Underweighting the US using index funds

aroominyork

JohnWinder said:

Linton said:

The only justification I can see for using market capitalisation is it reduces the costs of index funds. Is there another one?

Oh, yes. You don't have to endure multi-year periods of under-performance, compared to the whole market, trying to stay your hand from doing something stupid like changing strategies because of market peculiarities. And it's an uncomplicated, easy to understand investing approach that ordinary folk can feel confident will give them their share of the economic prosperity, without the drag of advisor fees (which at 0.5%/year for 40 years will reduce their final investment value by 17%).

Really well stated, and given the consistent rise of growth stocks/funds over the last decade, there are many of us who have not yet faced the challenge you describe. I consider myself lucky to have cut my self-investing teeth over the last 3-4 years in a benign environment, but I recognise that beating the market has been more good fortune than skill and I have moved the core of my holdings into index funds.

Prism

JohnWinder said:

Linton said:

The only justification I can see for using market capitalisation is it reduces the costs of index funds. Is there another one?

Oh, yes. You don't have to endure multi-year periods of under-performance, compared to the whole market, trying to stay your hand from doing something stupid like changing strategies because of market peculiarities. And it's an uncomplicated, easy to understand investing approach that ordinary folk can feel confident will give them their share of the economic prosperity, without the drag of advisor fees (which at 0.5%/year for 40 years will reduce their final investment value by 17%).

Selecting your own allocations is not as simple as a global market cap weighted fund but as long as someone accepts that their performance will different somewhat over time then surely that is exactly what they are looking for. Not to boost performance, although that might happen, but to reduce the risks of allocating too much into one region or industry and hopefully reduce the falls. This doesn't need to be expensive. There are passive funds for almost everything you need. In this example the perfect one of ex-US doesn't seem to be available but it can still be done with a small selection of regional funds - exactly the same way that Life Strategy or the Vanguard advisor service does it (which does charge the 0.5% fee but you could always copy yourself).

AlanP_2

This theme has moved from the advantages and disadvantages of cap-weighted index funds to the effect of a 0.5% adviser charge - Why?

The effect of a 0.5% adviser charge will be the same whatever the underlying investments are, it has no bearing on cap-weighted v ANO option.

So, what are the advantages of a cap-weighted index fund v an equal weighted index fund which are the most obvious direct comparators?

I would say "price" as the cap-weighted is likely to be a bit cheaper overall.

JohnWinder

Sorry, my sloppy attempt at brevity. I was trying to suggest that a 'vanilla' cap weighted global fund is so prominent in the pronouncements of the index investing protagonists like Krojer and Hales, and so available and established in the listings of the big fund management businesses, and so easy to understand in terms of merits and shortcomings, that most people could confidently adopt them as the basis for their life-long nvestments without needing to pay 0.5%/year to an advisor or DFM. I don't think I could be so confident about small-value cap funds or equal weighted ones. And a 1%/year advisor fee which we hear about here would take 30% off your final benefit.

aroominyork

AlanP_2 said:

So, what are the advantages of a cap-weighted index fund v an equal weighted index fund which are the most obvious direct comparators?

You seem to be comparing apples and pears. A cap weighted fund invests across a range of indexes. If you like small and mid caps, it might hold too little of them for your liking – Vanguard FTSE All Cap Index Fund invests (by Morningstar’s allocations) 17% in mid caps and 4% in small caps. An equal weighted product, by contrast, allocates an equal amount to all the companies within a single index, the most typical example being an S&P Equal Weight ETF (XDWE, although Morningstar mistakenly calls it XDEW), where you will invest as much in the smallest S&P constituent as in Apple.

Linton

JohnWinder said:

Linton said:

The only justification I can see for using market capitalisation is it reduces the costs of index funds. Is there another one?

Oh, yes. You don't have to endure multi-year periods of under-performance, compared to the whole market, trying to stay your hand from doing something stupid like changing strategies because of market peculiarities. And it's an uncomplicated, easy to understand investing approach that ordinary folk can feel confident will give them their share of the economic prosperity, without the drag of advisor fees (which at 0.5%/year for 40 years will reduce their final investment value by 17%).

1) Investing by some other allocation strategy than market cap weighting does not mean you have to endure multi-year periods of underperformance as, unless I have missed something, there is no evidence that investing by market cap provides higher performance than any other non-perverse sensibly applied equity asset allocation strategy.  My suspicion without any proof is that all such strategies over sufficient time will give much the same performance results.
2) For retired investors a 40 year time frame is pretty irrelevent especially as required income must be sustained over the short and medium term.
23 Maximum performance is not, in my view a sensible aim for serious investing.  Much better is sufficient performance at minimum risk.  It is here I believe that attention to asset diversification provides benefit.
4) Reductions of 17% of 40 years really are just noise.  There are relatively small decisions other than fees that have a far greater effect.  eg choosing VLS60 rather than VLS80 has reduced performance by about 2%/year on average. Over 40 years that is a reduction in return of about 50%.

AlanP_2

aroominyork said:

AlanP_2 said:

So, what are the advantages of a cap-weighted index fund v an equal weighted index fund which are the most obvious direct comparators?

You seem to be comparing apples and pears. A cap weighted fund invests across a range of indexes. If you like small and mid caps, it might hold too little of them for your liking – Vanguard FTSE All Cap Index Fund invests (by Morningstar’s allocations) 17% in mid caps and 4% in small caps. An equal weighted product, by contrast, allocates an equal amount to all the companies within a single index, the most typical example being an S&P Equal Weight ETF (XDWE, although Morningstar mistakenly calls it XDEW), where you will invest as much in the smallest S&P constituent as in Apple.

I don't think I am, as I am talking about comparing at the Index level (I should have made that clearer).

Your S&P Equal Weight v a S&P market-cap weighted index for example.

Both are passive strategies (after making the management decision about which to choose) that will track the Index so why is one inherently better than the other?

aroominyork

AlanP_2 said:

aroominyork said:

AlanP_2 said:

So, what are the advantages of a cap-weighted index fund v an equal weighted index fund which are the most obvious direct comparators?

You seem to be comparing apples and pears. A cap weighted fund invests across a range of indexes. If you like small and mid caps, it might hold too little of them for your liking – Vanguard FTSE All Cap Index Fund invests (by Morningstar’s allocations) 17% in mid caps and 4% in small caps. An equal weighted product, by contrast, allocates an equal amount to all the companies within a single index, the most typical example being an S&P Equal Weight ETF (XDWE, although Morningstar mistakenly calls it XDEW), where you will invest as much in the smallest S&P constituent as in Apple.

I don't think I am, as I am talking about comparing at the Index level (I should have made that clearer).

Your S&P Equal Weight v a S&P market-cap weighted index for example.

Both are passive strategies (after making the management decision about which to choose) that will track the Index so why is one inherently better than the other?

OK, gotcha - I misread. It's an interesting question whether there is a theoretical basis for whether S&P500 or S&P500 equal weighted will, costs aside, outperform over time. Not one I can answer. But here is their performance since 2014: cap weighted in blue, equal weighted in red.

Thrugelmir

aroominyork said:

AlanP_2 said:

aroominyork said:

AlanP_2 said:

So, what are the advantages of a cap-weighted index fund v an equal weighted index fund which are the most obvious direct comparators?

You seem to be comparing apples and pears. A cap weighted fund invests across a range of indexes. If you like small and mid caps, it might hold too little of them for your liking – Vanguard FTSE All Cap Index Fund invests (by Morningstar’s allocations) 17% in mid caps and 4% in small caps. An equal weighted product, by contrast, allocates an equal amount to all the companies within a single index, the most typical example being an S&P Equal Weight ETF (XDWE, although Morningstar mistakenly calls it XDEW), where you will invest as much in the smallest S&P constituent as in Apple.

I don't think I am, as I am talking about comparing at the Index level (I should have made that clearer).

Your S&P Equal Weight v a S&P market-cap weighted index for example.

Both are passive strategies (after making the management decision about which to choose) that will track the Index so why is one inherently better than the other?

OK, gotcha - I misread. It's an interesting question whether there is a theoretical basis for whether S&P500 or S&P500 equal weighted will, costs aside, outperform over time. Not one I can answer. But here is their performance since 2014: cap weighted in blue, equal weighted in red.

The divergence from 2016 is well documented and comprehendible with hindsight. 

JohnWinder

Linton said:

JohnWinder said:

You don't have to endure multi-year periods of under-performance, compared to the whole market, trying to stay your hand from doing something stupid like changing strategies because of market peculiarities. And it's an uncomplicated, easy to understand investing approach that ordinary folk can feel confident will give them their share of the economic prosperity, without the drag of advisor fees (which at 0.5%/year for 40 years will reduce their final investment value by 17%).

1) Investing by some other allocation strategy than market cap weighting does not mean you have to endure multi-year periods of underperformance as, unless I have missed something, there is no evidence that investing by market cap provides higher performance than any other non-perverse sensibly applied equity asset allocation strategy.  My suspicion without any proof is that all such strategies over sufficient time will give much the same performance results.
....
4) Reductions of 17% of 40 years really are just noise.  There are relatively small decisions other than fees that have a far greater effect.  eg choosing VLS60 rather than VLS80 has reduced performance by about 2%/year on average. Over 40 years that is a reduction in return of about 50%.

Agree; any approach might go on to out- or under-perform any other. My clumsy sentence was trying to say that should under-performance happen with one's 'out of the ordinary' (any deviation from whole market cap weighting), one has to resist the temptation to 'just go back to the ordinary' where there's safety in numbers (a lot of other people in the same boat). Not everyone's mindset is prone to that, but enough for me to put it up as an issue to be aware of.
I wouldn't say a reduction of 17% is just noise. And if you can manage your own simple, market tracking portfolio, it's free money. Getting better returns from VLS80, than VLS60 isn't free money, it comes with more risk.