Author Topic: passive portfolio: fully international or home-biased?  (Read 3011 times)

kvaruni

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passive portfolio: fully international or home-biased?
« on: July 20, 2015, 05:47:24 AM »
I'm changing my portfolio from active funds to passive funds, and I'm using the excellent justETF tool to get a basic idea of which ETFs to buy. The problem has to do with how to diversify on an international scale. As I see it, there are three options:
  • you buy a world equity, which is heavily biased towards the US;
  • you buy domestic equity, and top it up with a world equity and emerging markets;
  • you buy world equity as per each countries GDP.

Each option seems to have some issues. Some personal information: I am from the EU, currently living in the EU, but moving countries about every 4-5 years on average. This immediately highlights an issue with the first option. While the US is typically an equity stronghold, it means I'm purchasing USD equity and therefore am much more exposed to a currency risk. Option 2 sounds reasonable, but with my moving around it also means that it has the same problem as the first option. Option 3 is the most balanced, but it means considerable exposure to countries such as China (for better or worse).

Are any of these options better than the others? Or is it all just a matter of taste?

fb132

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Re: passive portfolio: fully international or home-biased?
« Reply #1 on: July 20, 2015, 05:50:39 AM »
As a canadian, I have a little bit of everything, 30% is local (Canadian), a small portion (maybe 15-20%) international and emerging markets and the majority of my investments goes towards US stocks. It keeps it diversified, if one economy tanks, at least I am protect with the other countries. I guess each to their own.

Let's go back in '08, the canadian market faired much better than the US, so the fact I had some money invested in Canada protected me from the massive drop from the US stocks. Now, the roles are reverse, the canadian economy is dropping, but the US is doing good so far.
« Last Edit: July 20, 2015, 05:52:22 AM by fb132 »

milesdividendmd

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Re: passive portfolio: fully international or home-biased?
« Reply #2 on: July 20, 2015, 06:14:38 AM »
If you want to be truly passive in your equity allocation, then you should allocate to equities based on market capitalization, not gdp. This means a whole world fund versus about a 50/50 allocation to total US/world ex-US.

Suprisingly the second option will be cheaper due to fund size effects.

If you allocate based on GDP, then your portfolio will shade towards international and value relative to a truly passive portfolio. This can be either a good or bad thing depending on your philosophy.

kvaruni

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Re: passive portfolio: fully international or home-biased?
« Reply #3 on: July 20, 2015, 08:25:51 AM »
You mean that with GDP I would need to rebalance?

what would the implications be of both philosophies? I'm still trying to figure out their real difference, other than the rather subjective "I don't want to be overexposed to country/region X".

chippy

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Re: passive portfolio: fully international or home-biased?
« Reply #4 on: July 20, 2015, 11:58:50 AM »
Being biased on US equity isn't as odd it seems. Most of the large US corporations are globally diversified conglomerates. Keep in mind that Apple buys iphones from China and sells a ton there; buying US equity often means buying global equity. (Same is true of many European and Japanese companies, see Total and Toyota.

forummm

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Re: passive portfolio: fully international or home-biased?
« Reply #5 on: July 20, 2015, 12:04:40 PM »
you buy a world equity, which is heavily biased towards the US;

This is incorrect. A market cap weighted world equity is not "biased" towards the US. It reflects the fact that the US has currently about half of the global market capitalization. If you want to own everything on a market cap basis, you should have about half your money in US equities.

Terrestrial

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Re: passive portfolio: fully international or home-biased?
« Reply #6 on: July 20, 2015, 01:51:57 PM »
My portfolio is generally more heavily weighted to US equities, for 3 primary reasons:

-I feel like i am generally much more knowledgeable about the general happenings and monetary policy/governance in the US than other areas of the world.

-Frankly, I just have more faith in the US markets than overseas, even after the financial crisis.  I think part of me also feels that if the US market totally collapses (not a correction/recession, but a true catastrophic event) that means that things are going to be so bad here that my portfolio will prob be the least of my worries anyway.  On the flip side, foreign markets can be having issues with relatively little impact to the goings on in the US.

-In the age of globalization most large US companies have significant presences/exposure overseas and extensive cross integration with foreign businesses anyway.  Also while exchange rates do impact US business earnings, there is less of an effect than on foreign businesses when you are pricing things in dollars.  This can be a good or a bad thing depending on how things are moving, but it's an unknown variable for me, I'm no currency expert.

This is not to say this is the 'best' way to do it, but it's what I do. 
« Last Edit: July 20, 2015, 01:57:31 PM by Terrestrial »

milesdividendmd

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Re: passive portfolio: fully international or home-biased?
« Reply #7 on: July 20, 2015, 03:21:23 PM »

You mean that with GDP I would need to rebalance?

what would the implications be of both philosophies? I'm still trying to figure out their real difference, other than the rather subjective "I don't want to be overexposed to country/region X".

If you weight your exposure based on gdp then this is a form of fundamental weighting which seeks to decouple portfolio exposure from the whims of price.

As an example if you weighted your portfolio based on capitalization in 1988 you would  have had 50% of your equity in Japanese equites, reflecting what we now recognize to have been a historic price bubble.

If you weighted by GDP you would have had far less than 50% exposure to the Japanese market (and have missed the run up in value that led to the imbalance between GDP/cap weighting in the first place, and the subsequent carnage as the bubble popped.)

Regardless of the measure you select (GDP, exports, cash flows) this will lead to a strategy that underweights expensive countries and overweights cheaper ones. ie you will be implementing a value strategy.

The positives of fundamental weighting

1.  It over exposes you to the value factor which should boost long term returns.

2.  It decreases your exposure to bubbles.

The negatives.

1.  It underexposes you to momentum which increases short term returns.

2.  Expense. Such a strategy is active, so you must periodically buy and sell countries in your portfolio (rebalance) to keep your country exposure in line with your fundamental of interest (GDP, cash flows, exports.) this costs money in the form of commissions, bid ask spreads, etc.

3.  You must have an accurate and real time way of measuring your fundamental. (Which requires effort.)

There is no right answer of course.


kvaruni

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Re: passive portfolio: fully international or home-biased?
« Reply #8 on: July 21, 2015, 01:33:27 AM »
Thanks everyone for the input. It definitely sounds like it is a matter of taste, but at least I'm now well-informed to make my decision!

brainfart

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Re: passive portfolio: fully international or home-biased?
« Reply #9 on: July 22, 2015, 10:29:33 AM »
>  it means I'm purchasing USD equity and therefore am much more exposed to a currency risk

Oh my. Just like every other investor on this planet who is not located in the US.

Sometimes it will work for you, sometimes against you. In the end, over the course of your investing career it will all even out.