Asset Allocation by Geography

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Mez!

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Asset allocation by geography. How much does it matter?

Obviously keeping an anchor to the wind in terms of home currency is important. However, I come across critiques of portfolio construction in terms of how under or over weight they are in comparison to the MSCI World Index.

Surely the most important aspect of portfolio construction is owning good companies/funds regardless of geography?

If one has a diversified portfolio across sectors, market cap and geography why consider, for example, rebalancing to 60% US stocks just because that reflects total world market cap?
 
I would turn that question on its head - do you have a good reason not to simply invest in all (or substantially all) publicly traded equities, regardless of where they are listed, in proportion to their market capitalisation?
 
Sarenco said:
I would turn that question on its head - do you have a good reason not to simply invest in all (or substantially all) publicly traded equities, regardless of where they are listed, in proportion to their market capitalisation?
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If I’m interpreting your question correctly, you are asking why should an individual not simply buy all the companies via a World Index tracker?

Well, in my opinion the total return from such a tracker can be beaten over the long term if one chooses wisely (easier said than done) and your portfolio is unnecessarily subjected to more currency exchange risk, unless you live in the US.

Therefore, asset allocation by geography isn’t very important to me. Except to hold a third or so in my home currency to give some protection against exchange risk.
 
So your reason for not investing in a global equity tracker is that you think the market consensus on the appropriate value to place on certain equities and/or currencies is wrong.

Fair enough.
 
Sarenco said:
So your reason for not investing in a global equity tracker is that you think the market consensus on the appropriate value to place on certain equities and/or currencies is wrong.

Fair enough.
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I remember when:

1. The market consensus on the value of tech shares was overly optimistic.

2. The market consensus on the value of Irish property was overly optimistic.

My point is, investment purely by ‘market consensus’ is blindly following the perceived wisdom of crowds. That doesn’t always work out well.
 
Mez! said:
Asset allocation by geography. How much does it matter?

Obviously keeping an anchor to the wind in terms of home currency is important. However, I come across critiques of portfolio construction in terms of how under or over weight they are in comparison to the MSCI World Index.

Surely the most important aspect of portfolio construction is owning good companies/funds regardless of geography?

If one has a diversified portfolio across sectors, market cap and geography why consider, for example, rebalancing to 60% US stocks just because that reflects total world market cap?
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If you do that, you'll probably find that you will have a similar enough portfolio to the MSCI World Index anyway.

...or you are going to end up with a ton of funds that takes up a load of time to manage.

But yes, having quality is the most important thing. How you pick the quality is the question.


Steven
www.bluewaterfp.ie
 
Mez! said:
1. The market consensus on the value of tech shares was overly optimistic.

2. The market consensus on the value of Irish property was overly optimistic.
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Did you know that at the time or do you just know it now with the benefit of hindsight?

You're right though - if you can consistently identify securities that have been mispriced by the market, you will become extremely wealthy over time. Of course, that is exceptionally difficult.
 
I have read that market returns have become more correlated across geographies over time. This makes sense, due to ease of capital flows and more trade links.

If this is the case, then geographical diversity shouldn't need to be as big a priority than in the past.
 
Sarenco said:
Did you know that at the time or do you just know it now with the benefit of hindsight?
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You’re missing my point. Investment via the perceived wisdom of crowds doesn’t always bear fruit.

Besides, a lot of the research into active vs passive is US based. The full merits of passive don’t apply to every market.

“Sarenco said:
You're right though - if you can consistently identify securities that have been mispriced by the market, you will become extremely wealthy over time. Of course, that is exceptionally difficult.
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I wouldn’t go as far as that. A more realistic statement might be:

If you can identify securities (or managers that can identify securities) that have been mispriced by the market and/or have potential to grow exponentially over time, you should increase your wealth over the long term with regular investment.
 
NoRegretsCoyote said:
If this is the case, then geographical diversity shouldn't need to be as big a priority than in the past.
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Or you could reach the opposite conclusion - if equity markets have become more correlated over time (due to globalisation), then an investor would have to be more (not less) geographically diversified to achieve the same diversification impact that a lower allocation to non-domestic equities would have achieved in the past.
 
Mez! said:
Investment via the perceived wisdom of crowds doesn’t always bear fruit.
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Ok but without the benefit of a time machine there's no way I can benefit from that truism.
Mez! said:
If you can identify securities (or managers that can identify securities) that have been mispriced by the market and/or have potential to grow exponentially over time, you should increase your wealth over the long term with regular investment.
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Sure but that's a very big "if"!

I don't have any confidence in my ability to identify misprced securities (or to pick managers with this ability) so I don't even try.
 
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Sarenco said:
Sure but that's a very big "if"!

I don't have any confidence in my ability to identify misprced securities (or to pick managers with this ability) so I don't even try.
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Granted, it is a big ‘if’. However in Euros, the MSCI World Index has returned 3.86% annualised since December 2000. Coupled with the backward tax treatment of ETF’s in Ireland. Can you afford not to say ‘if’?
 
Sarenco said:
Or you could reach the opposite conclusion - if equity markets have become more correlated over time (due to globalisation), then an investor would have to be more (not less) geographically diversified to achieve the same diversification impact that a lower allocation to non-domestic equities would have achieved in the past.
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It depends on what your objective is. I would say minimising expected volatility.

Geographical allocation is just a tool to achieve this, not an end in itself.
 
Mez! said:
Granted, it is a big ‘if’. However in Euros, the MSCI World Index has returned 3.86% annualised since December 2000. Coupled with the backward tax treatment of ETF’s in Ireland. Can you afford not to say ‘if’?
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I'm not sure I really understand what your point is here.

My investment objective is to reach my personal financial goals while taking the minimum risk possible. Taking punts on individual stocks/managers is not really compatible with that objective.
 
NoRegretsCoyote said:
It depends on what your objective is. I would say minimising expected volatility.
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Well, my objective is to be as diversified as possible across global stocks because I've no idea what companies, sectors or regions will succeed in the future.
 
Sarenco said:
Well, my objective is to be as diversified as possible across global stocks because I've no idea what companies, sectors or regions will succeed in the future.
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If you take that attitude you might as well save yourself the hassle and just buy one stock!

The performance of an asset class cannot be predicted, but it is reasonable to assume that correlations (negative or positive) between certain asset classes will hold.

To simplify, try to buy assets that tend to rise when other parts of your portfolio tend to fall, and vice versa.
 
NoRegretsCoyote said:
If you take that attitude you might as well save yourself the hassle and just buy one stock!

The performance of an asset class cannot be predicted, but it is reasonable to assume that correlations (negative or positive) between certain asset classes will hold.

To simplify, try to buy assets that tend to rise when other parts of your portfolio tend to fall, and vice versa.
Click to expand...

No, it's not reasonable to just 'assume' that anymore . The financial crisis was magnified because that very assumption about diversification and correlated assets failed dismally and crashed every single risk model out there. By all means, look at correlation but don't just blindly assume it will hold. Uncorrelated assets can all rise or fall at the same time depending the event. It might hold 95% of the time but as we all learnt, the 5% is still a risk.
 
NoRegretsCoyote said:
If you take that attitude you might as well save yourself the hassle and just buy one stock!
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I don't follow - how would owning a single stock meet my objective of achieving maximum diversification?

I've no idea what companies, sectors or regions will succeed in the future so I just buy the whole lot, in proportion to their market capitalisation. Last time I checked, the funds in which I'm invested hold equity interests in over 3,000 companies, across something like 45 countries, representing over 90% of the investable equity universe.

I know as a certainty that won't give me the best possible outcome. But I equally know that it won't give me the worst possible outcome. I will simply get the market return, less costs. I'm ok with that.

I also invest a portion of my assets in fixed-income investments of various flavours (sovereign and corporate bonds, deposits) and I own my own home.

Incidentally, I don't agree that the correlation between asset classes is relatively stable - they change all the time.
 
@Sarenco

I was being facetious. If you have no idea what will succeed, and your only criterion is success, then one stock is as good as a basket.


Buying the whole world in equal weight doesn't minimise risk per se.

For most people the main source of their wealth is Irish housing, their occupational pension scheme, and the state pension.

If you have money to spare, and want to minimise risk across your whole portfolio, then invest in something negatively correlated with these assets. Or, if this is hard to find, look for something which should be un-correlated with them: like forestry in Brazil or something.
 
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