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Emerging Markets Allocation
Comments
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We do not have to know what percentages of capital are applied to each market. We know that none of the sectors are over concentrated in the market's view. That is the whole point of index investing. Nobody knows which markets and sectors will outperform. We just buy the average portfolio and sit on it at minimal cost. That guarantees that we will beat most investors in the long run.
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…and to be the ultimate contrarian, index investors will get worse returns than some investors who look at the historical performance of portfolios with varying EM allocations and adjust their investments to overweight sectors. However, the benchmark that is most relevant is the performance you require to meet your own financial goals. If we are going to dig into the weeds of EM (or any other) allocation I think the historical standard deviation of the returns are at least as important as their magnitude.
And so we beat on, boats against the current, borne back ceaselessly into the past.1 -
Of course some active investors will be lucky and beat the market, but every dollar that outperforms the market will be exactly counter balanced by a dollar that underperforms the market, and that is before costs.
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I'm seven hours ahead of you, it was late here and I had intended to write that portfolio's became overly concentrated, not of course trhat index trackers did so. There have been several posts since February where holders of global trackers have expressed both concern and surprise that they were into the US market and Tech, to such a high degree, you were almost certainly involved in those discussions so you will already be aware.
To take one step back for a moment: a couple of members have suggested that any effort to analyse portfolio holdings by reviewing papers such as the one in the op, and any attempts to optimise or tweak them by understanding what they contain and why, is essentially a waste of time and that people who do so are to be pitied! That of course is utter nonesence since any serious attempt at learning in any field, is almost certainly going to improve outcomes, sooner or later. I have contrasted those attempts at analysis with the opposite extreme, which will no doubt have annoyed some! But the inesscapable reality is that UK investors generally are undereducated as far as investing is concerned, that is fact:- Surveys show that many young people are interested in becoming investors, but lack the skills or knowledge to do so, making them more vulnerable to riskier financial behavior.
- Experts say one solution is a more comprehensive programme of practical financial education embedded earlier on in the UK’s National Curriculum.
The result of this knoweldge gap is that amateur retail investors make uninformed and risky decisions, evidence for which we have seen repeatedly in this forum, some of which appears to include random buying or buying based on product popularity, rather than on any harder evidence relating to a products content and suitability. The easiest, simplist and least risky equities market investment product that a person can buy, is a global tracker, investors can chose from half a dozen or ten and not go too far wrong, as long as they have a sizeable investment horizon in front of them. But none of that means that when a blip occurs and Tech/US appears higher risk, that such buyers understand their potential exposure. My position quite simply is that some amount of disection, research and learning can help reduce that risk and frankly, I don't expect in these pages to be attacked or critisized for that, espcially when the opposite behaviour is very much in evidence.
If this forum has a short comming, apart from the usual social media issues, I think it may be that the discussions are not sufficently focussed on the lower end of the knowledge scale and the conversations tuned to address them accordingly. Put more simply, many people seem desparate for information but get lost or scared by technical and hi-brow debates by well intentioned experienced investors and are afraid to ask questions or participate. I have no hard evidence for this perception, other than ad hoc comments made by members and messages I've receieved. Still, it would benefit many I suspect if more junior and less experienced members were supported in a different way and that senior members remember that not everyone has their years of experience and understanding of the subject matter. It is primarily for this reason that initialte the topics that I do, in the hope of providing useful information for those who are just starting out.
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I have said several times that index trackers have their place, I hold a couple. I prefer managed funds because I like targeted funds for several reasons, none of which I continue to hold, if they don't beat the index and benchmark…..they get dumped, end of story.
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Over the years, there has been a steady stream of "new to investing", "where to start", "critique my portfolio" type questions and more knowledgeable forum users have mostly been helpful and patient with those less experienced investors. But the forum rules prohibit posters giving personalised financial advice, so discussion must be in general terms. This means that others can learn from previous threads. There is now also an official MSE guide. It may be a coincidence, but there seems to have been a lull in novice investing discussions lately, or it may be that the basics are now sufficiently covered for people to find the information they need without coming here and starting a new thread, which invariably would steer towards a multi-asset fund as a simple and generally suitable investment option.
I would suggest that your threads are of a much more advanced nature and more about investment philosophy, which there is nothing wrong with. I recall one of your early threads discussed upside and downside capture ratios, and other metrics for quantitative fund analysis. This one discusses academic research on global equity funds and their actual vs ideal allocation to EM. These are not topics that would be in the circle of concern of someone just starting out, rather topics of interest for someone who is already well above average knowledge. An article such as the one discussed in this thread could well be dynamite in the hands of a newbie if they come away thinking they should put close to 40% of their money in an EM fund (despite a few of us disclosing much lower exposure).
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You're going back to arguing that you think the US is higher risk than the rest of the investing world seems to realise.
If you say to someone 'US is high risk, and by the way, your global tracker is 60-70% US' then of course they will perhaps express surprise. If you say 'your global tracker takes the average, diversified, position on risk and doesn't overweight any particular country/sector' then they're less likely to be surprised.
The real risk is in people thinking they know better and trying to beat the markets (even in the name of trying to reduce risk - they are probably actually making it worse). It has been proven time and time again that this is what loses them money - see the recent 'many happy returns' podcast for example. The knowledge gap that exists is around savings and investments in general - equities, bonds etc. - and in what risk really is, what risky behaviours are, and how to mitigate them.
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The issue is NOT about whether trackers are or are not too US heavy or not, the issue was always about whether the people who buy them understand what they contain!
I am done here.
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And my point was how you talk to people when explaining what they contain matters. Talking about country allocations for a diversified global fund is not the important thing - that only matters to people who want to take matters into their own hands and try and beat the markets (be that returns, or risk). Doing so is itself an inherently risky, return-lowering, activity. As such, it might be suitable for those of us playing with our fun portfolios, but for new (or old) investors, they should understand and conquer their own behaviour risks before considering.
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I have a few comments on the interesting paper you’ve linked to.
The plots of information ratio, IR (see https://www.investopedia.com/terms/i/informationratio.asp for a definition and formula), which measures risk-adjusted performance against a benchmark (in this case the MSCI developed market index) in Displays 6 and 7 show two things
1) The IR was fairly flat over a wide range of allocations (e.g., roughly 0% to 70% to EM in both graphs) – in other words an allocation in that range would not have made a lot of difference to the outcomes when using IR as a metric.
2) The ‘optimum’ (i.e., the location of the peak IR) depended on the period chosen – I suspect (but am unable to calculate since there is, AFAIK, no freely available EM data going back further than 1988 or so) that the optimum would have varied considerably over different rolling periods. That the optimum was higher for the longer period (i.e., from 1925 rather than from 1988) might be explained by the excellent returns for EM in the 1970s and 1980s.
Display 5 in the paper shows that the EM allocation in the MSCI index grew from 2% to 13% between 1988 and 2020. This indicates that over that period EM outperformed the rest of the market. However, closer examination of the graph indicates that this outperformance has not been consistent, e.g., the late 1990s to early 2000s were a disaster for EM, the mid-2000s rather better, while the period from 2012 to 2020 was fairly flat. Again, this shows that the ‘optimum’ allocation to EM would have varied with time.
The median allocations of global equity funds (presumably, those available to retail US investors) shown in Display 8 (i.e., the left-hand three bars in the chart in the OP), which will include active as well as index funds, indicate that on the back of a decade of poor performance for EM, US active fund managers were not holding much EM in 2020. Perhaps that shouldn't be too surprising.
So, is any of this actionable? For me, the key results are a) that an allocation to EM in the 0% to 70% range didn’t make a lot of difference in the IR metric over two historic periods (from 1925 to 2020 and from 1988 to 2020) and b) that the optimum allocation varied with the period under study. In other words, choose what you like but stick with it since a period of underperformance may (but no guarantees) be followed by a period of outperformance. Trying to predict whether a particular period will result in under or out performance and then making significant adjustments to the allocation is, IMV, futile.
Finally, from the point of view of implementation, a cap weighted global index has the merit of being straightforward to hold. However, adding an EM index fund, which allows the allocation to EM to be increased if that is desired (although a decision then has to be made whether to rebalance or not), doesn't add that much complexity.
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