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Importance of weightings in world trackers

Index tracking funds and ETFs
Plutus
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Importance of weightings in world trackers

#81885

Postby Plutus » September 18th, 2017, 8:24 pm

Good evening all.

During some of the debates re: replicating a world equity tracker some reference has been made of 'unfavourable' situations where a particular geographical market has a highly skewed proportion of the fund.

Examples have been japan rising to 75% in the 1980s (?) and now the USA will be about 50% I think.

The aim of my own passive portfolio is to create roughly equal weightings of uk, USA, Europe, Japan, Pacific ex Japan and emerging markets.

But does it really matter? The market weighting merely a reflection of the relative strength of markets due to capitalisation and eventually the weights will change again and be rebalanced by the fund manager?

What is the benefit of more equal weightings? Is it that rebalancing will sell high and buy low?

Thanks for any thoughts.

hiriskpaul
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Re: Importance of weightings in world trackers

#81902

Postby hiriskpaul » September 18th, 2017, 9:44 pm

If you cap weight, there will be very little need to rebalance and the individual ETFs will need little rebalancing. Cap weighting does run the risk though of ending up in a Japan style situation due to nutty valuations. If you want to mitigate that risk, you could somehow bring CAPE or p/b into the weighting/rebalancing calculation in a way to cap any particular geographic weighting.

If you equal weight, you increase risk as you end up overweighting small caps and EM. That might work well in the long run, but it is more risky than cap weight and more costly as you have to rebalance. There may also be some gain on rebalancing back to equal weight. Theoretically there would be due to the imperfect correlations between regions.

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Re: Importance of weightings in world trackers

#81905

Postby Plutus » September 18th, 2017, 10:02 pm

Hi Paul and thank you for your reply.

What would be so wrong with a 75% weighting to Japan? It would reflect that Japanese companies were outperforming other regions.

If or when the Japanese economy tanked the weighting would reduce and other regions would then have a larger allocation in the fund.

Is the problem that this will be costly to the index fund manager to switch physical replication and so fees would rise?

Also if the fund was split equally in the 6 geographical constituents why is it more risky if the existing winners become tomorrow's losers and vice versa? The current risk is the reliance on the US economy but the emerging economies will eventually have a larger slice of the world economy? We don't really know for sure what will happen over 10, 20, 30 years.

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Re: Importance of weightings in world trackers

#82018

Postby hiriskpaul » September 19th, 2017, 11:47 am

Plutus wrote:Hi Paul and thank you for your reply.

What would be so wrong with a 75% weighting to Japan? It would reflect that Japanese companies were outperforming other regions.


Depends on the reason for the 75% weighting. If all markets had very similar fundamentals (p/e, p/b, CAPE, etc) and carried similar risks, then there would be nothing wrong with 75% in Japan, assuming that is how the cap weight worked out. What happens in the 80s was the fundamentals for Japan (stock market and property) got way out of line. Consequently the allocation of stocks in the cap weighted global market rose.

If or when the Japanese economy tanked the weighting would reduce and other regions would then have a larger allocation in the fund.


Yes, that is exactly what happened. If you had some way of limiting exposure to Japan, moving away from global cap weighting based on fundmentals, then you would have lost less money when the market tanked. You would also have made less money on the way up, which is the difficulty with any such system.

Is the problem that this will be costly to the index fund manager to switch physical replication and so fees would rise?


Not sure what you are asking here. If you allocate according to cap weight the only reallocation required is due to corporate actions. Global cap weight is the cheapest to track as it involves the smallest amount of trading.

Also if the fund was split equally in the 6 geographical constituents why is it more risky if the existing winners become tomorrow's losers and vice versa? The current risk is the reliance on the US economy but the emerging economies will eventually have a larger slice of the world economy? We don't really know for sure what will happen over 10, 20, 30 years.


Not all stocks and markets carry the same risks. The point I was making was that EM stocks are likely to be more risky than developed market stocks and smaller caps are likely to be more risky than larger stocks. By equal weighting across geographical regions, compared to cap weighting, you are increasing allocation to smaller stocks and increasing allocation to EM stocks. This means you are taking on increased risk compared to global cap weighting. This is not necessarily a bad thing to do as historically smaller caps have outperformed larger caps over the long run and EM stocks have outperformed developed, I was just pointing out that this is the consequence of equal weighting.

Another risk is that markets trading on high fundamentals (CAPE or p/b) have been found to subsequently underperform (on average) compared to when they are on lower fundamentals. This risk becomes apparent with cap weighting - the Japan scenario. So a possibility is to use rough cap weighting, but dynamically adjust according to CAPE of p/b. When CAPE or p./b is high for a market you underweight and when low you overweight.

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Re: Importance of weightings in world trackers

#82026

Postby Plutus » September 19th, 2017, 12:20 pm

Thank you @highriskpaul for taking the time to respond to all of my questions. That all makes perfect sense now.

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Re: Importance of weightings in world trackers

#82054

Postby JNC3 » September 19th, 2017, 2:52 pm

hiriskpaul wrote:Another risk is that markets trading on high fundamentals (CAPE or p/b) have been found to subsequently underperform (on average) compared to when they are on lower fundamentals. This risk becomes apparent with cap weighting - the Japan scenario. So a possibility is to use rough cap weighting, but dynamically adjust according to CAPE of p/b. When CAPE or p./b is high for a market you underweight and when low you overweight.


Is this why some fund managers on TV over the last few months have been saying to the audience of investors to underweight USA equities (because of High fundamentals) and overweight EM (because of low fundamentals). I also suspect Fund Managers usually make recommendations on TV after they have moved their equity positions in order to enhance their gains ?

JNC

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Re: Importance of weightings in world trackers

#82432

Postby Plutus » September 21st, 2017, 11:16 am

JNC3 wrote:
hiriskpaul wrote:Another risk is that markets trading on high fundamentals (CAPE or p/b) have been found to subsequently underperform (on average) compared to when they are on lower fundamentals. This risk becomes apparent with cap weighting - the Japan scenario. So a possibility is to use rough cap weighting, but dynamically adjust according to CAPE of p/b. When CAPE or p./b is high for a market you underweight and when low you overweight.


Is this why some fund managers on TV over the last few months have been saying to the audience of investors to underweight USA equities (because of High fundamentals) and overweight EM (because of low fundamentals). I also suspect Fund Managers usually make recommendations on TV after they have moved their equity positions in order to enhance their gains ?

JNC


Hi JNC.

If it's of any use or interest I took the P/B value from Vanguard VWRL and its constituent geographical regions:

2.2 VWRL (world)
1.9 VUKE (UK)
2.9 VNRT (North America)
1.9 VERX (Europe Ex UK)
1.3 VJPN (Japan)
1.5 VAPX (Asia Pacific Ex Japan)
1.8 VEFM (Emerging)

Also I sometimes take a peek at the JP Morgan and Blackrock quarterly global asset allocation views to see what they think is under or over valued.

Correlation across regional indices remains low, favoring broad diversification across global equity markets. But at the margin our most favored regions remain the eurozone and Japan, ahead of the U.S. and emerging markets, with the UK our least preferred region. In bond markets we expect yields to grind higher over the fourth quarter and see U.S. Treasuries outperforming most other sovereign markets, in particular German Bunds, which look vulnerable given the robust level of eurozone growth.

https://am.jpmorgan.com/us/en/asset-man ... ights-gaav

I think that I might be guilty of actively passively investing!

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Re: Importance of weightings in world trackers

#82444

Postby JNC3 » September 21st, 2017, 11:49 am

Plutus wrote:
Also I sometimes take a peek at the JP Morgan and Blackrock quarterly global asset allocation views to see what they think is under or over valued.



Thanks for the P/B info and JP Morgan link. Do you have a link for the 'Blackrock quarterly global asset allocation'

Do you adjust your global portfolio according to the World Regional P/B ratio's or do you have equal weights or VWRL Market Cap weights for regions ?

Thanks,
JNC

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Re: Importance of weightings in world trackers

#82448

Postby hiriskpaul » September 21st, 2017, 12:10 pm

Plutus wrote:
JNC3 wrote:
hiriskpaul wrote:I think that I might be guilty of actively passively investing!


Passive investments are not just for passive investors!

The oldest and biggest ETF is the S&P 500 ETF SPY at about $250B. Tens of billions of dollars worth of SPY are traded each day. The TER of SPY is currently uncompetitive at 9bps when compared to the next biggest S&P 500 ETFs (iShares $127B and Vanguard $73B) at only 4bps. Why don't holders flip to iShares or Vanguard? Only reason I can think of is that the spread on SPY is smaller. well under 1bps. You are only going to care about the larger but still tiny spreads on the iShares and Vanguard ETFs if you are very actively trading.

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Re: Importance of weightings in world trackers

#82536

Postby Hariseldon58 » September 21st, 2017, 6:07 pm

My solution to this problem of a single market becoming 'expensive' in a World tracker and being overweighted in my replication of a World tracker was to set geographic allocations which reflected typical exposure over the last 10 years or so, (with an idiosyncratic low weighting to Japan), I add to this a holding in VWRL and VVAL. (Vanguard Global Value) with occasional rebalancing.

The blend is cheaper, tends to underweight some markets and overweight smaller and 'cheaper' stocks. There is no right or wrong solution but this is one I feel has merit and I am more comfortable with.

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Re: Importance of weightings in world trackers

#82538

Postby Plutus » September 21st, 2017, 6:14 pm

JNC3 wrote:
...
Thanks for the P/B info and JP Morgan link. Do you have a link for the 'Blackrock quarterly global asset allocation'

Do you adjust your global portfolio according to the World Regional P/B ratio's or do you have equal weights or VWRL Market Cap weights for regions ?

Thanks,
JNC


Hi I think that the Blackrock opinion on assets and markets will be somewhere amongst https://www.blackrock.com/investing/ins ... nt-outlook

I'm still contemplating on what to do with my global passive portfolio. I think that I've settled on this allocation after about 3 changes of mind but I'm obviously not going to be too strict on the percentages, probably aiming for 10-15% on those that I've listed as 12.5%:

UK: 10%
North America: 35%
Europe: 12.5%
Japan: 12.5%
Pacific ex Japan: 12.5%
Emerging: 12.5%
Smaller Companies/value/punts/gambles : 5%

It's complicated in that I have a 100% pension fund invested in North America and funds in AVCs that are invested in UK and International equities. I'm trying to get an overall summary of how I'm invested and once I've re-balanced a bit I'll try to leave things alone and only review annually.

It would have been easier if I was starting afresh without any legacy investments (I'd have just used VWRL) but I don't want to overtrade either by ditching everything.

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Re: Importance of weightings in world trackers

#83063

Postby xxd09 » September 23rd, 2017, 10:45 pm

Hi Plutus
Following this thread with interest
My position-retired -70+
Using a Vanguard World Index tracker for equities and a Vanguard Hedged Global Bond Index fund for bonds
30/70 Asset Allocation as I have "enough" and it let's me sleep at night!
Also simpler to manage as I get older
Seems to have withstood 2000 and 2008 events
Vanguards weighting seem to be good .Products from other competing companies appear to have similar weightings.
xxd09
PS I also have "legacy" wrappers 2SIPPs and 2ISAs(wife and I)
I treat wrappers as one portfolio re Asset Allocation

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Re: Importance of weightings in world trackers

#83088

Postby Plutus » September 24th, 2017, 8:26 am

xxd09 wrote:Hi Plutus
Following this thread with interest
My position-retired -70+
Using a Vanguard World Index tracker for equities and a Vanguard Hedged Global Bond Index fund for bonds
30/70 Asset Allocation as I have "enough" and it let's me sleep at night!

Morning xxd09 thanks for posting.

I'm 45 and I'm a member of the local government pension scheme so I've decided to have a zero bond/fixed interest allocation in my ISA portfolio.

I do have some cash in zopa and Santander accounts that I aim to redeploy to equities.

It's interesting to see how other people have decided on their asset allocation, do you rebalance to maintain the 30/70 mix?

Regards.

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Re: Importance of weightings in world trackers

#83125

Postby xxd09 » September 24th, 2017, 11:34 am

Hi Plutus
As you can imagine I am now withdrawing money from the SIPPs and ISAs to fund retirement
This is done In a manner that rebalances the Asset Allocation
ie if Bonds are up -take from them.If equities are up then that is the one used Or take from both funds equally if portfolio is in balance
This is a simple calculation with only 2 funds!
Just turn required quantity bonds or equities into cash and withdraw
Rarely need to rebalance otherwise
I have done it once or twice if equities went on a “tear” and rose greatly but mostly don’t touch!
xxd09

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Re: Importance of weightings in world trackers

#83141

Postby Plutus » September 24th, 2017, 1:21 pm

xxd09 wrote:...
This is a simple calculation with only 2 funds!
Just turn required quantity bonds or equities into cash and withdraw
Rarely need to rebalance otherwise

That's something for me to aspire to!

I have lingering legacy investments but I think that I have the total investment portfolio accounted for on a spreadsheet.

If at any time I feel that I've got the allocation correct then I'll make new equity additions via VWRL only, as well as higher interest cash accounts as an alternative to bonds.


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