonds? The more bonds a country issues (either the country's government or the companies that are housed there), the higher their percentage of the overall world bond market would be? Is that correct?

Sorry if this is really elementary or oversimplified or if I'm just framing it poorly. I'm trying to determine if a Total World Bond fund makes as much sense as a Total World Stock fund.
djm2001
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Re: the effect of performance on Total World Stock vs Total World Bond

Post by djm2001 »

goonie wrote: Wed Jan 13, 2021 5:24 pm I think I'm correct in stating that, in general, when a country's stock market does well, its percentage of the overall global equity market increases. And when its market does poorly, its percentage decreases. Again, just speaking in general.
Performance is basically total return. While it's true that market cap (price x units) does track total return better for stocks than for bonds, market cap will still experience tracking error (w.r.t. total return) over time. Main reasons for tracking error are 1) dividends, and 2) stocks getting listed and de-listed result in discontinuous jumps. The analogous discontinuity for bonds is old bonds maturing, and new bonds being issued. But yes, at a high level market cap tracks total return better for stocks than for bonds.
goonie wrote: Wed Jan 13, 2021 5:24 pm However, I'm not sure if performance applies to the global bond market. With the global bond market, aren't the market percentages really just about who's issuing the most bonds? The more bonds a country issues (either the country's government or the companies that are housed there), the higher their percentage of the overall world bond market would be? Is that correct?
The total market cap for bonds is not only a function of the number of bonds issued, but also the price of the bonds. As such, this is a function of both supply and demand of bonds. If most people think that a particular bond (or country's bonds) stink, then few people will buy it, and the price and market cap will be low, even though the number of bonds issued is large. Therefore, it's not necessarily true that the more bonds a country issues, the higher its percentage of the overall world bond market cap.
goonie wrote: Wed Jan 13, 2021 5:24 pm Sorry if this is really elementary or oversimplified or if I'm just framing it poorly. I'm trying to determine if a Total World Bond fund makes as much sense as a Total World Stock fund.
Yes, total world bond fund makes as much sense as total world stock market from a theoretical perspective. At a very zoomed out level, the bond market and the stock market can be considered a single market, with bonds being just another available investment choice on the table. The market as a whole chooses to how allocate its money across both stocks and bonds in much the same way that it does across various slices of stocks (e.g., value vs growth, US vs non-US, emerging vs. developed, whatever). Side note: Actually, the market is choosing to allocate its money across various compensated risk factors underlying stocks and bonds, not to stocks and bonds directly. Stocks and bonds are a means to access those risk factors. Bonds are more heavily driven by term and credit risk factors; and stocks by value and size and the so-called market beta (which is a proxy for a combination of risk factors that drive the equity market) according to the Fama French 3-factor model.

In summary:
  • Total return is not accurately tracked over time by price or market cap for either stocks or bonds due to money/assets entering and exiting the system through certain mechanisms such as dividends, stock listing/de-listing, old bonds maturing, and new bonds being issued. This continuous drift is more pronounced for bonds than for stocks, mainly due to bonds constantly throwing off a larger fraction of their total return as dividends.
  • Market cap makes sense to determine allocations both within total world stocks and within total world bonds, and indeed across both stocks and bonds as a whole... for the "average" investor. If you are different from average (and everyone is) w.r.t your personal intrinsic exposure to risk factors, then you should adjust for that difference. E.g., you might reduce your bond holdings if you have a stable job and many years of work ahead.
Last edited by djm2001 on Thu Jan 14, 2021 5:58 am, edited 1 time in total.
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goonie
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Re: the effect of performance on Total World Stock vs Total World Bond

Post by goonie »

Thank you very much djm. That is an excellent write-up. You cleared up quite a bit for me.
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