Author Topic: Home field bias: does it make us under diversify internationally?  (Read 8928 times)

milesdividendmd

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America has been the shining star of Capital markets at least since 1900. But do we attribute too much significance to this fact? And does this past performance necessarily predict future performance?

I  investigated these questions in this  post,

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Enjoy, and please share your preferred level of international diversification, and your justification/thoughts.

Alexi
« Last Edit: May 20, 2014, 09:04:14 PM by arebelspy »

matchewed

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Re: Home field bias: does it make us under diversify internationally?
« Reply #1 on: May 20, 2014, 04:00:54 PM »
I think you're mixing up a couple of different concepts to maybe warn people away from domestic (read US) funds as a source of diversification. I wouldn't call US total market funds international funds, what I would say is that the US is a huge economy with every single type of industry under the sun represented in the companies within the US total market. Those companies also do a great deal of their business overseas and therefore have their performance influenced by the economies of countries overseas all the while being mitigated by the fact that they do business with all sorts of different countries and regions. Gone are the days where US companies did business solely in the US (if those days even really ever existed.

The real question you have to answer is that is there a benefit to diversifying internationally? What does a portfolio gain if it does so? Why do I have to have my portfolio in proportion to the global equity balance?

*edit to remove my snark*
« Last Edit: May 20, 2014, 04:05:24 PM by matchewed »

KingCoin

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Re: Home field bias: does it make us under diversify internationally?
« Reply #2 on: May 20, 2014, 04:22:05 PM »
The real question you have to answer is that is there a benefit to diversifying internationally? What does a portfolio gain if it does so? Why do I have to have my portfolio in proportion to the global equity balance?

Yes. For all the press it receives, emerging market equity has been a heroic historical underperformer, having had both higher risk and lower returns than more developed equities. This makes their place in a portfolio fairly questionable (they're neither on the efficient frontier, nor provide much diversification value). The future may be different, but even during a period of explosive growth countries like China have had anemic equity growth at best. Problems with corporate governance, corruption, accounting standards, etc. often means more earnings go to corporate and government kleptocrats than investors.

I guess it's worth diversifying into other developed nations, but the world is becoming so intertwined that the value of doing so is probably becoming less and less.

milesdividendmd

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Re: Home field bias: does it make us under diversify internationally?
« Reply #3 on: May 20, 2014, 04:35:15 PM »
I don't know that I am warning people away from domestic funds (after all I do disclose that I favor 60% of my equities being domestic in my own asset allocation.)

The reason to own foreign funds is for the diversification benefit (ie. higher CAGR at the the same level of risk). 

Although globalization does increase the correalation of all classes of equities, their remains imperfect coorealation of the US market with the rest of the world.  Last year is a great example of a year when the US dramatically outperformed the rest of the developed world (and emerging markets.) All things being equal this means that US stocks are now more expensive relative to non US stocks.  2000-2010 was a period of dramatic outperformance of emerging markets.  At sometime in the future, the Non-US Developed world will likely outperform the US, since their stocks are now cheaper.

Long term there is very little difference between the returns of the US and the rest of the developed world.

And back testing tells us that long term  by owning a significant slice of international equities, we would have outperformed both the US and the rest of the world with our blended portfolio.

As to the future,  its anyone's guess....  I certainly have no clue.  But I'm a big believer in diversification.  That's one of my own biases.

Alexi

I think you're mixing up a couple of different concepts to maybe warn people away from domestic (read US) funds as a source of diversification. I wouldn't call US total market funds international funds, what I would say is that the US is a huge economy with every single type of industry under the sun represented in the companies within the US total market. Those companies also do a great deal of their business overseas and therefore have their performance influenced by the economies of countries overseas all the while being mitigated by the fact that they do business with all sorts of different countries and regions. Gone are the days where US companies did business solely in the US (if those days even really ever existed.

The real question you have to answer is that is there a benefit to diversifying internationally? What does a portfolio gain if it does so? Why do I have to have my portfolio in proportion to the global equity balance?

*edit to remove my snark*
« Last Edit: May 20, 2014, 04:37:23 PM by milesdividendmd »

milesdividendmd

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Re: Home field bias: does it make us under diversify internationally?
« Reply #4 on: May 20, 2014, 04:47:34 PM »
In my own mind I always seperate emerging markets from foreign developed markets.  EM have unique characteristics that have little to do with their being foreign, and everything to do with them being situated in the developing world.  It's important not to conflate Emerging Markets with Foreign developed markets for this reason, (not implying that you are making this mistake.)

If you wanted to truly "own the haystack"  the simplest formula might be to split your equity allocation 50/50 between the total us stock market and the MSCI all country world index which includes 13% Emerging markets.

Alexi

The real question you have to answer is that is there a benefit to diversifying internationally? What does a portfolio gain if it does so? Why do I have to have my portfolio in proportion to the global equity balance?

Yes. For all the press it receives, emerging market equity has been a heroic historical underperformer, having had both higher risk and lower returns than more developed equities. This makes their place in a portfolio fairly questionable (they're neither on the efficient frontier, nor provide much diversification value). The future may be different, but even during a period of explosive growth countries like China have had anemic equity growth at best. Problems with corporate governance, corruption, accounting standards, etc. often means more earnings go to corporate and government kleptocrats than investors.

I guess it's worth diversifying into other developed nations, but the world is becoming so intertwined that the value of doing so is probably becoming less and less.

matchewed

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Re: Home field bias: does it make us under diversify internationally?
« Reply #5 on: May 20, 2014, 05:16:49 PM »
I don't know that I am warning people away from domestic funds (after all I do disclose that I favor 60% of my equities being domestic in my own asset allocation.)
There is a difference between "warning people away from domestic funds" and "warning people away from domestic funds as a source of diversification". I agree you are not doing the first however you are doing the second by stating that people don't have their funds allocated in a manner which reflects global equity as if they need to.

I'm just questioning whether they need to.

The reason to own foreign funds is for the diversification benefit (ie. higher CAGR at the the same level of risk). 

Although globalization does increase the correalation of all classes of equities, their remains imperfect coorealation of the US market with the rest of the world.  Last year is a great example of a year when the US dramatically outperformed the rest of the developed world (and emerging markets.) All things being equal this means that US stocks are now more expensive relative to non US stocks.  2000-2010 was a period of dramatic outperformance of emerging markets.  At sometime in the future, the Non-US Developed world will likely outperform the US, since their stocks are now cheaper.

Long term there is very little difference between the returns of the US and the rest of the developed world.

And back testing tells us that long term  by owning a significant slice of international equities, we would have outperformed both the US and the rest of the world with our blended portfolio.

Does it?

As to the future,  its anyone's guess....  I certainly have no clue.  But I'm a big believer in diversification.  That's one of my own biases.

Alexi

Agreed but I think we may not necessarily agree on whether the US is considered diversified enough.

milesdividendmd

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Re: Home field bias: does it make us under diversify internationally?
« Reply #6 on: May 20, 2014, 05:53:30 PM »
Nice use of portfolio analyzer!

I think you'll agree that all three portfolios have no significant difference in terms of their CAGR.

If you change the time period From 1972 - 2012 you will find that the international portfolios come out on top (again not significant.) from this we can conclude that 2013 was a good year for the US stock market.

What I think is more significant, is that the efficiency of the diversified portfolio is  better regardless of time period. (higher sharp ratio.)

If you're a believer in reversion to the mean (I am), then now would not be the right time to increase your allocation towards US markets.

Alexi

clifp

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Re: Home field bias: does it make us under diversify internationally?
« Reply #7 on: May 20, 2014, 06:08:03 PM »
I'd highly recommend reading Bernstein short Ebook "Skating Where the Puck was: The correlation game in a flat world.".
TL:DR on the book is that correlations between all assets class are increasing significantly.  So for instance the correlation between the EAFE and the S&P 500 has risen from around .5 in the 1980s to over .9 today. 

So there really isn't much benefit from buying large cap international funds from a diversification standpoint.
I personally have about 20% in international funds, with an overweighting of emerging markets cause long term I think they will do well.

Cyrano

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Re: Home field bias: does it make us under diversify internationally?
« Reply #8 on: May 20, 2014, 06:08:21 PM »
Does it?

In accumulation phase, portfolio volatility is relatively unimportant. If you never have to withdraw, you never withdraw during a downturn.

But run the same portfolios in depletion phase, and we get a very different resultů.
Results

milesdividendmd

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Re: Home field bias: does it make us under diversify internationally?
« Reply #9 on: May 20, 2014, 06:25:34 PM »
Cyrano,

Wonderful point. I hadn't seen this illustrated before, but your demonstration is very thought provoking.

And to me it brings up another point. The increased efficiency of diversification could be used to derisk identical returns on a portfolio, or to increase your equity allocation, without significantly increasing your expected risk.

Alexi



RapmasterD

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Re: Home field bias: does it make us under diversify internationally?
« Reply #10 on: May 20, 2014, 09:06:21 PM »
I'm not a moderator of this forum, but do find it personally offensive that you are now repetitively initiating thread discussions by pointing people to your personal blog to kick off the topic. EX: 1) Betterment versus Vanguard Part 2, 2) Why I'll never invest in Lending Club, and 3) now this thread....

If you have something of merit you want to share, then introduce your topic and point of view right here on this forum. IMHO it is disingenuous to redirect people to your blog, whether the motive is for profit or not.

And if this behavior were widely replicated by others, then this forum would soon become a wasteland of annoying redirects. Many participants on this forum, unlike you, derive revenue from blogging and from participating in forums like this one to raise their brand profile. But they don't engage in the practice you are currently engaging in. You know what you are doing. Please stop doing it.
« Last Edit: May 20, 2014, 09:10:10 PM by RapmasterD »

innerscorecard

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Re: Home field bias: does it make us under diversify internationally?
« Reply #11 on: May 20, 2014, 10:15:13 PM »
The real question you have to answer is that is there a benefit to diversifying internationally? What does a portfolio gain if it does so? Why do I have to have my portfolio in proportion to the global equity balance?

Yes. For all the press it receives, emerging market equity has been a heroic historical underperformer, having had both higher risk and lower returns than more developed equities. This makes their place in a portfolio fairly questionable (they're neither on the efficient frontier, nor provide much diversification value). The future may be different, but even during a period of explosive growth countries like China have had anemic equity growth at best. Problems with corporate governance, corruption, accounting standards, etc. often means more earnings go to corporate and government kleptocrats than investors.

I guess it's worth diversifying into other developed nations, but the world is becoming so intertwined that the value of doing so is probably becoming less and less.

If that is the consensus view regarding emerging markets, won't the principle of reflexivity mean that the prices of those assets will already reflect these downsides? And won't these downsides sometimes be magnified too much by market psychology so that these assets are comparatively, as well as absolutely cheap, and so will sometimes provide higher returns when the psychological pendulum swings back the other way again? For example, Gazprom and PetroChina are corrupt and poorly governed enterprises, but they are also much, much cheaper than Exxon or BP.

Hamster

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Re: Home field bias: does it make us under diversify internationally?
« Reply #12 on: May 21, 2014, 12:02:23 AM »
America has been the shining star of Capital markets at least since 1900...

[MOD EDIT: Link removed.  Please stop spamming links promoting your own site.  A single link in your signature is sufficient, and will be under every post you make.  Thanks.]

I'm not a moderator of this forum, but do find it personally offensive that you are now repetitively initiating thread discussions by pointing people to your personal blog to kick off the topic....

And if this behavior were widely replicated by others, then this forum would soon become a wasteland of annoying redirects.

I welcome people sharing interesting content from their personal blogs here, but I agree that threads that recap and redirect to another blog post feel spammy, and it would be nice to keep the links in signatures. That said, in miles' defense there are plenty of examples of this same type of post being allowed on this forum.  For example, here's a thread initiated with a redirect link to RootOfGood's blog from 2 days ago. Nobody appeared to care. RootOfGood has been starting similar threads with recaps of his blog posts and redirect links since last fall. I'm not trying to single anyone out, but I would just suggest to the mods and other forum community members that if this is the standard, that it would be nice to see it applied equally.

RapmasterD

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Re: Home field bias: does it make us under diversify internationally?
« Reply #13 on: May 21, 2014, 01:10:34 AM »
America has been the shining star of Capital markets at least since 1900...

[MOD EDIT: Link removed.  Please stop spamming links promoting your own site.  A single link in your signature is sufficient, and will be under every post you make.  Thanks.]

I'm not a moderator of this forum, but do find it personally offensive that you are now repetitively initiating thread discussions by pointing people to your personal blog to kick off the topic....

And if this behavior were widely replicated by others, then this forum would soon become a wasteland of annoying redirects.

I welcome people sharing interesting content from their personal blogs here, but I agree that threads that recap and redirect to another blog post feel spammy, and it would be nice to keep the links in signatures. That said, in miles' defense there are plenty of examples of this same type of post being allowed on this forum.  For example, here's a thread initiated with a redirect link to RootOfGood's blog from 2 days ago. Nobody appeared to care. RootOfGood has been starting similar threads with recaps of his blog posts and redirect links since last fall. I'm not trying to single anyone out, but I would just suggest to the mods and other forum community members that if this is the standard, that it would be nice to see it applied equally.

Yup. That's spammy as well. And the blog pointed to has ads. Annoying.

arebelspy

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Re: Home field bias: does it make us under diversify internationally?
« Reply #14 on: May 21, 2014, 07:11:05 AM »
[MODERATOR VOICE ON]

I welcome people sharing interesting content from their personal blogs here, but I agree that threads that recap and redirect to another blog post feel spammy, and it would be nice to keep the links in signatures.

The OP in this case had literally dozens of posts linking directly to their blog.  Given their post count isn't that high, it was overwhelming, to say the least.  Poster has been warned and issued a temporary ban (this was their second rule violation) and discussed the issue via PM.

For example, here's a thread initiated with a redirect link to RootOfGood's blog from 2 days ago. Nobody appeared to care. RootOfGood has been starting similar threads with recaps of his blog posts and redirect links since last fall. I'm not trying to single anyone out, but I would just suggest to the mods and other forum community members that if this is the standard, that it would be nice to see it applied equally.

Do you understand that the moderators are unpaid volunteers who, as members of the community, try our best to keep this a fun place to visit?  We don't catch every single post.  Futher, we try to give someone the benefit of the doubt if they're just linking a post or two, we don't want to shut that down right away.  The OP in this thread spammed dozens of times before we caught it and decided they had crossed the line.

It would be nice if you would give us the benefit of the doubt, rather than just a sarcastic "it would be nice to see it applied equally."

If you see a comment you consider spam, feel free to report it using the link at the bottom right of every post.

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Hamster

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Re: Home field bias: does it make us under diversify internationally?
« Reply #15 on: May 21, 2014, 08:55:09 AM »
Sorry if it came off as sarcastic. I truly didn't mean it to be sarcastic or critical of the mods.

It  was just my observation that I could see why a forumite might think it's acceptable to start multiple threads referencing their own blog posts, having seen it elsewhere on the forum. At any rate, keep posting, keep modding, keep saving, and keep sharing the word. I really do value this community.

arebelspy

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Re: Home field bias: does it make us under diversify internationally?
« Reply #16 on: May 21, 2014, 09:00:53 AM »
Gotcha.  Appreciate the clarification.  :)
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RapmasterD

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Re: Home field bias: does it make us under diversify internationally?
« Reply #17 on: May 21, 2014, 11:03:04 AM »
arebelspy -- Next time I'm in Vegas, I'm taking you to the Carrot Top show, on my dime.

arebelspy

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Re: Home field bias: does it make us under diversify internationally?
« Reply #18 on: May 21, 2014, 11:29:06 AM »
Absolutely not necessary, but I do enjoy hanging out with other Mustachians, so definitely let me know if you're in town (that goes for anyone).  :)
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
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RapmasterD

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Re: Home field bias: does it make us under diversify internationally?
« Reply #19 on: May 21, 2014, 08:12:21 PM »
Absolutely not necessary, but I do enjoy hanging out with other Mustachians, so definitely let me know if you're in town (that goes for anyone).  :)

So I was kidding...I mean...Carrot Top? But I actually was in Vegas for a full day and part of a night last week, including three long hours at the SWA terminal. No plans to come back, but anything can happen. Cheers!

arebelspy

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Re: Home field bias: does it make us under diversify internationally?
« Reply #20 on: May 22, 2014, 07:02:51 AM »
So I was kidding...I mean...Carrot Top?

Some people find him funny - you don't have a show in Vegas for a decade without selling tickets.

/shrug
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
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SDREMNGR

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Re: Home field bias: does it make us under diversify internationally?
« Reply #21 on: May 22, 2014, 04:43:44 PM »
So I was kidding...I mean...Carrot Top?

Some people find him funny - you don't have a show in Vegas for a decade without selling tickets.

/shrug

I think people go see him because they are scared that he will beat them up if they don't go.  Have you seen him lately?  He's really freaky big now.

RapmasterD

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Re: Home field bias: does it make us under diversify internationally?
« Reply #22 on: May 22, 2014, 09:42:23 PM »
People -- Let's set the record straight. I would go see Carrot Top in a NEW YORK MINUTE!

Will

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Re: Home field bias: does it make us under diversify internationally?
« Reply #23 on: May 22, 2014, 09:50:39 PM »
I'd go see him for free, but I don't think I would spend money to see him.