Why Vanguard's Tracking Error?

minimumcost

dunstonh said:

1. If the UK is crap now

UK Large Cap has been crap for over 25 years.    Where the UK does well is small and mid cap. Although they have had a drag on them since the Brexit referendum but not as much as the UK general market.

1. If the UK is crap now and I'm already in it then staying in makes some sense even though I'm and avid 'you can't time the market' guy.... but...

If there are no cost issues or tax issues then you should be invested today in the same way you would be if you were putting the money in for the first time today.   No point waiting.

2. Monitor it until it goes up then switch to a cheaper than Vanguard, but like-for-like fund.

In the meantime, the alternative has gone up by more and you wish you had done it earlier.

That's a very good way of putting what I was trying to argue with my daughter today.... basically that it is foolish to think the UK might go up relative to the rest ROW just because it has gone down to date... exacerbated by discounting the fact that the short term market may be more a measure of investor sentiment than underlying corporate performance. However, as a long term investor if I invest in the GBP and take income out in GBP to buy things in GB am I not better of with a UK bias?

Another_Saver

minimumcost said:

dunstonh said:

1. If the UK is crap now

UK Large Cap has been crap for over 25 years.    Where the UK does well is small and mid cap. Although they have had a drag on them since the Brexit referendum but not as much as the UK general market.

1. If the UK is crap now and I'm already in it then staying in makes some sense even though I'm and avid 'you can't time the market' guy.... but...

If there are no cost issues or tax issues then you should be invested today in the same way you would be if you were putting the money in for the first time today.   No point waiting.

2. Monitor it until it goes up then switch to a cheaper than Vanguard, but like-for-like fund.

In the meantime, the alternative has gone up by more and you wish you had done it earlier.

That's a very good way of putting what I was trying to argue with my daughter today.... basically that it is foolish to think the UK might go up relative to the rest ROW just because it has gone down to date... exacerbated by discounting the fact that the short term market may be more a measure of investor sentiment than underlying corporate performance. However, as a long term investor if I invest in the GBP and take income out in GBP to buy things in GB am I not better of with a UK bias?

Your last question is hotly debated. While Lars Kroijer (kroijer.com) does help explain investing for newer and more amateur retail investors, he has this idea that because your life and house and job and bank account are all concentrated in one country, you should try and get your investments - the one thing you can easily globalise - out of the country. To me that makes no sense.

A global portfolio has its place from a diversification standpoint - the global stock market tends to be less volatile than any single country's stock market - and protects against single country risks like Brexit, the double whammy of being hit hard by Covid healthwise and economically, and the greater that "old" industries like oil, gas, banks and miners hold in the UK large cap market vs the global market. Having a global portfolio is not a necessity, but it is generally considered more sensible and less risky than a more UK-weighted portfolio. Also, no-one knows which way currencies are going to move and the effects of currency changes tend to make little difference in the long-run.

Both the UK large cap (and 80% of the UK is categorised as large cap, within the FTSE 100) and global markets are very correllated, and had very similar returns until the Brexit referendum. And you are right that just because the UK has done crap lately does not mean it is necessarily going to catch up (I think it will, but because of the significantly lower valuations). 3/4 of FTSE 100 earnings come from overseas and the FTSE 100 tends to behave more like the global market (apart from the last 4 years) than the FTSE 250, which is much more domestically-oriented. So by buying VLS 100 because of the extra UK exposure, you aren't really getting more £ bias.

Worked example: say... 5% (that's a guess) of the earnings of global companies outside the UK come from imports into the UK, and 30% of UK company earnings come from within the UK (25% of FTSE 100 earnings, 50% of FTSE 250 earnings). In the global all cap, if the UK makes up 5% of the fund, then 30% of 5% = 1.5%, and 5% of 95% = 4.75%, so 1.5% + 4.75% = 6.25% of that fund's earnings are in £. In VLS 100, the UK makes up 25% of the fund, 30% of 25% = 7.5%, and 5% of 75% = 3.75%, 7.5% + 3.75% = 11.25% of the VLS 100's earnings come from within the UK.

You could buy a FTSE 250 index fund, but that's another issue and I would suggest researching it to understand what it is, how it behaves, and why it has outperformed the FTSE 100 since the Millennium before making an investment decision as it can be (sometimes much) more volatile than a global equity index fund and your returns are much more dependant on and tied to the success of the UK.

For a set and forget retirement fund, either VLS 100 or the Vanguard FTSE Global All Cap (HSBC FTSE All World would be even cheaper) are both fine. Personally I would prefer VLS 100 because of the extra home bias which I think can do a little better over the next decade or so, others see the UK large cap (and with VLS 100, 80% of that extra UK exposure you're buying is large cap) as a value trap full of dinosaur companies in dying industries that will never recover.

bowlhead99

minimumcost said:
 However, as a long term investor if I invest in the GBP and take income out in GBP to buy things in GB am I not better of with a UK bias?

Much of what you 'buy in GBP' will have a non-GBP related cost base.

You go to a UK dealership and pay pounds for a car made out of aluminium (which was priced globally in USD) and built at a plant in France or Poland or Turkey or Japan or Korea where the employees are paid in Euros or Zloty, Lira or Yen or Won. 

You buy a name-brand iron from Phillips in the Netherlands (EUR cost base) and a washing machine sold by a German company (EUR) who outsource their manufacturing to Hungary (HUF).

Your bananas and oranges and avocados aren't grown in the UK so your pounds are converted behind the scenes to buy whatever currency the grower wants, and the relative strength of the currencies determines your price.

Your cleaner wants a pay rise because she is sending a portion of her wages back to her mum in Romania or Portugal and the combination of the Leu or Eur exchange rate and the local inflation in that country means that her mum's rent  now costs more pounds.

The price of your takeaway curry is impacted by how many people who can efficiently work the local Indian restaurant's kitchen (because they speak bengali or urdu or hindi and simply interact better with their co-workers for that reason) are minded to apply for jobs there, mindful of what their wage would translate to when sent back to their extended family back home (INR).

Your gardening is done by a fellow who spends most of his money on European lager and US-headquartered Netflix subscriptions and although the price he pays for those goods and services is in pounds, it's derived from a foreign cost base multiplied by the current exchange rate, so now he doesn't want to work for just £10 an hour, it's £12. Still, you pay him in pounds and don't take any interest in why he wanted the £12 (which related to EUR or USD / GBP fx rate), you just accept that gardening is getting expensive these days.

You back up your computer to cloud storage in Indonesia  (IDR) while checking the time on your Swiss watch (CHF) to see whether the skin on your roasted New Zealand (NZD) lamb is likely to have got crispy yet, at the same time as your direct debit goes out to Kaspersky in Russia  (RUB) for your antivirus subscription while ordering something cheap online which required a design developed by the Americans (USD) with manufacturing and shipping capability from China (RMB/CNY). While sitting around you look into whether your next TV or smartphone should be built in Taiwan (TWD) or Japan (JPY) or China (CNY) or Korea (KRW) or from a US brand (USD) that outsources the circuit board manufacture to Vietnam (VND) while keeping the intellectual property rights for itself.

Sure, you can tell yourself that you are a Brit and that you damn well better have pounds for your retirement because every purchase on your debit card will be in pounds, but really if the GBP depreciates relative to those other currencies, your retirement will be expensive. If you own shares in international companies, you will simply use some dividends or sale proceeds of your shares in Samsung to buy your Korean TV or smartphone and some of your shares in Microsoft or Google to pay for your trip to the cinema to see some American-produced blockbuster and some of your shares in Volkswagen, Porsche, BMW or Renault to pay for some German pills from the pharmacy or a holiday to Spain, and some of your shares in Nestle to fund your last ski trip to Switzerland while relying on Essilor Luxotica (EUR) to pay for your reading glasses or Oakley, Raybans or Transitions sunglasses and Sonova (CHF) to get you a top of the range hearing aid.

What you might find is that of what you buy in retirement, 95% or more of it is literally priced in pounds, *but*  95% of the business activities whose costs wind up feeding into the final price in pounds come from other countries, and therefore that pounds price is influenced by how many EUR or USD or CNY the suppliers want to receive. A typical world equities tracker fund which allocates no more than a few percent to the UK stockmarkets (of which less than half of that UK stockmarket value comes from UK-operating and UK-facing companies) is not necessarily going to be a bad way to fund a retirement in the globalised world we have today.

Remember when you buy a loaf of bread in retirement, the pound you want to buy it with will be competing with your neighbour's pound to buy the same loaf. If he doubled his money in pounds terms by investing internationally while sterling devalued, he will be able to offer two pounds for the loaf, so even though you didn't lose anything by investing domestically and your grew your pound to £1.50, you are still at a disadvantage when you go to the baker at the end of the road and the baker says I only have one freshly-baked loaf left, who wants it?

Of course, you don't know if your pound will appreciate or depreciate over time. Still, if you introduce bias (home bias or away bias), you are saying you're placing a bet in which you reckon it's better to invest heavier towards one way or the other. If you are in that situation that you want to make a call one way or another, most people would probably go 'home'. Some will pick that due to patriotism ('UK is best'), or research ('I have looked into it and UK equities have cheaper prices and I think pricing will revert to long term averages so UK should do better') or simply ease of use / naivety  ('I don't know, but home sounds easier'). As long as you have some sort of rationale for it and don't feel you will kick yourself too hard if you are proved wrong by the passage of time, no harm done.

minimumcost

As an ab initio investor I find this thread very interesting. Let me tell you two stories:

1. I was a big ticket sales guy for a high growth software companies that sold $multi-million packages to big name global corporates. When I had a huge deal on the go I'd get calls from investment analysts trying to get insight to peddle to their investor clients. They pressed me with question to which I had no idea what the answer might be or, that due to SEC rules, I was prohibited from answering. I'd give them some spurious poorly considered opinion that the following day would appear on Bloomberg (and the like) word-for-word quoted as their expert opinion. On the strength of this utter BS whole market sectors moved by $BN's. So, even if there is someone out there that has the right knowledge, understanding, or academic research the shear weigh of crap wipes it out. Dave, my VAR friend, introduced me to the works of  Kahneman and Tversky and Nichols Taleb that told me markets trade the way they do because humans are very bad at understanding probability.

2. One of the companies I worked for was, at the time, the world largest trading platform supplier. I noted that while the traders dealt on their own account the VAR guys never traded. Their job is to try and describe everything in pure enumerated logical terms. I asked one of them why they never traded. He told me the traders believed they know how to outwit probability, but the numbers always, without exception, said you can't, if they win it's dumb as luck ... and that the purpose of the organization was to act on behalf of clients and take a cut of every deal irrespective of its direction.

Consequently, my opinion now is that people will probably live for a certain length of time during which they may have money to invest and time to live of the proceeds. The variance on these two period is very small compared to the short term variance in market movements. Second, over the typical life time of a person companies will be striving to make profits and governments around the world will be making different decisions making it better or worst for their local companies to make profits. This means that over that period and every period for a very long time the profits returned to investors have always been better than any other generally available asset class, and with very little variance in the returns. Therefore, investing in a portfolio representative of global companies is on the balance of probability the only purely logical decision to make. Please cite me wrong?

minimumcost

For a set and forget retirement fund, either VLS 100 or the Vanguard FTSE Global All Cap (HSBC FTSE All World would be even cheaper) are both fine. Personally I would prefer VLS 100 because of the extra home bias which I think can do a little better over the next decade or so, others see the UK large cap (and with VLS 100, 80% of that extra UK exposure you're buying is large cap) as a value trap full of dinosaur companies in dying industries that will never recover.

Good answer. Say one agrees that the UK will do better over the next decade. It may be because recent events have dragged it down and that people, the same kind of people that exist all over the world and that run companies, will be trying hard to recover (i.e. regressing to the mean), Then surely the rebalancing nature of a tracker fund will replace the dinosaurs with newer better performers. Therefore if you have a decade or so to be invested is VLS 100 not the better choice than a less UK weighted option. I.e. you're exploiting the luxury of have a long time to wait in a markets that's dominated by shorter term traders.

Another_Saver

minimumcost said:

As an ab initio investor I find this thread very interesting. Let me tell you two stories:

1. I was a big ticket sales guy for a high growth software companies that sold $multi-million packages to big name global corporates. When I had a huge deal on the go I'd get calls from investment analysts trying to get insight to peddle to their investor clients. They pressed me with question to which I had no idea what the answer might be or, that due to SEC rules, I was prohibited from answering. I'd give them some spurious poorly considered opinion that the following day would appear on Bloomberg (and the like) word-for-word quoted as their expert opinion. On the strength of this utter BS whole market sectors moved by $BN's. So, even if there is someone out there that has the right knowledge, understanding, or academic research the shear weigh of crap wipes it out. Dave, my VAR friend, introduced me to the works of  Kahneman and Tversky and Nichols Taleb that told me markets trade the way they do because humans are very bad at understanding probability.

2. One of the companies I worked for was, at the time, the world largest trading platform supplier. I noted that while the traders dealt on their own account the VAR guys never traded. Their job is to try and describe everything in pure enumerated logical terms. I asked one of them why they never traded. He told me the traders believed they know how to outwit probability, but the numbers always, without exception, said you can't, if they win it's dumb as luck ... and that the purpose of the organization was to act on behalf of clients and take a cut of every deal irrespective of its direction.

Consequently, my opinion now is that people will probably live for a certain length of time during which they may have money to invest and time to live of the proceeds. The variance on these two period is very small compared to the short term variance in market movements. Second, over the typical life time of a person companies will be striving to make profits and governments around the world will be making different decisions making it better or worst for their local companies to make profits. This means that over that period and every period for a very long time the profits returned to investors have always been better than any other generally available asset class, and with very little variance in the returns. Therefore, investing in a portfolio representative of global companies is on the balance of probability the only purely logical decision to make. Please cite me wrong?

It's your decision, what matters is that you are confident and comfortable in it and won't doubt it or regret it.
That said, what you've said in the quoted post seems entirely logical, rational, reasonable and sensible. I've heard people say things like "I only invest in emerging markets because China is the future" so it's refreshing to see an "ab initio" investor skip through the many layers of badly understanding how things work to reach the serene plateau of accepting that a global index fund is the least unlucky way to do it.

minimumcost said:

For a set and forget retirement fund, either VLS 100 or the Vanguard FTSE Global All Cap (HSBC FTSE All World would be even cheaper) are both fine. Personally I would prefer VLS 100 because of the extra home bias which I think can do a little better over the next decade or so, others see the UK large cap (and with VLS 100, 80% of that extra UK exposure you're buying is large cap) as a value trap full of dinosaur companies in dying industries that will never recover.

Good answer. Say one agrees that the UK will do better over the next decade. It may be because recent events have dragged it down and that people, the same kind of people that exist all over the world and that run companies, will be trying hard to recover (i.e. regressing to the mean), Then surely the rebalancing nature of a tracker fund will replace the dinosaurs with newer better performers. Therefore if you have a decade or so to be invested is VLS 100 not the better choice than a less UK weighted option. I.e. you're exploiting the luxury of have a long time to wait in a markets that's dominated by shorter term traders.

Im 27 and I upweight the UK a lot more than that, all the way upto 2/3 of my portfolio (well it was 2/3, but I bought a few Teslas over the last couple of years and the price went mad this year so now I'm only 60% UK) which an investment professional might call a "high conviction portfolio".

From your earlier post it sounds like you've already talked yourself into a global index fund. That (arguably) takes all the stress, worry, doubt, potential for regret out of it - buy the world and sit on it for life. A tracker fund, more specifically a plain index fund, doesn't do the replacing of the old with the new, the market and economy does that and a tracker fund is simply a way to access/capture/track that natural growth, the fund doesn't do anything, it is just a means/portal/vehicle through which you can "buy the world" (if you're talking about a global index fund).
I suddenly feel like singing The Circle of Life, god I miss Karaoke...