Opinion on Index trackers, diversification, flexibility, rebalancing

MrMartyn · 9 January 2015 at 9:41PM

I'm very much a fan of passive index-tracker type funds (with dividends re-invested in the same fund) after reading The Motley Fool UK Investment Guide a number of years ago. As such, I have been investing in a FTSE All-share index tracker fund (in an ISA) for quite a while, investing various different levels of monthly contributions over about the last 6 to 7 years. The returns haven't been as good as I expected (perhaps due to the "lost decade" for the UK stock market), but I still have faith in the principle of drip-feeding monthly contributions in and holding for the long term (at least 10 years and ideally 20 years or more) to benefit from the power of compound interest. I'm in my early 40's.

However, I've begun to wonder whether a FTSE All-share tracker fund might not be diversified enough, and whether I should therefore be thinking about investing in a world index tracker fund (e.g. one that tracks an index such as the MSCI World Index). I'm using an ISA platform so I have a good choice of funds and can spread my contributions accross several funds if I want to. I decided to break my monthly contribution down as follows (approximately):

34% UK
33% US
20% Europe (ex UK)
13% Rest of world

For the UK I chose a FTSE100 tracker (because dividend yield seems typically higher than FTSE All-share)

For Europe I chose a FTSE Developed Europe ex UK Index tracker.

For the US I was going to choose an S&P500 tracker, but...

...For Rest of the world I chose a World index tracker. However, I found that they tend to be approximately 50% weighted to US shares, so I did not need a separate US fund.

I worked out contribution levels for the 3 funds (UK, Europe, World) so as to approximately match the above percentages. But...

...It just occurred to me that although I now have much greater diversification, albeit within one asset class (equities), I don't have much flexibility. For example, if the US booms and EM (Emerging Markets) falls, I can't sell some US and buy some EM because they are both covered in the one fund (the World index tracker). In effect, it is difficult to rebalance. I did look for a "World ex US Index" type fund but couldn't find anything.

What I'm now wondering is...

...Should I abandon the World index fund and instead split the money between several other trackers (e.g. US, Japan, Pacific ex Japan, Emerging Markets)?

Is there any point in having one fund that covers the whole world? (simplicity, plus more diversified & less volatile maybe?)

I did consider some lifestyle / multi-index fund-of-funds type funds, but they seemed to be quite heavily weighted towards the US, which I feel slightly uncomfortable about because it seems to me like a lot of "buy high" at the moment (just my layman's opinion). To put this in perspective, my opinion is that currently: the US is relatively high, UK neither high nor low. Not sure about Europe and rest of world but from what other people say, they seem more like low or medium rather than high at the moment.

Note: the above applies to my intended future ISA contributions. I've not yet decided whether to transfer the money that I've already invested in the FTSE All-share tracker into a more diversified fund (or funds). I think I'll keep it invested in the FTSE All-share tracker for the time being.

Thanks.

PS: I recently ordered a copy of "Smarter Investing" (by Tim Hale), based on what people have said on this forum. It's not arrived yet but I look forwards to reading it.

Disclaimer: I am not an expert. My comments are my opinions only and should not be taken as advice. Any information I post may or may not be correct, and should therefore not be relied upon as fact. If you act on anything I post here you do so entirely at your own risk. I do not accept any liability.

Ryan_Futuristics · 9 January 2015 at 10:16PM

I'd actually say the past 6 years or so have been about as good as it gets for passive investing strategies - and this is partly why they dominate the popular narrative at the moment

I'd absolutely agree re: investing in separate Japan, Asia, N.American funds - the advantage is you can build a position gradually, e.g. buying what's cheap this year (emerging and europe) and avoiding what's expensive (n. america)

But then I'd add: don't stick with a passive strategy on religious principle ... In some regions (e.g. Europe and smaller companies) active management is a clear winner, whereas in others (e.g. N.America) passive generally gives you better long-term odds because of their lower fees

The big concern at the moment is that slowing developed markets (buoyed by years of QE) could enter a prolonged sideways period - we've just seen a year in which the FTSE 100's been flat (and it's been pretty flat since 1999)

So the best investment strategy may be one which can still appreciate in challenging markets - and many professional investors are recommending taking a slightly more active role in portfolio management: adding to funds on dips rather than maintaining a drip-feed investment strategy

This chart could be a very useful resource for investors tempted to look for value - but I'd always recommend having at least half of your fund long (untouched) in quality equities, while pursuing potentially higher returns in the mid-to-long-term from undervalued regions and sectors

http://www.starcapital.de/research/stockmarketvaluation?SortBy=Shiller_PE

Personally I like Tim Hale's book, but I wouldn't take anything as 'gospel' - the popular opinions dominating today will simply reflect what's worked over the previous decade ... And as we've seen, no two decades tend to be particularly alike

Active/passive, value/growth/momentum, diversified/conviction ... I think there are good rationales for pursuing multiple approaches, whilst keeping things as simple as possible

Sobryma · 10 January 2015 at 11:36AM

If you dig into World Index funds it is actually very difficult to find a real world index fund, most for example either appear to miss Emerging Markets or Smaller cos. As my main managed pension is UK dominated I use in my work pension an International fund as a core and then tilt to regions I like usually on a perceived value basis.You can also look to REIT, commodity, gilts etc. to help diversify.

enthusiasticsaver · 10 January 2015 at 11:48AM

Is there any reason why you have chosen to go for purely equities rather than multi asset (including corporate bonds, gilts etc?)

InvestInPoker · 10 January 2015 at 12:25PM

Is there any point in having one fund that covers the whole world?

The reason to go for a single fund solution like something that tracks the MSCI World index or possibly a vanguard lifestrategy type thing is simplicity and ease of use. You never have to worry about rebalancing it either.

Should I abandon the World index fund and instead split the money between several other trackers (e.g. US, Japan, Pacific ex Japan, Emerging Markets)?

If you don't go the single fund route you can tilt your portfolio as you want. As you already pointed out things like MSCI World miss out on things like smaller companies/emerging/frontier market exposure. Also it is probably cheaper if you buy separate index funds for each part of the developed world rather than the one world index fund (which tend to be slightly higher in costs than the individual parts).

If you take separate funds for everything it is much better imo. You can add the spicier elements as you please. Personally I am in for the very long haul and have added plenty of smaller company, emerging and frontier exposure to my own.

I did consider some lifestyle / multi-index fund-of-funds type funds, but they seemed to be quite heavily weighted towards the US, which I feel slightly uncomfortable about

That's fine and I am not going to get into arguments about how ones portfolio should be tilted at the moment, but the US does make up roughly 50% of the worlds capitalisation so what you are seeing is not "heavily weighting" it is merely the current market weighting. If you invest in separate funds you could underweight the US as much as you choose but less than 40% would be definitely under representing uncle sam compared to his world standing.

PS: I recently ordered a copy of "Smarter Investing" (by Tim Hale), based on what people have said on this forum. It's not arrived yet but I look forwards to reading it.

Extremely good book based on solid foundations. You will love it I can tell!

Also and to Ryan Futuristics post

Personally I like Tim Hale's book, but I wouldn't take anything as 'gospel' - the popular opinions dominating today will simply reflect what's worked over the previous decade ... And as we've seen, no two decades tend to be particularly alike

The point of Hales book actually is he takes nothing he is told as gospel. Neither does he take "popular" opinions (nor should anybody with intelligence take an opinion just because its popular), his advice is based on absolute mathematics and fact.

but

Active/passive, value/growth/momentum, diversified/conviction ... I think there are good rationales for pursuing multiple approaches, whilst keeping things as simple as possible

Completely agree and on the age old Active/Passive debate I also use both (go Neil Woodford).

jimjames · 10 January 2015 at 12:39PM

enthusiasticsaver wrote: »

Is there any reason why you have chosen to go for purely equities rather than multi asset (including corporate bonds, gilts etc?)

I'm the same, I couldn't see point in bonds when I've got 25 years plus timescale.

InvestInPoker · 10 January 2015 at 12:46PM

jimjames wrote: »

I'm the same, I couldn't see point in bonds when I've got 25 years plus timescale.

Exactly the same here. I am staying 100% Equities in my investment portfolio until I have <20 years left on my timescale. From then on I will introduce safer investments gradually until its a 50/50 balance on my stop working and put feet up forever more date.

MrMartyn · 10 January 2015 at 1:24PM

Hi All. Here are some replies to your replies......

Ryan Futuristics

- Thanks for your detailed reply. I didn't mention in my original post that I first started investing in the FTSE All-share tracker in the year 2000 for about 1 year before I had to stop due to being out of work. I suppose I bought in near the top, hence the disappointing returns over the following years. I never thought the FTSE 100 would still not have exceeded the level it reach during the dot-com boom even 15 years later. Of course I've had the dividends reinvested (minus charges) but that doesn't amount to much. I might have been better off putting that money into a savings account instead since the interest rates were better back then!

Where you mention:

"adding to funds on dips rather than maintaining a drip-feed investment strategy"

... I have invested some modest lump sums occasionally when the market has dipped, whilst still allowing my monthly ISA contributions to go in. All the while I still remember the well known sayings:

"Timing the market is a mug's game!"
"Time in the market, not timing the market!"

I'm not keen on managed funds due to having read that: apparently the vast majority of managed funds fail to beat the index over more than about 3 years, and I'm not lucky enough to pick one of the few managed funds that does. My main concern about index trackers though, is that apparently they don't do as well in less developed economies (e.g. Emerging Markets) as they do in developed economies (e.g. US, UK).

Sobryma

- Thanks for your comments.

enthusiasticsaver

- I suppose the reason is that I believe that equities tend to out-perform bonds and gilts in the long term. Also I've read comments in recent years that have suggested that the bond market is in a bubble at the moment. Then again, there seems to be a lot of bubbles nowadays.

InvestInPoker

- Thanks for your comments. Regarding what you say:

"The reason to go for a single fund solution like something that tracks the MSCI World index or possibly a vanguard lifestrategy type thing is simplicity and ease of use. You never have to worry about rebalancing it either."

... I did think that simplicity & ease of use would be the main reason. One idea I had was to buy-on-the-dips in something like a FTSE100 tracker (since I'm quite familiar with the FTSE100) and then when it's showing a good profit, sell some of my holding and transfer the money into a World index tracker fund in the hope of "locking in my gains" for the long term. Of course, I know that my gains would not be actually locked in because markets can fall as well as rise. What do you think of that idea? Is a World index tracker likely to be more stable and will it grow as well?

I do wonder if my urge to find better returns might ultimately lead to lower returns (in other words: maybe I should just stick with a FTSE 100 or FTSE All-share tracker). I had a lot of faith in FTSE 100 & FTSE All-share trackers after reading the Motley Fool book, because it seemed well reasoned and backed up by a lot of research. They mention the Barclays Capital Equity-Gilt study and state an impressive figure for average annual return from British shares. I don't know how other region/country markets track records compares with that. Then again, we seem to be in a long period where the the UK market is delivering much lower returns and who knows how long that will last?

Ultimately, by trying to trade/re-balance, I might unwittingly become my own "active" fund manager, albeit with index funds rather than individual securities.

jimjames

- Thanks for your comments.

Thanks All. I've enjoyed reading your comments.

Disclaimer: I am not an expert. My comments are my opinions only and should not be taken as advice. Any information I post may or may not be correct, and should therefore not be relied upon as fact. If you act on anything I post here you do so entirely at your own risk. I do not accept any liability.

InvestInPoker · 10 January 2015 at 1:36PM

MrMartyn wrote: »

InvestInPoker

One idea I had was to buy-on-the-dips in something like a FTSE100 tracker (since I'm quite familiar with the FTSE100) and then when it's showing a good profit, sell some of my holding and transfer the money into a World index tracker fund in the hope of "locking in my gains" for the long term. Of course, I know that my gains would not be actually locked in because markets can fall as well as rise. What do you think of that idea? .

I think you sound like a gambler.

Don't think about "locking" in profit or any rubbish like that. Read Tim Hales book, decide on how much risk you want to handle and how long a time period you have and invest accordingly in the right products for you.

Personally you sound like a pretty clued up intelligent guy who is hungry to learn about all of this. I think you will be happier with a multi fund portfolio that you rebalance yourself as you go on but that's just a guess. A world index fund will be lower volatility than a pure UK index fund (although in the big scheme of things, a world index fund is still a highly volatile choice of investment).

ExMugPunter · 10 January 2015 at 2:17PM

MrMartyn wrote: »

[/INDENT] My main concern about index trackers though, is that apparently they don't do as well in less developed economies (e.g. Emerging Markets) as they do in developed economies (e.g. US, UK).

We certainly hear that a lot, but is it actually true?

gadgetmind · 10 January 2015 at 3:51PM

Some EM funds beat trackers, some don't. If you feel lucky, spin the wheel and choose a fund, but don't go looking for one with recent (3-5 year) out-performance as that's using a lot of shaky assumptions.

Opinion on Index trackers, diversification, flexibility, rebalancing

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