Why buy UK?

[1nvest]

For the record I mistook the thread for the similar discussion I was involved in on the Investment Strategies board... sorry for the OT.

Fair enough.

Oh, doesn't smoking weed at the time of passive board scratch posting count as eligible! Downer and jet out!

[GeoffF100]

Just because Shell is worth 10X Tesco doesn't automatically imply that you should invest 10X as much of your money in it.

Yes, it does, for the reasons already given.

The only reason to invest more in Shell is if you believe it will do better over time. Massively better if you are prepared to invest so much more. Is that a reasonable assumption?

No, that would not be a reasonable assumption. Nobody knows which stock will do better.

Why when the measurable risks are similar and, if EMH is to be believed, expected return should also therefore be similar?

The US is 62% of the the FTSE All-World index, whereas New Zealind is 0.1%. Investing the same amount of money in New Zealand as the US would not make sense. The US provides a much bigger spread of risk and a much bigger return than New Zealand. If a large proportion of the world's capital was allocated in that way, New Zealand would be ridiculously overpriced. Similarly for Shell and Tesco.

CAPM assumes the EMH (along with the other assumptions of that model) and proves that the optimum portfolio (which is the same for everyone) is market weighted.

[Bubblesofearth]

No, that would not be a reasonable assumption. Nobody knows which stock will do better.

So why invest more in Shell? Of course Shell will have more invested in it overall than Tesco but you can't simply jump from that to say an individual investor should invest that way.

The US is 62% of the the FTSE All-World index, whereas New Zealind is 0.1%. Investing the same amount of money in New Zealand as the US would not make sense. The US provides a much bigger spread of risk and a much bigger return than New Zealand. If a large proportion of the world's capital was allocated in that way, New Zealand would be ridiculously overpriced. Similarly for Shell and Tesco.

CAPM assumes the EMH (along with the other assumptions of that model) and proves that the optimum portfolio (which is the same for everyone) is market weighted.

It doesn't prove anything of the sort. It says that total investment in the US and NZ should be market weighted but says nothing about how an individual investor should allocate funds. In fact the expected return from NZ should be higher than for the US precisely because of the extra risk. This risk can be effectively mitigated by diversification across countries just like it can by diversification by company within any given country.

If you personally were constructing a portfolio of 20-30 shares would you really invest in them according to their market cap?

BoE

[Lootman]

the expected return from NZ should be higher than for the US precisely because of the extra risk.

Then you do not understand what risk is. Taking on risk does not guarantee out-performance at all. Risk may give you a hgher possibilty of out-performance but only at the cost of a higher possibility of failure as well.

If taking on more risk, e.g. allocating 100% to New Zealand or AIM shares, assured better returns then we would all gobble down that free lunch.

If you personally were constructing a portfolio of 20-30 shares would you really invest in them according to their market cap?

I certainly would not ignore size. Turn that question around. If you really believe that size limits returns then why would you let a winner run? Surely as it becomes bigger you should reduce your exposure to it, no?

[Bubblesofearth]

Then you do not understand what risk is. Taking on risk does not guarantee out-performance at all. Risk may give you a hgher possibilty of out-performance but only at the cost of a higher possibility of failure as well.

If taking on more risk, e.g. allocating 100% to New Zealand or AIM shares, assured better returns then we would all gobble down that free lunch.

I suspect you don't understand what is meant by 'expected return'. Of course a riskier investment has a higher possibility of failure, that's on the tin. It is the reason that the expected return will be higher. Expected return is calculated by multiplying potential outcomes by the chances of them occurring and then totalling these results. It is not an assured return.

I certainly would not ignore size. Turn that question around. If you really believe that size limits returns then why would you let a winner run? Surely as it becomes bigger you should reduce your exposure to it, no?

LTBH vs rebalancing is a different topic and one that has been well covered in other discussions.

BoE

[GeoffF100]

So why invest more in Shell? Of course Shell will have more invested in it overall than Tesco but you can't simply jump from that to say an individual investor should invest that way.

You can simply say that. A passive investor says that he does not know as much as the market and simply copies the market's capital allocation. If the market says that Shell is worth ten times as much as Tesco, he does not argue with that. He invests ten times as much in Shell as Tesco. He knows that if he does that he will beat most active investors after costs, and the longer the clock runs, the greater the proportion of active investors that he will beat. Tens of $trillions are now invested in that way.

If you personally were constructing a portfolio of 20-30 shares would you really invest in them according to their market cap?

Why would I want to construct a portfolio of 20-30 shares when I know that I cannot beat the market?

[Bubblesofearth]

You can simply say that. A passive investor says that he does not know as much as the market and simply copies the market's capital allocation. If the market says that Shell is worth ten times as much as Tesco, he does not argue with that. He invests ten times as much in Shell as Tesco.

The market says that Shell is worth 10X Tesco. It doesn't say that £5000 invested in Shell will do better, or be less risky, than £5000 invested in Tesco.

BoE

[GeoffF100]

You can simply say that. A passive investor says that he does not know as much as the market and simply copies the market's capital allocation. If the market says that Shell is worth ten times as much as Tesco, he does not argue with that. He invests ten times as much in Shell as Tesco.

The market says that Shell is worth 10X Tesco. It doesn't say that £5000 invested in Shell will do better, or be less risky, than £5000 invested in Tesco.

Nobody knows which or the two shares will do better, or which will prove to be the less risky. When in a hole stop digging. If you do not know more than the market, buy a tracker.

[tjh290633]

You can simply say that. A passive investor says that he does not know as much as the market and simply copies the market's capital allocation. If the market says that Shell is worth ten times as much as Tesco, he does not argue with that. He invests ten times as much in Shell as Tesco.

The market says that Shell is worth 10X Tesco. It doesn't say that £5000 invested in Shell will do better, or be less risky, than £5000 invested in Tesco.

BoE

You two are at loggerheads. It's a simple fact that an individual private investor cannot construct a market weighted portfolio of the index constituents. If they want such a portfolio, then they buy it ready made in the form of a tracker.

If you look at the market constituents, they do not move in unison. Some go up, some go down and the market reflects an average of those movements. Since the turn of the century the FTSE100 has risen from about 6900 to just over 8000 in 24 years. Some shares have done better, some have disappeared. If a lower capitalisation share doubles in price, the market index hardly moves, but if AZN or SHEL have a hiccup, the index moves a lot.

For someone who invests in a selected number of shares, it is more practicable to adopt a nominally equal weighted portfolio. He may choose to let his shares do what they will or he may decide to set a limit on the weight of an individual holding. This entails an occasional rebalancing, with redistribution to lower weight holdings. This can have the effect of moving from lower yield holdings, which have risen, to higher yield holdings which have hung back in comparison. This can also have the effect of outpacing the market cap. based portfolio.

Been there, done it. No special expertise needed.

TJH

[Bubblesofearth]

Nobody knows which or the two shares will do better, or which will prove to be the less risky. When in a hole stop digging. If you do not know more than the market, buy a tracker.

Try a thought experiment. Imagine there are only 2 companies available to invest in, A and B. A is worth 10X B. Both carry the same risk.

Now imagine a pool of investors. Each investor would like to invest an equal amount in A and B because the performance of the companies are not perfectly correlated and their risk is equivalent. However, as you have pointed out, they cannot all do this as that would drive the price of B to a level that would massively overvalue that company, i.e. the expected return would be massively lower than for A.

If, on the other hand, everyone invested according to cap weight then they would all invest 10X as much in A as in B. This is the scenario in which the expected return of A and B would be equivalent. But this is not the ideal investment from the pov of risk as it doesn't benefit fully from the imperfect correlation between the two companies.

In a perfectly efficient market, the solution to this would be a compromise, B should trade at a slight premium to A such that the expected return is slightly lower. I realise this seems counter-intuitive (the smaller company offering a lower expected return) but it makes sense when considering the risk-adjusted return of a portfolio of A and B. It is a natural consequence of diversification benefit. In the real World the opposite is more often the case, smaller companies demand a higher expected return because investors are mostly considering them, and the risk they carry, on an individual basis.

Sadly there is very little evidence available comparing equal weight LTBH strategies with cap weight strategies which means all of this remains primarily theoretical. But if you can obtain even an equivalent expected return from two companies with the same risk then equal weighting has to be the most logical investment strategy.

BoE

[dealtn]

Nobody knows which or the two shares will do better, or which will prove to be the less risky. When in a hole stop digging. If you do not know more than the market, buy a tracker.

Try a thought experiment....

Try an alternative thought experiment. On an Investment Forum there is a place called Passive Investing where this round of table tennis is off topic...

[JohnW]

Someone can invest in a selected number of shares rather than the whole market, but it's riskier - more winning and more losing one would expect. Why?
Buying a whole-market fund brings with it market risk (which is riskier than safe bond risk) for which stock investors require better returns than bond investors. Companies issuing stock can’t avoid paying that higher return or no one would take on the risk by buying the stock. But if you buy only one stock or theme stocks you take on the risk that come with the whole market eg from war, inflation, interest rate changes etc as well as taking on the risks particular to that stock or thematic stocks; and because you don’t have to take that risk (as you can own the whole market) no one will want to pay you for taking the risk. People only reward you for taking in risk when they have to. Of course, it might turn out that those individual stocks outperform the market, or underperform the whole market, but idiosyncratic risk is uncompensated whereas market risk is compensated. Basically it’s a bad deal. No crime in doing it, but we should recognise that’s what we’re doing.
One moves towards a solution by buying lots of individual stocks or some funds of individual stocks. Now we're moving towards owning the whole market at higher cost. Doesn't seem like the better strategy.

[JohnW]

There has been an equal weighted index for 20 years for the SP500 and others. The returns and risk have been similar.
https://www.bogleheads.org/forum/viewtopic.php?t=336402

[Lootman]

There has been an equal weighted index for 20 years for the SP500 and others. The returns and risk have been similar.
https://www.bogleheads.org/forum/viewtopic.php?t=336402

RSP has done well considering that it has an annual cost of 0.2% whilst a cap-weighted S&P 500 tracker like VOO costs just 0.05%.

RSP also has the curse and cost of having to rebalance to maintain equal weighting, whereas a cap-weighted tracker is self-balancing.

And of course it would be more challenging to try to equal weight small caps or the total market.

[Bubblesofearth]

There has been an equal weighted index for 20 years for the SP500 and others. The returns and risk have been similar.
https://www.bogleheads.org/forum/viewtopic.php?t=336402

Take a look at the response a couple of posts down by ipdiddly. He/she gets it.

BoE

[Bubblesofearth]

Try an alternative thought experiment. On an Investment Forum there is a place called Passive Investing where this round of table tennis is off topic...

Hi dealtn, have I upset you in a previous post

Does this mean, according to you, no questioning or challenging of the passive investment approach is permitted on here? I would have thought that was absolutely central to the remit of any board (except perhaps HYP practical). Otherwise is there not the danger of group think?

BoE

[GoSeigen]

Nobody knows which or the two shares will do better, or which will prove to be the less risky. When in a hole stop digging. If you do not know more than the market, buy a tracker.

This is nonsensical because I am the market whether I actively buy individual shares or passively buy a tracker.

The difference is that in one case I am using my abilities to price each share approximately correctly in my judgement, in the other I don't care what price I pay/receive for each share, I leave it to my counterparty to pick whatever price they choose.


GS

[JohnW]

Look at it this way, when you choose to buy stock A, one of three stocks you own, you have to be a bit careful to not pay too much because it represents a sizeable part of your portfolio. With that risk in mind it's worth only £x/share for you. Now I'm going to buy it too as part of a tracker. Frankly, I don't give a toss that it's a bit risky because if it crashes and burns I've got another 3000 stocks to save my bacon; so I'm happy to pay a bit more than £x for it. So, for you to buy it you have to pay the price I pay; no one will sell it to you for less if they can sell it to me for more, so you're forced to pay more for it than you thought it was worth given all you know about that stock. You're not getting a good deal. Now, you could partly solve the problem by holding 150 stocks, or better 300, but is that going to be cost effective when you get 3000 for a song?

[Hariseldon58]

Interesting post the other day regarding Equal Weight Indices and the practicalities https://www.researchaffiliates.com/publications/articles/1028-alternative-to-a-manic-ai-market-rafi-vs-equal-weight?evar36=eml_rafi-vs-equal-weight-2024-04-24_heroJustPublished_buttonLink&_cldee=14bfbG-sns5OGByEZnDstpsreDdwOsds-9TBZHNKOFh0jKBop3mNryyRkGYiuljY&recipientid=contact-28b07b162487ea1180e9870ad18a4adf-7b0af56e336a45238a047e9c1611880f&esid=705a0079-4702-ef11-a1fd-000d3a17a0a6

The research is from Research Affiliates an they have a vested interest in promoting the RAFI fundamental index but interesting nether the less.

[JohnW]

It is, so let's follow a reasonable path.
I like an index, now find a suitable fund to track it: low cost; small tracking error; returns and volatility in line with alternative funds one might choose. I don't know if we can get RAFI funds in UK, but portfoliovisualizer shows some US funds. There's only 11 years of return history for those funds, so we might not be getting the full picture about RAFI funds.
SFLNX the Schwab US large cap RAFI, and the Invesco US FTSE RAFI have never been ahead of the SP500 or the US total market since they started, but with less volatility. 2%/year behind in one case.
We can't invest in indexes, and however good that article makes out the RAFI index is, if you'd have invested in such funds it appears it wouldn't have helped much.