Diversification across equities

Thrugelmir

underground99 said:

ChilliBob said:

Linton said:

I aim for my Growth 100% equity portfolio to be as widely diversified as possible.  I do not adopt a core/satellite approach, instead using a set of specific geographical based funds, both large and small companies.  The problem with a core index is that you start off in the wrong place with say US at 60%, the top 10 companies all in the same very few sectors with 14% of the entire portfolio.  The satellites then have an impossible job to smooth out this concentration of assets. 

That makes sense, I guess no matter the size of your pot if you have 80% in a global equities tracker then no amount of very specific allocation will tip that balance by much. What's interesting about all of this is what you, @Linton @Thrugelmir and @underground99 are saying about the concentration risk. On the one hand this makes perfect sense when you consider the make up of the index and how much you'd end up holding in FAANGs alone vs everything else. There's plenty of research to support this from various sources On the other hand you have the likes of Lars K and others stating that doing anything besides investing in the widest possible index is you declaring you have an edge and know more than the market! - It's a view point quite a few people have and again comes from various sources. As a new investor this does represent a question as to which camp you feel makes the most sense, I began this investing malarky quite firmly in the second camp, with Lars, Monevator etc being my main points of reference. Over time though, and especially over the last few months I feel I'm coming round more towards the other viewpoint.

 Lars K et al would say you are taking more risk if you underweight Apple and Amazon, and certainly you can see that your returns would have the potential to be very different if you didn't take them at market weight. 

That depends on the index being tracked. Major global indexes used are based on free float. 

ChilliBob

Thrugelmir said:

underground99 said:

ChilliBob said:

Linton said:

I aim for my Growth 100% equity portfolio to be as widely diversified as possible.  I do not adopt a core/satellite approach, instead using a set of specific geographical based funds, both large and small companies.  The problem with a core index is that you start off in the wrong place with say US at 60%, the top 10 companies all in the same very few sectors with 14% of the entire portfolio.  The satellites then have an impossible job to smooth out this concentration of assets. 

That makes sense, I guess no matter the size of your pot if you have 80% in a global equities tracker then no amount of very specific allocation will tip that balance by much. What's interesting about all of this is what you, @Linton @Thrugelmir and @underground99 are saying about the concentration risk. On the one hand this makes perfect sense when you consider the make up of the index and how much you'd end up holding in FAANGs alone vs everything else. There's plenty of research to support this from various sources On the other hand you have the likes of Lars K and others stating that doing anything besides investing in the widest possible index is you declaring you have an edge and know more than the market! - It's a view point quite a few people have and again comes from various sources. As a new investor this does represent a question as to which camp you feel makes the most sense, I began this investing malarky quite firmly in the second camp, with Lars, Monevator etc being my main points of reference. Over time though, and especially over the last few months I feel I'm coming round more towards the other viewpoint.

 Lars K et al would say you are taking more risk if you underweight Apple and Amazon, and certainly you can see that your returns would have the potential to be very different if you didn't take them at market weight. 

That depends on the index being tracked. Major global indexes used are based on free float. 

Can you explain what you mean by the last bit please? (sorry!)

Also, what do people make of the equal weight approach of some etfs? Surely a bit mental that something like Apple would habe equal weight to something pretty small that's just snuck into the index? I must be missing something! (There aren't many compared to market weight so I'm guessing they're not very popular for a reason) 

Thrugelmir

ChilliBob said:

Thrugelmir said:

underground99 said:

ChilliBob said:

Linton said:

I aim for my Growth 100% equity portfolio to be as widely diversified as possible.  I do not adopt a core/satellite approach, instead using a set of specific geographical based funds, both large and small companies.  The problem with a core index is that you start off in the wrong place with say US at 60%, the top 10 companies all in the same very few sectors with 14% of the entire portfolio.  The satellites then have an impossible job to smooth out this concentration of assets. 

That makes sense, I guess no matter the size of your pot if you have 80% in a global equities tracker then no amount of very specific allocation will tip that balance by much. What's interesting about all of this is what you, @Linton @Thrugelmir and @underground99 are saying about the concentration risk. On the one hand this makes perfect sense when you consider the make up of the index and how much you'd end up holding in FAANGs alone vs everything else. There's plenty of research to support this from various sources On the other hand you have the likes of Lars K and others stating that doing anything besides investing in the widest possible index is you declaring you have an edge and know more than the market! - It's a view point quite a few people have and again comes from various sources. As a new investor this does represent a question as to which camp you feel makes the most sense, I began this investing malarky quite firmly in the second camp, with Lars, Monevator etc being my main points of reference. Over time though, and especially over the last few months I feel I'm coming round more towards the other viewpoint.

 Lars K et al would say you are taking more risk if you underweight Apple and Amazon, and certainly you can see that your returns would have the potential to be very different if you didn't take them at market weight. 

That depends on the index being tracked. Major global indexes used are based on free float. 

Can you explain what you mean by the last bit please? (sorry!)

Free float is the shares available that can be openly traded on the markets. Excludes shares bound by restrictions, for example those granted to management where they are unable to sell for given periods. Or shares held by family trusts or related companies. 

underground99

ChilliBob said:

Thrugelmir said:

underground99 said:

ChilliBob said:

Linton said:

I aim for my Growth 100% equity portfolio to be as widely diversified as possible.  I do not adopt a core/satellite approach, instead using a set of specific geographical based funds, both large and small companies.  The problem with a core index is that you start off in the wrong place with say US at 60%, the top 10 companies all in the same very few sectors with 14% of the entire portfolio.  The satellites then have an impossible job to smooth out this concentration of assets. 

That makes sense, I guess no matter the size of your pot if you have 80% in a global equities tracker then no amount of very specific allocation will tip that balance by much. What's interesting about all of this is what you, @Linton @Thrugelmir and @underground99 are saying about the concentration risk. On the one hand this makes perfect sense when you consider the make up of the index and how much you'd end up holding in FAANGs alone vs everything else. There's plenty of research to support this from various sources On the other hand you have the likes of Lars K and others stating that doing anything besides investing in the widest possible index is you declaring you have an edge and know more than the market! - It's a view point quite a few people have and again comes from various sources. As a new investor this does represent a question as to which camp you feel makes the most sense, I began this investing malarky quite firmly in the second camp, with Lars, Monevator etc being my main points of reference. Over time though, and especially over the last few months I feel I'm coming round more towards the other viewpoint.

 Lars K et al would say you are taking more risk if you underweight Apple and Amazon, and certainly you can see that your returns would have the potential to be very different if you didn't take them at market weight. 

That depends on the index being tracked. Major global indexes used are based on free float. 

Can you explain what you mean by the last bit please? (sorry!)

FTSE and MSCI and S&P indexes are designed to be investible so they are not just weighted to company total value but to the amount of equity available in 'free float', i.e. what could practically be bought on the open market. 

So for example, Nike and McDonalds and Coca Cola are all about $170-230bn of market value, while Walmart is valued at $380bn.  However, half of Walmart is owned by the Walton family and they are not going to let it go. So the amount of Walmart in 'free float' is more like $190bn. In a portfolio listing of an S&P tracker fund, you'd see Coke at about position 30, Nike and McDonalds at about position 40, and Walmart in the middle at about #35.   

Walmart actually has a bigger total market capitalisation than Mastercard at about $360 bn (position 15 in the S&P500), but it has a lot less in 'free float' so when you are trying to measure how the market price of the companies in the index has moved, S&P would take almost twice as much notice of a move in Mastercard share price than a Walmart one - because it would affect the total value of share actually floating around to be bought and sold, more.

Likewise some of the Chinese companies are heavily owned by founding families or state owned, with a relatively small proportion of shares available for investors (esp. from outside China) to come and buy. So in a FTSE All-World index, Chinese entities only make up about 5% of the index, not much more than the UK (and about a third of that is just Alibaba and Tencent which have HK or US listings) whereas if you were on the ground in China you could add up the total market cap of all their companies and find a lot more.

Also, what do people make of the equal weight approach of some etfs? Surely a bit mental that something like Apple would habe equal weight to something pretty small that's just snuck into the index? I must be missing something! (There aren't many compared to market weight so I'm guessing they're not very popular for a reason) 

There are not many about, and if they had as much money to deploy as some of the massive cap-weighted tracking funds that operate in the US, the larger ones would perhaps struggle to deploy their capital on an 'equal weight' basis into some of the small companies. And if they did it over several thousand worldwide companies found in a global index, that would be a lot of small positions to maintain which is costly to administer if you periodically rebalance them.  But as a philosophy, you could say it's a bit mental that something like Apple would deserve 50x or 200x the weight of something else if they are both well-established public companies. An equal weight fund helps you end up with relatively more money in the smaller companies.

I hold a mid-cap fund IWFS which follows MSCS mid cap equal weight index.  It excludes the massive companies and the smallcaps and equal weights the ones in the middle. It doesn't literally try to put the same amount in Amazon as The Gap. But the billion dollars under management is split into (say) 0.11% slices and put into 900 companies.  Depending on what typical size of company exists on what stockmarket, its typical geographic spread is different to a capweighted index (e.g. it holds relatively a lot more Japan and a lot less US than the typical developed world tracker).

This type of index helps to spread some of the money that would have been piled into Apple etc down into the next tier of companies. As it rebalances twice a year it will have more transaction costs than a cap-weighted tracker that just sits there and has the company allocations ebb and flow. And management fees will be a bit higher than the simpler funds that require less maintenance. Still, if the smallcaps outperform the largecaps by 0.x% a year, that could cover the incremental costs. I have used it for a number of years for broad exposure even if it is an imperfect solution to investing in a broad range of holdings.  The megacaps will be covered by other funds (whether active or capweighted passive) and a more active (rather than indexed) approach is probably required for the smaller companies, so this seems a workable solution for mid-sized company holdings.

ChilliBob

Cheers @underground99 as always, a very insightful reply. I actually looked at the iShares mid-cap size fund earlier today:
https://www.ishares.com/uk/individual/en/products/270057/ishares-msci-world-size-factor-ucits-etf?switchLocale=y&siteEntryPassthrough=true
Is that the one you reference above despite the different code?
Regarding small caps, for the UK I'm looking into active managers - the likes of Marlborough, Premier Miton, TM Flemming etc, for the rest of the world I haven't considered if I'd need to use Active or Passive here really, I'd be keen to hear your (and others, of course) views of course. 

I figure if you swerve the active management for UK that leaves FTSE250 trackers really, which doesn't excite me too much compared to the active side of things here, although it's a damn sight more expensive of course.

underground99

ChilliBob said:

Cheers @underground99 as always, a very insightful reply. I actually looked at the iShares mid-cap size fund earlier today:
https://www.ishares.com/uk/individual/en/products/270057/ishares-msci-world-size-factor-ucits-etf?switchLocale=y&siteEntryPassthrough=true
Is that the one you reference above despite the different code?
Regarding small caps, for the UK I'm looking into active managers - the likes of Marlborough, Premier Miton, TM Flemming etc, for the rest of the world I haven't considered if I'd need to use Active or Passive here really, I'd be keen to hear your (and others, of course) views of course. 

I figure if you swerve the active management for UK that leaves FTSE250 trackers really, which doesn't excite me too much compared to the active side of things here, although it's a damn sight more expensive of course.

IWSZ listed on London stock exchange (sedol BP3QZD7) has its price listed in USD.
IWFS is the same priced in GBP with sedol BP3QZF9.  It's the same fund with the same performance, but to buy the USD-priced version your broker will need to buy dollars to do the trade and later sell the dollar proceeds to get pounds back for you, so it would cost you some forex commissions.

ChilliBob

Awesome, thanks for the clarity, much appreciated  

JohnWinder

ChilliBob said:

Also, what do people make of the equal weight approach of some etfs? Surely a bit mental that something like Apple would habe equal weight to something pretty small that's just snuck into the index? I must be missing something! (There aren't many compared to market weight so I'm guessing they're not very popular for a reason) 

They can have periods of better and worse performance compared to a cap weighted index, so I think they leave you open to regret (when they under-perform) and the danger that you'll change strategy at the worst time (while they're under-performing). There's no basis for regret with cap weighting (when it under-performs some other strategy) because you're getting market returns (less costs), and that's anybody and everybody's fair share, and because any other strategy will have its turn at under-performing on a risk-adjusted basis (because nothing out-performs the market indefinitely - or if it does, we can't identify it beforehand). One of the reasons postulated for the good performance of equal weighted funds is that they give more weight to small companies, and small companies have higher expected returns (because they're more risky).

Bailing out when the fund under-performs is not only bad for you, but it risks the fund closing as others do the same, leaving the die-hards stranded in a dead fund. I think tired old dogs just don't bother. Here's a couple of discussions:

https://www.bogleheads.org/forum/viewtopic.php?t=270182

https://www.bogleheads.org/forum/viewtopic.php?t=333146

Linton

JohnWinder said:

ChilliBob said:

Also, what do people make of the equal weight approach of some etfs? Surely a bit mental that something like Apple would habe equal weight to something pretty small that's just snuck into the index? I must be missing something! (There aren't many compared to market weight so I'm guessing they're not very popular for a reason) 

They can have periods of better and worse performance compared to a cap weighted index, so I think they leave you open to regret (when they under-perform) and the danger that you'll change strategy at the worst time (while they're under-performing). There's no basis for regret with cap weighting (when it under-performs some other strategy) because you're getting market returns (less costs), and that's anybody and everybody's fair share, and because any other strategy will have its turn at under-performing on a risk-adjusted basis (because nothing out-performs the market indefinitely - or if it does, we can't identify it beforehand). One of the reasons postulated for the good performance of equal weighted funds is that they give more weight to small companies, and small companies have higher expected returns (because they're more risky).

Bailing out when the fund under-performs is not only bad for you, but it risks the fund closing as others do the same, leaving the die-hards stranded in a dead fund. I think tired old dogs just don't bother. Here's a couple of discussions:

https://www.bogleheads.org/forum/viewtopic.php?t=270182

https://www.bogleheads.org/forum/viewtopic.php?t=333146

I suspect that given enough time you will find that nothing beats an equal weighted strategy or any other strategy applied consistently.  I haven't seen any evidence that there is something special about cap weighting. If there was it should be possible to prove it mathematically and the argument would be over.

In any case the objective of avoiding high concentrations in particular regions, sectors or individual companies is to reduce risk, not increase performance.  Though doing so may lead to higher portfolio performance - I am happier avoiding major single points of failure in my equity holdings and so have a higher % in my overall portfolio than would be the case if it was invested in cap weighted indexes.