Transfer from management of investments in active Wealth Manager to Vanguard passive funds

Linton

JohnWinder said:

Dont try to predict anything to do with the markets.  The important thing is to ensure is that if it is a reasonable possibility  that US large stocks do perform badly the portfolio as a whole  is not too badly hit. So constraiun the % of your portfolio you put into them and leave room for allocations elsewhere.

If you hold the market, cap weighted, you’ll take a bigger hit if the whole market falls than I will if I hold less of those mega cap US stocks which contribute a lot to the total capitalisation of the market. Yes, indeed. Or, if those big US stocks alone have a bad run, you’ll do especially badly.

Dont try to predict anything to do with the markets.

To be wary of those big cap US stocks I would be predicting that one segment of the market will behave in a particular way, mais non?

You merely need to predict that some event could particularly hit one market segment, not that it will.  There is strong evidence that it could from the fact that it has in the past 25 years.

GeoffTF

Linton said:

GeoffTF said:

Linton said:

GeoffTF said:

Linton said:

GeoffTF said:

bundoran said:

GeoffTF said:

dunstonh said:

GeoffTF said:

dunstonh said:

Aminatidi said:

One reason.

Also a bit of personal psychology there where I'm trying to move towards passives and rightly or wrongly Vanguard not having 3000 active funds minimises the occasional urge to tinker

But Vanguard doesn't have the best or cheapest trackers in every area.  So, limiting yourself to just them could compromise the outcome.

Vanguard's trackers are as good as any. The cost of the platform will usually be more important than a small difference in the OCF. Transaction costs cannot be compared between providers because there is no standard method of calculation. You do not need trackers "in every area". Adding more of them will not increase your chances of a good outcome.

I never said you needed trackers in every area.   

However, Vanguard do have one of the largest range of trackers in non-core areas.   They are just not as low cost in core areas compared to other fund houses.

If charges are a driver behind the decision, as they are in this thread, then restricting yourself to Vanguard trackers only increases your charges.

The vast majority of Vanguard funds are aimed at speculators who believe that a particular market or sector will outperform. 

The vast majority of Vanguard funds are aimed at long term passive investors who want to invest in either the whole world, the developed world, or regions of the world in a proportion which they have chosen and are comfortable with for their own reasons; or people who wish to invest in a mixed asset fund like Lifestrategy.

To say that these passive funds and mixed asset funds - which make up the vast bulk of Vanguard's offering - are "aimed at speculators" is asinine.

Choosing "regions of the world in a proportion which they have chosen and are comfortable with for their own reasons" is speculation. That is not what Jack Bogle advocated. I have not said that Vanguard is wrong to offer those funds.

As for your last sentence, kindly quote me accurately and be polite.

Nonsense in my humble opinion.  Choosing not to invest more than 60% of one's life savings in one single country whose returns are dominated by one or two sectors which are in turn  dominated by a handfull of massive companies seems to me to be taking a prudent approach rather than speculation.

What matters most here is diversification between companies, not countries. For the most part, the political boundaries are irrelevant. Companies can incorporate wherever they choose. They can derive most of their earnings overseas. Moving their headquarters does not change much. There can be relevant differences. Local taxation can be different, for example, but that should be reflected in the share price. There are special considerations for Emerging Market companies, but they should also be reflected in the share price.

If a company decided to incorporate in New York, rather than Canada, I would not reduce its weighting because of that.

The home market is an exception, because UK company dividends are not subject to withholding tax, for example. There are rational reasons for a home bias.

Countries can be a proxy for quite different sector asset allocations and differences in style. Hence they are also a single point of failure. Look at the US markets in the tech boom/crash era.

 

Professional investors try to exploit that. There is abundant evidence that they do not have more than chance success. Bogle would have asked why you believe that you are more capable of pricing market sectors than them. He would not have advocated under-weighting the tech stocks.

The objective is to achieve sufficient real long term return at minimum risk, not to maximise return. My belief is that all well diversified sensibly managed portfolios will achieve much the same long term returns. I agree that attempts to achieve higher long term returns than this are on average likely to fail. However different allocations will have different short/medium term behaviours.

I see nothing magic about a market capitalisation based portfolio. Its only advantage is the low cost of implementation, the downside is restricted diversification being over dependent on a small number of closely related companies and susceptibility to over-enthusiastic speculation in high risk areas.

Why do you feel it necessary to rely on support from gurus? Surely your arguments should be defensible on their own.

As I have said, financial theory tells us that the market capitalisation portfolio gives the highest risk adjusted long term return. You can trade off risk and return by holding cash or bonds or using leverage. The market portfolio offers the highest level of diversification. (Under-weighting the most diversified and lowest volatility market does not help here.) Over enthusiastic speculation does occur, but the professionals do not have a better than luck chance of exploiting that, so why should you?

This conversation started with me pointing out than Vanguard offered many funds that would have been frowned upon by its founder. I am not offering my opinions here. I am just trying to explain why market weighted portfolios are the way to go without all the mathematics.

JohnWinder

classic answer is a chunk allocated to bonds or cash but there is no market cap baseline for that split.

Nice insight. It wouldn’t matter what the market cap weight of cash was as a determinant of how much cash we each should hold, since we should hold as much as we need for our circumstances, including zero cash or 100%. 

As to bonds, I think it is known how big the bond market is compared to the stock market, and William Sharpe thinks the most efficient portfolio reflects exactly that mix. But individuals may not want the risk stocks carry, and so hold more bonds and less stocks than the market cap weightings. I think that makes sense. We don’t even need to replicate the whole bond market in our portfolios since government bonds have near guaranteed returns. You don’t need to diversify in the bond market to reduce risk.

That just leaves stocks. You can reduce the idiosyncratic risk of individual stocks or market segments by holding the lot. Doing it by cap weighting works nicely, or even equal weighting isn’t too bad except that there are a lot more frictional losses with equal weighting as you have to keep trading to re-weight the holdings, and we can’t all hold the smallest companies by equal weighting with the biggest ones as there just isn’t enough stock in the little ones. So it wouldn’t be equal weighting.

GeoffTF

JohnWinder said:

As to bonds, I think it is known how big the bond market is compared to the stock market, and William Sharpe thinks the most efficient portfolio reflects exactly that mix. But individuals may not want the risk stocks carry, and so hold more bonds and less stocks than the market cap weightings.

The chart on page 6 of this paper shows the composition of the market portfolio:

https://www.ssga.com/library-content/pdfs/global/global-market-portfolio-value-of-investable-assets-touch-all-time-high.pdf

43% equities. Most of the posters on boards like this are much more risk tolerant than the market as a whole. Either that, or they are blind to the risks that they are running.

GeoffTF

Here are charts showing the change of the global market sector percentages over time:

https://www.msci.com/research-and-insights/visualizing-investment-data/regional-breakdown-of-market-sectors-over-time

The share of information technology has grown over the last decade. It is possible that its market share will decline. Sectors grow and shrink over time. That does not matter if hold the market portfolio, because you hold everything, the next decade's winners as well as its losers. Nobody knows when the market share of information technology will fall, if indeed it ever does. If you do not know when something will happen, it is a mugs game trying to trade it.

Linton

GeoffTF said:

Linton said:o

GeoffTF said:

Linton said:

GeoffTF said:

Linton said:

GeoffTF said:

bundoran said:

GeoffTF said:

dunstonh said:

GeoffTF said:

dunstonh said:

Aminatidi said:

One reason.

Also a bit of personal psychology there where I'm trying to move towards passives and rightly or wrongly Vanguard not having 3000 active funds minimises the occasional urge to tinker

But Vanguard doesn't have the best or cheapest trackers in every area.  So, limiting yourself to just them could compromise the outcome.

Vanguard's trackers are as good as any. The cost of the platform will usually be more important than a small difference in the OCF. Transaction costs cannot be compared between providers because there is no standard method of calculation. You do not need trackers "in every area". Adding more of them will not increase your chances of a good outcome.

I never said you needed trackers in every area.   

However, Vanguard do have one of the largest range of trackers in non-core areas.   They are just not as low cost in core areas compared to other fund houses.

If charges are a driver behind the decision, as they are in this thread, then restricting yourself to Vanguard trackers only increases your charges.

The vast majority of Vanguard funds are aimed at speculators who believe that a particular market or sector will outperform. 

The vast majority of Vanguard funds are aimed at long term passive investors who want to invest in either the whole world, the developed world, or regions of the world in a proportion which they have chosen and are comfortable with for their own reasons; or people who wish to invest in a mixed asset fund like Lifestrategy.

To say that these passive funds and mixed asset funds - which make up the vast bulk of Vanguard's offering - are "aimed at speculators" is asinine.

Choosing "regions of the world in a proportion which they have chosen and are comfortable with for their own reasons" is speculation. That is not what Jack Bogle advocated. I have not said that Vanguard is wrong to offer those funds.

As for your last sentence, kindly quote me accurately and be polite.

Nonsense in my humble opinion.  Choosing not to invest more than 60% of one's life savings in one single country whose returns are dominated by one or two sectors which are in turn  dominated by a handfull of massive companies seems to me to be taking a prudent approach rather than speculation.

What matters most here is diversification between companies, not countries. For the most part, the political boundaries are irrelevant. Companies can incorporate wherever they choose. They can derive most of their earnings overseas. Moving their headquarters does not change much. There can be relevant differences. Local taxation can be different, for example, but that should be reflected in the share price. There are special considerations for Emerging Market companies, but they should also be reflected in the share price.

If a company decided to incorporate in New York, rather than Canada, I would not reduce its weighting because of that.

The home market is an exception, because UK company dividends are not subject to withholding tax, for example. There are rational reasons for a home bias.

Countries can be a proxy for quite different sector asset allocations and differences in style. Hence they are also a single point of failure. Look at the US markets in the tech boom/crash era.

 

Professional investors try to exploit that. There is abundant evidence that they do not have more than chance success. Bogle would have asked why you believe that you are more capable of pricing market sectors than them. He would not have advocated under-weighting the tech stocks.

The objective is to achieve sufficient real long term return at minimum risk, not to maximise return. My belief is that all well diversified sensibly managed portfolios will achieve much the same long term returns. I agree that attempts to achieve higher long term returns than this are on average likely to fail. However different allocations will have different short/medium term behaviours.

I see nothing magic about a market capitalisation based portfolio. Its only advantage is the low cost of implementation, the downside is restricted diversification being over dependent on a small number of closely related companies and susceptibility to over-enthusiastic speculation in high risk areas.

Why do you feel it necessary to rely on support from gurus? Surely your arguments should be defensible on their own.

As I have said, financial theory tells us that the market capitalisation portfolio gives the highest risk adjusted long term return. You can trade off risk and return by holding cash or bonds or using leverage. The market portfolio offers the highest level of diversification. (Under-weighting the most diversified and lowest volatility market does not help here.) Over enthusiastic speculation does occur, but the professionals do not have a better than luck chance of exploiting that, so why should you?

This conversation started with me pointing out than Vanguard offered many funds that would have been frowned upon by its founder. I am not offering my opinions here. I am just trying to explain why market weighted portfolios are the way to go without all the mathematics.

I would question your assertions that the market portfolio offers the highest level of diversification and the highest risk adjusted return.

ISTM that you are applying financial theory to a situation far beyond the one for which it was developed and for which its assumptions are valid.. in particular as I understand it the theory assumes that the underlying investments are part of the same market where the performance of a large number of individual shares varies independently and randomly with a Gaussian distribution about a central value. 

The situation where there are a relatively small number of partially independent internally correlated markets with different medium term behaviours subject to major short term shocks could be quite different and I suspect too difficult to analyse with relatively simple statistics.  Perhaps computer simulation would provide a better understanding of how such a system behaves.

Diversification can be measured in various ways. An intuitively simple one is the % of the portfolio allocated to the largest underlying holdings. With the current distribution of company sizes market cap allocation does not come out well. Obviously the most diversified portfolio on this measure would be equally weighted but that seems to me to be intuitively wrong and for practical reasons would advocate a constrained market cap approach.

Being neither a professional mathematician nor economist (though with a great interest in both topics) my understanding could well be wrong and I would be delighted to be corrected by someone with a deeper one.

JohnWinder

I would question your assertions that the market portfolio offers the highest level of diversification and the highest risk adjusted return.

I suppose there are lots of ways to think about diversification, and it doesn't matter which one uses as long as it is made clear. Having a lot more of your money in Apple than Beaver Bros Hat Makers may not feel like the best diversification, but a market cap distribution of your money is the sort of diversification that index investors (generalising!) believe is the best.

As to risk adjusted returns with the whole market, if a segment of the market had a higher risk adjusted return, and people knew about it, they would buy those stocks because they are more attractive than other stocks, and this would increase those stocks’ price and thus push down those stocks’ returns (just as rising bond prices pushes down their returns), until the market reaches its new equilibrium where there are no segments with better risk adjusted returns. The adjustment occurs in minutes or seconds (as quickly as trading can occur), probably micro-seconds these days/nights.

‘as I understand it the theory assumes that the underlying investments are part of the same market where the performance of a large number of individual shares varies independently and randomly with a Gaussian distribution about a central value.

Reference, please.

JohnWinder

I would question your assertions that the market portfolio offers the highest level of diversification and the highest risk adjusted return.

Always good to question.

For those with a maths proclivity John Norstad tries to prove that the total market is the most efficient (best return for risk). https://web.archive.org/web/20170628202816/http://www.norstad.org/finance/tsmproofs.pdf

‘The most diversified portfolio M is the market portfolio... there is no scope for further risk reduction by means of diversification.’ Finance and Financial Markets, Keith Pilbeam, 4th edition, 2010, Macmillan.  Pilbeam is a Professor at University of London.  

‘Investors will diversify more and more until they hold the most diversified portfolio possible--the market portfolio. The market factor is the best, most diversified portfolio investors can hold under the CAPM.’

Asset Management: A Systematic Approach to Factor Investing, Andrew Ang, Oxford University Press, 2014.

Linton

JohnWinder said:

I would question your assertions that the market portfolio offers the highest level of diversification and the highest risk adjusted return.

Always good to question.

For those with a maths proclivity John Norstad tries to prove that the total market is the most efficient (best return for risk). https://web.archive.org/web/20170628202816/http://www.norstad.org/finance/tsmproofs.pdf

‘The most diversified portfolio M is the market portfolio... there is no scope for further risk reduction by means of diversification.’ Finance and Financial Markets, Keith Pilbeam, 4th edition, 2010, Macmillan.  Pilbeam is a Professor at University of London.  

‘Investors will diversify more and more until they hold the most diversified portfolio possible--the market portfolio. The market factor is the best, most diversified portfolio investors can hold under the CAPM.’

Asset Management: A Systematic Approach to Factor Investing, Andrew Ang, Oxford University Press, 2014.

From my reading of your referenced paper John Norstad proves that no portfolio can be more efficient than the total market portfolio.  He does not disprove my assertion that many other portfolios may be equally efficient  Also he is assuming a well defined and accepted value of risk.  In practice my view of the cost of risk may differ from yours due to our different circumstances.  If so that could lead to a different appropriate Total Market.

Linton

JohnWinder said:

I would question your assertions that the market portfolio offers the highest level of diversification and the highest risk adjusted return.

I suppose there are lots of ways to think about diversification, and it doesn't matter which one uses as long as it is made clear. Having a lot more of your money in Apple than Beaver Bros Hat Makers may not feel like the best diversification, but a market cap distribution of your money is the sort of diversification that index investors (generalising!) believe is the best.

As to risk adjusted returns with the whole market, if a segment of the market had a higher risk adjusted return, and people knew about it, they would buy those stocks because they are more attractive than other stocks, and this would increase those stocks’ price and thus push down those stocks’ returns (just as rising bond prices pushes down their returns), until the market reaches its new equilibrium where there are no segments with better risk adjusted returns. The adjustment occurs in minutes or seconds (as quickly as trading can occur), probably micro-seconds these days/nights.

‘as I understand it the theory assumes that the underlying investments are part of the same market where the performance of a large number of individual shares varies independently and randomly with a Gaussian distribution about a central value.

Reference, please.

Discussions of this whole aea tend to get very complicated as there is a lack of clarity and circularity of definitions, assumptions, and deductions and the connection of all this to reality.

To take risk adjusted returns for example.

One assumes the Efficient market Hypothesis is true (EMH) and then come against the awkward fact that simple returns dont obey it.  So if EMH is true there muct be some other factor controlling it.  Let's call it the Risk Adjusted Return (RAR).  Then one says that the EMH is true because it equalises the RAR.  Can you define and calculate the RAR independently? It would be useful to do because then one could predict the true value of a share.  Sadly I must suggest the whole theory is circular, perhaps like Dark Matter.

More practically it is assumed that if the RARs are the same the investments are equivalent.  But the circumstances of particular investors may lead them to have different views as to the cost of Risk.  It is not a matter of one value being right and the other wrong as decided by market forces with the efficacy of index funds guaranteed - for each individual "right" could be different.

Onto the question of markets and Gaussian distributions.  As a starter economic statisticians like Gaussian distributions because their maths is pretty.  If each component of a fund  follows a Gaussian distribution in their performance variability the average as shown by the fund price will also follow a Gaussian distribution.  However I need to delve more deeply into the area.

I dont think the forums are the best place to explore these complex topics in any detail and we are already drifting away from the OP.