International equity exposure - Strategies for getting better diversification

[FreelanceToFreedom]

I read an interesting article about the popular international ETFs and how they are quite concentrated into a handful of countries (Japan, in particular).

https://www.lynalden.com/international-stocks/

The TL;DR is that most international funds are market-cap weighted, which concentrates the exposure to larger companies based in a handful of countries. It leaves you with very high exposure to low-growth countries like Japan (up to 25%), and very little to high-growth emerging markets and smaller developed markets.

The author suggests a few ways to improve diversification -
1. Adding a dividend-focused intl fund, which helps balance out exposure
2. Overweighting emerging markets
3. Adding country-specific ETFs, targetting "cheapest" countries by CAPE or other 


I hadn't seen this discussed here, and thought the article brought up some good points. I don't want to over-complicate things, but I also want to have truly global exposure and am comfortable with the volatility of emerging markets.

Thoughts?

[Andy R]

It's an interesting idea, but it doesn't hold up well under further investigation.

• Everything this person knows, the entire collective market knows, and has priced it in, so it is an argument that i don't believe can be won based on actual reasoning. Honestly you could stop there and I don't think there is an argument that can defend against this.

Other bits and pieces
• Assuming Russia will do well just because it has a low P/E ratio... enough said.
• Weird that this person lumped in dividend funds with dividend appreciation funds when the two are fundamentally different.
• There is a similar (or rather, better) argument for increasing value and small companies, or possibly GDP weighting.
• Weird that they took notice of dividends at all. It makes more sense to go by value metrics directly since dividends alone are the outcome and not the reason those stocks are more 'valuey'.

The really slippery slope you go on with this persons argument of holding set amounts of each, is that if you had this idea back say 100 years ago when the US was some 30% of the world by market cap, you would have missed out on a fortune of out performance as the mean they would assumed was not actually the mean that is reverted to within their lifetime.

This was something I struggled with in my portfolio as a non-american, not really thrilled with the idea of half my international 45 countries equities in one country, but there just isn't an argument that holds up against the first point above. It's a bit like someone saying democracy sux and yes they are right but it doesn't help you when all other known options are worse.

[FreelanceToFreedom]

It's an interesting idea, but it doesn't hold up well under further investigation.

• Everything this person knows, the entire collective market knows, and has priced it in, so it is an argument that i don't believe can be won based on actual reasoning. Honestly you could stop there and I don't think there is an argument that can defend against this.

Other bits and pieces
• Assuming Russia will do well just because it has a low P/E ratio... enough said.
• Weird that this person lumped in dividend funds with dividend appreciation funds when the two are fundamentally different.
• There is a similar (or rather, better) argument for increasing value and small companies, or possibly GDP weighting.
• Weird that they took notice of dividends at all. It makes more sense to go by value metrics directly since dividends alone are the outcome and not the reason those stocks are more 'valuey'.

The really slippery slope you go on with this persons argument of holding set amounts of each, is that if you had this idea back say 100 years ago when the US was some 30% of the world by market cap, you would have missed out on a fortune of out performance as the mean they would assumed was not actually the mean that is reverted to within their lifetime.

This was something I struggled with in my portfolio as a non-american, not really thrilled with the idea of half my international 45 countries equities in one country, but there just isn't an argument that holds up against the first point above. It's a bit like someone saying democracy sux and yes they are right but it doesn't help you when all other known options are worse.

You make some good points. Something to think about!

Would you instead try to up exposure to intl small cap, or intl value?

Re; the dividend focus. As I read it, she was recommending intl dividend funds more because their geographical focus was less concentrated, not really because of the div yield itself. One of the charts in the article shows how adding a dividend metric helps balance out the country distribution.

[Eric]

The TL;DR is that most international funds are market-cap weighted, which concentrates the exposure to larger companies based in a handful of countries. It leaves you with very high exposure to low-growth countries like Japan (up to 25%), and very little to high-growth emerging markets and smaller developed markets.

Why would that matter?  You're not investing in the country's success, but in the success of the companies domiciled there.  What if Samsung starts selling TVs to every single new household in Nigeria?  Owning more Nigerian companies won't help with that.

The whole "equal weighting" argument is entirely foreign to me (pun intended).  Of course I want to own more of the more successful companies.  The idea that I'd own the exact same dollar amount of Google vs some newly released IPO doesn't hold water.

[MustacheAndaHalf]

I prefer to pick and choose from articles, since some ideas I find interesting and others poorly supported.

There's a long history of there being a "value factor", as something you need to explain the risk-reward of the stock market.  There's the Fama-French 3 factor model (stock market, value, small cap) and all following models that include value as a factor.  It can be measured with price/earnings or price/book or even CAPE 10.  Larry Swedroe shows examples of it both in the U.S. and international, both before the factor was discovered and afterwards.  Showing a factor has ... "value" after it's discovered is especially important.

So the idea of selecting 25% of countries based on value criteria is interesting.  Unfortunately I don't trust Meb Faber, having read his book with the byline "survey of the world's top investment strategies".  He replaced top investor Warren Buffet with the S&P 500, even though Buffet is famous because he beat the S&P 500.  Larry Swedroe, famous for advocating a small/value tilt, gets represented (in an appendix) by a portfolio with no small/value stocks.  And so on... everyone gets represented by something they are not, which then lets Meb Faber arrived at his conclusion that these strategies don't matter.  So I have a problem with any data source from that author.

This article really doesn't defend it's use of dividends.  It says dividends help avoid Japan... but why are dividends used to do that?

I would be interested in the undervalued countries approach.  Right now most country-specific ETFs have two significant risks: they have high expense ratios, which need to be overcome with even higher returns.  And they don't contain many stocks.  Taking an example from earlier in this thread, the 3 Russia ETFs I found each had less than 30 stocks.

Maybe we should pitch this idea of undervalued countries in AQR's direction to see if they publish something about it?