lnternational portfolio allocation
I know we’ve discussed this ad nauseum, but is there any good (yet readable) literature out there on a good portfolio allocation for domestic vs. international equities?
The SmartMoney Asset Allocator recommends 20% international for me. That’s just crazy talk. I’m currently targeting 44% international, but I think that’s probably still way too low. (The rest: 18% commod, 9% US small, 20% US large, 9% tech.)
I would be happy to weight it by market cap, if I knew what US market cap was vs. international. Regardless, it seems like international (not just emerging markets) will outperform U.S. permanently, going forward. Thoughts on this?
Now I’m thinking something closer to 60% int’l. That would leave like 15% commod, 6% US small, 12% US large, 7% tech. But maybe THAT’S crazy?
There’s also the issue of investing in what you know (a la Warren Buffett), and I don’t know much about international. I just put my money into general low-cost int’l index funds, and they do well. But I have no sense of how to allocate across regions or countries, etc.
As I’m thinking through this, it’s dumb that I have 38% domestic broken into three categories, while my 44% international is just one category (though I do invest in both EM and large cap int’l).
I know I’m talking to myself at this point…just thinking “out loud”.
Now I’m thinking:
50% international (20% EM, 30% large)
30% domestic (17% large, 7% tech, 6% small)
20% commodities
Would love any feedback. I know this is aggressive. I wonder if anyone is over-weighting cash at this point? I’ve stopped allocating cash as a % of portfolio, instead just targeting a “rainy day”/working-capital level of $10K.
current allocation:
US small/mid cap: 21%
US large cap: 11%
Global ex-US and ex-EM): 12%
EM: 45%
Commodities: 11%
EEM is broken down as:
HK: 15%
Korea: 14%
Brazil: 13%
Taiwan: 10%
South Africa: 8%
India: 7%
Russia: 5%
Mexico: 5%
Great Britain (i think this is european EM stocks listed in london): 3%
China: 3%
VWO, another EM ETF i own, has a similar breakdown.
i also bought more into BRIC (EEB for all 3, but not equally weighted; i used EWZ, RSX, INP, and PGJ respectively for each country), as well south africa (EZA) and malaysia (EWM). would love to find a vietnam ETF.
i wouldn’t mind doing some more individual stock picking. the only single stock pick i have is GS, and it’s not a large position. CashBack and i have been talking about AAPL. he thinks there’s value at this price. BRK/B is something i’ve been thinking about, though i wonder if it’s too expensive, and what happens after Warren is no longer managing it?
All those asset allocators are crap because they don’t take into account your biggest asset: your human capital. Think of human capital as a security that pays your salary every two weeks as a dividend. For somebody in the finance industry, it’s immediately apparent that your human capital is a huge implicit investment in U.S. equities. For somebody in my position, human capital is probably more like a bond than an equity, although there are arguments that for investors with long horizons, human capital is more like equity (because the capital-to-labor income ratio is pretty stable over time, so if capital becomes a lot more valuable, labor income will eventually catch up).
The above observation argues for a lot of overweighting of international equities in your portfolio. I’m 70% international equities, 20% domestic equities, and 10% commodities. Now that interest rates have fallen, we’re going to pay off Dr. Path’s student loans in full next week. After that liquidation, I’ll be holding relatively more commodities. There’s positive serial correlation (i.e. momentum) in commodity returns, and GSG has been kicking butt recently.
Anyway, I have a pretty loose target for my portfolio. Garbage in, garbage out: for the most part, the errors in the heroic assumptions you have to make in order to get these mathematical portfolio optimizations to run swamp most of the gains you can obtain by running those optimizations. As long as your portfolio’s well-diversified and you have a positive amount of equity mostly invested in low-cost index funds, you’ve probably squeezed out most of the gains available.
I like Beefcake’s international target. I agree we should all be that diversified outside the USA, but I would add a few reasons.
Look: it seems to me that even if you were to weight based on relative capitalization (intl vs. world), you would still be underweight internationally because in emerging markets, stock markets are still immature. (Although, the current bubble in China shows that people will run stuff up quick.)
Also, global growth for the rest of our lives is going to be skewed internationally. I absolutely agree with that.
FiftyFive: I’m pretty sure that VWO tracks the exact same index as EEM, so it would definitely have the same breakdown as EEM. But VWO has a lower expense ratio so I’ve been making all my new buys in VWO. I don’t know why we didn’t see it earlier; probably because it gets less volume.
I agree that it’s likely that GDP growth in emerging markets is likely to be higher in our lifetimes than GDP growth in developed economies. (But this is not a guarantee; see Russia or Africa, for example.) But that doesn’t necessarily mean that stock market returns in emerging markets will be higher in developed economies.
Emerging market stock returns will only be higher if (1) investors on average have underestimated the growth rate of international GDP, and/or (2) emerging market economies are riskier and therefore offer a higher expected return as compensation, in which case that higher return isn’t a free-lunch profit, but something that could very well never materialize.
Look and CashBack, it sounds like you guys are betting on reason (1) above, since reason (2) isn’t something to get that excited about. What are your stories for why investors are underappreciating emerging markets?
My best guess is that emerging market stock markets will provide somewhat higher average returns going forward, but this is mostly compensation for their additional risk. Also, I suspect that the Chinese stock market is due for a big crash. There are some really funky things going on over there that just don’t seem right.
Ah, the Professor exerting discipline on our gambling ways. So we’re all convinced of the value of diversifying internationally to reduce overall risk. And some of us, at least me and FiftyFive and maybe Look also, feel like emerging markets are just a good bet too.
You raise a good question because it exposes a nagging question that I’ve never really resolved. Why do we so strongly assume that everything is priced into the market already. Why is it that, when information that materially changes projections for a stock comes out, it takes a long time for the market to absorb it? I would think either it’s a liquidity issue or an information dissemination issue. For example, I track Apple very closely and it’s run-up to current levels has been gradual over the course of the entire year, not at distinct points when a) it announced iPhone or b) explained how it was accounting for revenue from iPhone (and thus revealing the strength of its ATT deal). I chalk it up to the fact that information disseminates slowly. I would imagine that’s why there’s success in Buffet/Lynch’s adage “invest in what you know”: your own expertise probably is what keeps you ahead of the rest of the market. I don’t know if studies have ever been done on this whole “investing in what you know” thing, but I totally believe it.
So on a macro scale, I believe that there is a lot of growth potential in emerging markets because the market is slow to capture their value. And over the long haul, I expect that will always be true of emerging markets generally. Bold statement? Maybe too bold. It’s honestly just based on convos with my bro about the nascent stock market in our family’s home country. The political risk is low there (they’ve tied their future to the global economy and are getting in line with global expectations of conduct). Growth is strong. Yet as he looks over the books of the public companies there, all he sees is value. He chalks it up to foreign analysts who know very little about the country keeping people out or going slow because of “risk” when it’s more their lack of information/knowledge. Maybe this is an argument that I should be in this one country because of the insider knowledge we have. But then that would not be diversifying!
Plus it’s rather easy to intuit this phenomenon happening elsewhere. Emerging markets do well and we say it’s pay-off for risk when maybe it’s just value that is slow to be captured. That’s my major hypothesis.
When it comes to China, I think we have an interesting confluence of events: tons of personal savings that can go somewhere, lack of investment options currently, and a cultural disposition for gambling. Get this: when my mom asks me if I invest, the Chinese phrase is literally “do you play stocks?” as if it’s a game; that’s really what a lot of people see it as. I totally agree it’s a bubble and a danger zone.
So when we seek a “well-diversified” portfolio, to what extent should we act on information like that and stay out? That is, would we be undiversified if we invested internationally except for China? If so, would the converse be also true, that we should overweight in countries that we deem to be good values still?
minor differences, really, but just in case people are curious: VWO and EEM are not the exact same baskets. EEM has 352 holdings, the top 10 representing 24% of the portfolio. VWO has 850 holdings, the top 10 representing 16% of the portfolio. VWO has 5% more of the portfolio in Consumer Goods, and EEM has 5% more of the portfolio in Energy. VWO has 0.30% expense ratio, and EEM has 0.75% expense ratio.
Interesting. From reading the stated strategy of each etf, it looks like VWO tries to adhere closely to the MSCI Emerging Markets Index, whereas EEM “seeks investment results that correspond generally to the price and yield performance of the MSCI Emerging Markets index.” That gives EEM an awful lot of wiggle room. Overall performance of VWO seems to be better even though they follow very similar tracks.