International stocks?

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tarentola
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Re: International stocks?

Post by tarentola » Sat May 02, 2020 3:45 am

To put the question backwards: should a non-US PP investor invest in US stocks and if so, what percentage? As a Euro investor, I am inclined to 50% EU, 30% US, 20% EM (not far off World allocation), but I have no evidence for this.

My impression, from portfoliocharts.com and my own experience, is that the performance of a non-US PP in local currency is not very different from that of a US PP in dollars. So maybe there is no advantage to including stocks from outside the investor's home market.
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Re: International stocks?

Post by Hal » Sat May 02, 2020 5:36 am

I would suggest that the smaller your countries economy, the more international shares you should own. From memory, around half of Australia stock market capitalisation comes from four banks. More diversification than that certainly helps me sleep at night.

The attached link indicates around 2/3 of the MSCI World consists of US companies.
Also, have a look what happens in non-steady state conditions. Money was hardly rushing into Australian 10 year bonds as a safe haven last month.

https://www.msci.com/documents/10199/49 ... 93b1f3d60b

https://markets.ft.com/data/etfs/tearsh ... GB:ASX:AUD
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Re: International stocks?

Post by tarentola » Sat May 02, 2020 6:30 am

Yes Hal, that makes sense: the stock index used should be diversified, and that may not be the case in a small country. Also as you mention, US bonds do have a safe haven status for investors worldwide. TLT (US 20+ year Treasuries) is +24% since January, while its European equivalent MTH is only +6%.
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Re: International stocks?

Post by jalanlong » Sun Jun 27, 2021 10:16 am

I listened to 3 financial podcasts this weekend featuring guests that I thought had good ideas on portfolio construction etc. One thing was interesting to me though. All 3 said you need international stocks in your portfolio for "diversification" in case of a declining dollar or for value against the high growth US stocks. None of the 3, however, gave any data to support that claim.

Ever since I have been investing, most commentators have gone with the "you need international stocks for diversification" advice. The actual data, however, shows no such benefit over the last 50 years. Over that time, a portfolio of US only stocks beats the pants off of a US & International Portfolio. As for the diversification claim, most years the markets move in tandem. In that 50 years there were only a couple of years when foreign outpaced US by any significance but yet many years were the US outperformed. So where does this whole mantra of international stocks helping your portfolio come from? I cannot find any evidence that it does at all. Is it just another one of those things that seems to make sense on the surface and therefore people parrot but never actually research?
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Re: International stocks?

Post by D1984 » Sun Jun 27, 2021 1:52 pm

jalanlong wrote:
Sun Jun 27, 2021 10:16 am
I listened to 3 financial podcasts this weekend featuring guests that I thought had good ideas on portfolio construction etc. One thing was interesting to me though. All 3 said you need international stocks in your portfolio for "diversification" in case of a declining dollar or for value against the high growth US stocks. None of the 3, however, gave any data to support that claim.

Ever since I have been investing, most commentators have gone with the "you need international stocks for diversification" advice. The actual data, however, shows no such benefit over the last 50 years. Over that time, a portfolio of US only stocks beats the pants off of a US & International Portfolio. As for the diversification claim, most years the markets move in tandem. In that 50 years there were only a couple of years when foreign outpaced US by any significance but yet many years were the US outperformed. So where does this whole mantra of international stocks helping your portfolio come from? I cannot find any evidence that it does at all. Is it just another one of those things that seems to make sense on the surface and therefore people parrot but never actually research?
A couple of caveats to the above along with reasons and explanations:

1. The first (and the most important) is that anyone who says "why invest in international....it's clear the US-only investor would've been better off because he/she stayed out of lower-performing international stocks altogether" are confusing ex post returns with ex ante returns. It's a simple mathematical identity that some country has to be the top performing one at any given point in time and IIRC the US has been--at least among developed countries; I cannot speak for it vs any particular emerging market--that country over the past 25 or 30 years. However, how was an investor supposed to know this back in 1990 or 1995 or 1996? Heck, assuming one had started at the late March or early April 1996 inception of the IShares country ETFs, Italy of all countries was beating the US until the summer of 2011 (Italy's stock market being one of the weakest performers overall from 1996 to the present day); the same applies for Austria (it did godawful from mid-1996 to 2001 and then roared back as one of the world's best performing markets from 2002 until 2009; it only got lapped by the US--assuming one had invested an equal amount in Austria and US index funds in early 1996 when the IShares Austria index ETF came out--in September 2011). Singapore is probably the worst-performing developed market vs the US for the whole time period since 1994 or 1995 to today....but how were you to know that in the early or mid-1990s...because from 1965 or 1966 until year-end 1993 Singapore stocks beat US stocks by almost as per year on average much as Japanese stocks beat US stocks from 1960 to 1988. From 1900 to 2017 Australian stocks handily beat US stocks. The point is, no one can know in advance exactly what the top performer will be and whether that will be US stocks or another country's stocks.

2. Second, part of the reason diversifying outside of one's own countries stocks helps is that even if it doesn't actually increase total returns (or even if it actually decreases them slightly overall) over a given period on average, it can smooth out the returns and reduce the risk of a bad starting sequence (and thus a permanently lower SWR) if your own home country has a few crappy years starting out....or even if your own home country's returns aren't necessarily all that bad the first few years but international's ex-your home country's returns are really stunning over those same first few years. Two shining examples of this:

Example A. US stocks vs international: Starting in pretty much any year from 1966 (or perhaps even 1965) until the mid 1970s (or maybe even the late 1970s) gives a higher 30-year SWR if you include foreign equities rather than if you hold only 100% US. The same applies IIRC to 1959 as well (ex-US had two very good years in 1959 and 1960 despite being crappy from 1962 to 1965) and may apply from 1957 as well (since that 30-year sequence would include 1957 where ex-US stocks had a bit over 10% positive return while US equities lost money that year, then 1958 where they returned about half of what US stocks did, then 1959 and 1960 where they spanked US stocks). Actually, come to think of it (this is just from simulating it in PV), even starting in 1986 a blend of 65/US TSM/35 Total Intl would've provided around a 9.29% 30-year SWR whereas a 100% US TSM portfolio would've only given an SWR or between 9.06 and 9.07%; given that Intl stocks roughly equaled US stocks in 1983, beat them by a percent or so in 1984, and walloped them in 1985 by almost 19 percent I'm almost certain that starting in 1983, 1984, or 1985 would give a higher SWR for a blend of US TSM and Total Intl than a similar US TSM only portfolio but alas, PV only goes back to 1986 for Intl equities so I can't simulate it nearly so easily as I did the one starting in 1986.

Example B. Australian stocks vs international (note that for an Australian investor "intl" would include US stocks plus other non-Australia EAFE countries plus Canada plus--after the mid-1980s--the EM countries): As I noted before, Australian stocks were the world's champion for the whole period from 1900 to 2017; they had very few 20 or 30 year periods where their returns were bad or mediocre overall for the entire period (even including the Great Depression; an investor in Australian stocks at the start of 1929 would've actually made money over the five year period from 1929-1933; he/she would also have done quite well for the ten year period from 1929-1938, the 20-year period from 1929-1948, and the 30-year period from 1929-1958). However, the Australian market did have some "barely-sorta-kinda-crappy" four or five year periods (as well as one or two "just plain horrible my God what did we do to deserve this" four or five year periods) and if you as an Australian investor started your portfolio withdrawals for retirement at a year at the beginning of one of these sequences, you'd have been better off holding some foreign equities as well. Examples would be 1951, 1981, pretty much most years from 2011 to the present (although we won't know fully how those turned out until 30 years passes since the start date the simple fact is that most of what happens in the first 5-10 years determines whether you will get a good high SWR or not and on average since 1-1-2011 for most of this period Australian stocks have somewhat lagged "non-Australia EAFE+EM" and have very much lagged the US TSM), and I also suspect the starting year 1990 might've given a higher SWR for an Australian investor if he held Intl as well (which again would include US since for an Aussie the US would be a foreign stock market); The Australian market did about the same as total Intl (from an Aussie perspective) in 1990, beat it handily from 1991 to 1993, and while I don't have AUD denominated total intl returns for 1994 to 1999 I do know that the AUD weakened around three and a half percent overall against the USD from 1-1-1994 to 12-31-1999 and I also know that from 94 to 99 Aussie stocks returned around 10.82% CAGR in AUD whereas total intl ex-Australia returned around 17.1% CAGR in USD terms which would probably be around 17.2% or 17.3% CAGR in AUD terms given the weakening of the AUD against the USD over this time frame. The Australian market's performance from 1991 to 1993 might be enough to overcome this (and certainly it also beat total intl handily from 2000 to 2010) but it might not've been; I haven't run a year by year SWR sim to see.

My favorite "Australian equity vs the rest of the world's stocks" SWR story, though, has to be the one starting in 1970. Australian stocks did STUNNINGLY from 1965 to 1969 (they returned an average nominal CAGR of around 20.5%--this includes a return of 14.7% in 1969 which was a bad year for both US stocks and US bonds and one in which non-US stocks only returned a few percent) and also did swimmingly well from 1975 to 1980 (a nominal CAGR of over 32.6%). The problem was that for the unlucky Aussie starting in the middle of these two periods--i.e. in 1970--he/she would've been badly burned by a series of poor years; Australian inflation from 1970 to 1974 was as follows:

1970 = 3.44%

1971 = 6.14%

1972 = 6.02%

1973 = 9.09%

1974 = 15.42%


Nominal (non-inflation adjusted) Australian equity returns for these years were as follows:

1970 = -16.20%

1971 = 4.30%

1972 = 26.40%

1973 = -23.30%

1974 = -26.90%


Real (inflation adjusted) Australian equity returns for these years were thus as follows (only one year--1972--was even positive in real inflation-adjusted terms; 1970 was bad at an almost 20% real loss, and 1973 and 1974 were simply appalling):

1970 = -19.64%

1971 = -1.84%

1972 = 20.38%

1973 = -32.39%

1974 = -42.32%

Notice two things: One, Australian stocks actually did worse during this time period than they did during the Depression from 1929-1933; and two, while you would've earned some truly mouthwatering returns from 1975 to year-end 1980 they would've come too late to save your SWR (remember what I said about returns for roughly the first few years being rather important in determining SWR) since your inflation-adjusted withdrawals from 1970 to 1975 would've already depleted your portfolio so much that when the boom did come there wasn't quite enough left in your portfolio for the bull market to help save your SWR with; the 1975-1980 roaring bull market in Australian stocks was thus like the last-minute pardon from the governor that finally comes though two minutes AFTER you are executed...it arrived too late to do you much good at that point!). This five-year period of poor returns for Aussie stocks actually manged to make the 30 year and 40 year SWR for an Australian investor higher for the period starting in 1-1-1970 if he had simply invested in Australian government Treasury Bills vs had he invested in an 80/20 Australian stock/Australian bond portfolio (if you don't want to take my word for it check out Tyler's Portfoliocharts site and it will verify that this is the case)! The Australian investor starting in 1970 could've saved his/her bacon by splitting their stock allocation into, say 60% or 65% or even 75% Australian stocks and the rest in international equities (of course some gold would've helped as well).

I'm not going to go into advanced detail about any other countries where they had good returns on average over a whole 30-year retirement period but where two, three, four, five or six crappy early years would've killed their SWRs but several other very good examples would be:

Singapore (or for that matter Hong Kong) starting in 1973 (the Hong Kong Hang Seng stock index lost almost 80% of its value for the years 1973-1974 and the Singapore Straits Times stock index lost just over 65% of its value for these two years; combine that with double-digit average annual inflation for this period for either country and you can see that it didn't matter how good the bull market boom in these markets was from 1975 to the early 1990s because your portfolio would've been long depleted by then if it was invested all in Singapore or HK stocks; investing in at least some foreign equities would've allowed you to rebalance into screamingly cheap Singapore or HK stocks at yearend 1974 and thus you would've had some "dry powder" left to rebalance into these stocks and ride the boom upwards and save your portfolio,

The UK starting in 1973 (same deal as above....the UK Financial Times stock index lost almost 75% for the 1973-74 period and inflation reached almost 25% by the end of 1974; unless you had any foreign stocks that could be sold in order to rebalance into generationally cheap UK stocks in December 1974 you would've been screwed; withdrawals would deplete your portfolio too quickly even considering the more than doubling of UK stocks during 1975 (and indeed the overall bull market from 1975-1989 in UK stocks that gave a CAGR of over 30% nominal for this period counting reinvested dividends) for the bull market to do you much good.

Switzerland starting in 1962; the Swiss market was one of the world's best performers from 1958-1961 as Swiss stocks went up almost 3.3 times in real inflation-adjusted terms over these four years in what was basically a bull market that became a bubble; this was followed by five years from 1962-1966 when Swiss stocks saw their real inflation-adjusted value cut roughly in half despite the actual Swiss economy doing just fine (actual underlying stock earnings were OK but stock prices were hit as the bubble unwound and valuations came back down to Earth). Had you invested purely in Swiss stocks the big rebound from 1967-72 as Swiss equities more than doubled wouldn't have come soon enough to save you UNLESS you had a balanced portfolio with some non-Swiss stocks as well (this is especially true since Swiss stocks would again lose 55.5% in real terms from 1-1-1973 to 12-31-1974, do well in 1975, and then have a roughly flat period overall where stocks bounced up and down but finished a bit below where they started that left the 100% Swiss stock investor worse off in real terms at the end of 1981 than he had been at the end of 1975). Heck, even by the end of 1987 the 100% Swiss market investor had earned only around 0.40% real per year assuming he'd been unlucky enough to have made a lump sum investment at the very start of 1962....and all this over a period when real Swiss GDP almost doubled; also keep in mind that if you were to try and create a hypothetical perfect country for capital market investment Switzerland would be pretty close; rich, stable, safe, neutral, highly capitalist, business-friendly, orderly, low-crime, low-tax (at least by OECD or European standards), cautious, conservative, prudent, and to boot it was even on a quasi-gold standard during this whole period whereas the US left the gold standard in 1971! This just goes to show that if valuations turn against you your home country's market can do poorly for a long time even if your underlying economy does fine (just ask the Japanese LOL) and if it can happen in a country like Switzerland it can probably happen anywhere.


3. The third thing I want to mention (and then I promise I'll stop as this post is rather long already) is that much of Intl ex-US's crappy performance since 1989 or 1990 is due to it weighting Japan at such a high amount at the peak of the Japanese asset price bubble....in other words, this is a flaw of a purely cap-weighted index; ANY other weighting method (equal stock weight, or equal country weight, or a fundamental index weighting like RAFI, or nominal GDP weighted, or real GDP weighting that discounts changes in currency and simply weights by real inflation-adjusted constant intl dollar measured GDP, or a system like the EAFE Lite 20 or EAFE Lite 30 where one country could not be more than 20 or 30% of the index no matter how much it was if simply weighted by market cap, etc) would've yielded a better return overall for the period of the last 30 or 31 years; despite what you may think (since Japan was basically one of the best performing countries from the 1950s to 1988) most other weighting methods would've done about the same as the regular cap-weighted EAFE from its 1970 inception to the early 1980s; from 1984-1988 they would've lagged the cap-weighted EAFE slightly but then from 1989 onwards they'd have more than made up for it) these indexes didn't do much worse from 1970 to 1988 even tough they would've definitely been underweight Japan for most years from 1973 or 1974 until well into the late 2000s. I can post data (as links to downloadable Excel spreadsheets) proving this if you'd like.
Last edited by D1984 on Sun Jun 27, 2021 4:53 pm, edited 8 times in total.
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Re: International stocks?

Post by I Shrugged » Sun Jun 27, 2021 2:29 pm

I’ve had half of our stock money in Ftse xUS for 12 years. Most of the 12 the SP500 has outperformed. My day is coming! ;)
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Re: International stocks?

Post by D1984 » Sun Jun 27, 2021 3:46 pm

I Shrugged wrote:
Sun Jun 27, 2021 2:29 pm
I’ve had half of our stock money in Ftse xUS for 12 years. Most of the 12 the SP500 has outperformed. My day is coming! ;)
FWIW most of my international exposure is actually in actively managed funds. I know active funds aren't theoretically supposed to outperform (but see Note 1 below) index funds but IMO the farther you get from plain old generic US largecap blend, US largecap growth, or US TSM (i.e. once you start investing in stuff like US smallcap deep value, US microcap, international, international small, international SCV, emerging markets, etc) the more it might pay to actually have someone pick stocks instead of just buying the haystack. The EAFE index and/or the ACWX index haven't exactly set the world on fire the past twenty, twenty five, or thirty years and some of the active funds (and/or their predecessor SMAs) that were beating (or at least tieing) their relevant indices then are still nicely beating them now.

Note 1: The whole "active doesn't beat index after taxes and expenses" thing can be minimized by: Buying the lowest cost or instl share class whenever possible (to reduce management fees) and holding the funds inside a 401K/Roth/IRA in order to minimize/eliminate any effect from taxes on dividend and year-end capital gain distributions.
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Re: International stocks?

Post by I Shrugged » Mon Jun 28, 2021 9:36 am

D1984 wrote:
Sun Jun 27, 2021 3:46 pm
I Shrugged wrote:
Sun Jun 27, 2021 2:29 pm
I’ve had half of our stock money in Ftse xUS for 12 years. Most of the 12 the SP500 has outperformed. My day is coming! ;)
FWIW most of my international exposure is actually in actively managed funds. I know active funds aren't theoretically supposed to outperform (but see Note 1 below) index funds but IMO the farther you get from plain old generic US largecap blend, US largecap growth, or US TSM (i.e. once you start investing in stuff like US smallcap deep value, US microcap, international, international small, international SCV, emerging markets, etc) the more it might pay to actually have someone pick stocks instead of just buying the haystack. The EAFE index and/or the ACWX index haven't exactly set the world on fire the past twenty, twenty five, or thirty years and some of the active funds (and/or their predecessor SMAs) that were beating (or at least tieing) their relevant indices then are still nicely beating them now.

Note 1: The whole "active doesn't beat index after taxes and expenses" thing can be minimized by: Buying the lowest cost or instl share class whenever possible (to reduce management fees) and holding the funds inside a 401K/Roth/IRA in order to minimize/eliminate any effect from taxes on dividend and year-end capital gain distributions.

Good info. Yeah I don’t have the tax sheltered space so the tax efficiency of the index fund is a real benefit.
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Re: International stocks?

Post by jalanlong » Tue Jul 06, 2021 4:43 pm

D1984 wrote:
Sun Jun 27, 2021 1:52 pm

3. The third thing I want to mention (and then I promise I'll stop as this post is rather long already) is that much of Intl ex-US's crappy performance since 1989 or 1990 is due to it weighting Japan at such a high amount at the peak of the Japanese asset price bubble....in other words, this is a flaw of a purely cap-weighted index;
I do think that is a huge issue but I dont know a way around it. I have researched at least 50 broad based international etfs and every one of them has approximately 40% in Japan, UK and Germany. So the fact that Finland or Italy has such great returns during a specific time has no bearing on my possible returns as a US investor. The only way I see around this is to buy single country ETFs and equal weight them which seems like a lot of work. Plus even those funds are cap weighted so that the largest components are the multinational firms that tend to follow the US market anyway.
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Re: International stocks?

Post by D1984 » Thu Jul 08, 2021 6:19 am

jalanlong wrote:
Tue Jul 06, 2021 4:43 pm
D1984 wrote:
Sun Jun 27, 2021 1:52 pm

3. The third thing I want to mention (and then I promise I'll stop as this post is rather long already) is that much of Intl ex-US's crappy performance since 1989 or 1990 is due to it weighting Japan at such a high amount at the peak of the Japanese asset price bubble....in other words, this is a flaw of a purely cap-weighted index;
I do think that is a huge issue but I dont know a way around it. I have researched at least 50 broad based international etfs and every one of them has approximately 40% in Japan, UK and Germany. So the fact that Finland or Italy has such great returns during a specific time has no bearing on my possible returns as a US investor. The only way I see around this is to buy single country ETFs and equal weight them which seems like a lot of work. Plus even those funds are cap weighted so that the largest components are the multinational firms that tend to follow the US market anyway.
This is one of those situations where you wonder why no major ETF issuer has offered a GDP-weighted (or at least an "EAFE Lite" type of index fund like I mentioned in my post) EAFE or EAFE+Canada ETF. The costs to run it wouldn't be very much with commissions as low as they are today; plus an ETF only needs a minimum of around $24 or $25 million to be self-sustaining in terms of paying for itself without an absurdly high expense ratio. There is an index fund (MAIIX) for the regular cap-weighted EAFE that has an ER of 0.09 and another one (VTMGX) for the regular cap-weighted EAFE + Canada that has an ER of 0.07; it should be possible to do either an equal-country weight fund, an EAFE Lite (or EAFE+Canada Lite), or a GDP-weighted developed markets fund for maybe a 0.10 or 0.12 ER tops (even a true equal stock weighted developed international markets ETF could be done for probably under a 0.23 or 0.24 ER). Maybe this is a circular chicken-and-egg case of "the market doesn't provide it because it doesn't perceive anyone wants it since no one seems to be demanding it, but no one is demanding it because they don't perceive the market wants to provide it." The difference in returns from 1989 or 1990 to today would've been fairly significant. Until an ETF issuer comes up with such an ETF (or even a mutual fund) I'll just stick to actively-managed funds for international exposure....at least within my tax-sheltered space.

Using the IShares individual country ETFs isn't that great of a solution either; they have ERs of 0.51% or higher...if I'm paying that kind of fee I'll take my chance with an actual active manager, thank you very much.

PS - Just some data for EAFE (or similar ex-US developed country index) based on ANY form of weighting besides naive regular cap-weighting. I have ran backtests for all of the following:

1. A nominal GDP-weighted EAFE index (actually, MSCI itself provides this one back to 1970) based on nominal GDP for each country.

2. A "true constant $ at PPP" GDP weighted EAFE index (using constant 1990 Geary-Khamis Int'l PPP weighted dollars from the Angus Maddison database for 1970-2010 and at-PPP constant 2017 Int'l dollars from the World Bank's database for 2011 to 2020); doing this helps remove any overweighting or underweighting of countries that might occur over several years just because a country's currency strengthens/weakens relative to those of its peers while its economy--and thus its underlying actual real GDP--grows at roughly the same rate or so as those peer countries.

3. An equal-weighted EAFE index (by stocks, not by country) with data provided from MSCI from 2020 back to the mid-1990s and from a gentleman who goes by the handle "NovelInvestor" before that back to 1974 (using data he obtained from MSCI).

4. An equal country-weighted EAFE index (where each country gets an exact equal weight and the index is rebalanced every December 31st for the next year....in other words, if there were, say, 12 countries in the index then each would get an 8.33333% weight regardless of the countries' actual market cap or GDP)

5. A slight variation on #4 where I--in order to answer any potential accusation of "well of COURSE the equal country-weighted index did better....it only had Japan at a tiny portion of its actual cap-weight since there were upwards of 16 countries in the EAFE even back in the 1980s.....you knew Japan would underperform from 1989 onwards so this is cheating"--deliberately added a 20% Japan weight to the equal country-weight EAFE index each year. By this I don't mean I set Japan's weight at just 20% each year; what I did was set Japan's weight at 20% PLUS whatever it's actual index weight was; in other words this index each year consisted of an 80% amount of the equal country weight EAFE (which obviously included Japan at whatever its weight was in said index) and then the other 20% of the index was the MSCI Japan Index. This means that (for example) if in a particular given year there were 20 countries in the equal country-weighted index (19 of which were not Japan and one of which was Japan) then Japan would get a weight of 5% in this index; as such, Japan's total weight in the "EAFE Equal Country Weight plus 20% Japan" index for that year would be 24% (since 5% of 80% is 4% and 4% + 20% is 24% ); obviously Japan's weight in the index would vary a bit year by year based on how many other countries were in the EAFE index for any given year but adding 20% extra in Japan regardless of that helps to answer the charge that I am deliberately skimping on Japan's weighting just because I know in hindsight that its stock returns stunk for 20+ years.

6. The same as in #5 above but putting Japan at 25% plus whatever its actual index weight was rather than 20% plus whatever its actual index weight was.

7. The RAFI Developed Ex-US Large Cap index; this is a fundamentally-weighted (earnings/revenues.dividends) index rather than being cap-weighted.

8. Various "EAFE Lite" or "Japan Light" indices that fixed Japan's weight at the LESSER of either:

A. Its actual index weight, or
B. 20%, 25%, or 30% of the total index weight.

So for example, for the "EAFE Japan Lite 25" Index if Japan's index weight at the beginning of a given year was, say 18.22% (or indeed any number between 0.01% and 25.00% ) then the weighting--and the returns--would be the same as for the regular cap-weighted EAFE index; if Japan's weight was, say, 45.85% then it would instead be capped at 25% and the rest of the index countries would be proportionally increased in weighting as per their cap weights. Since MSCI provides an EAFE Ex-Japan Index (the EASEA Index) back to 1970 it was relatively easy to set up a spreadsheet to calculate all this using the known returns from the EAFE, EASEA, and MSCI Japan indices.

I would also like to add that before anyone says this is "cheating" because I am targeting only Japan by capping its index weight and that I am only doing this since I know that Japan underperformed from 1989 to the mid 2010s and thus have the unfair advantage of hindsight bias...well, to be frank the only country (at least after the 1970 inception of the MSCI EAFE index) that this would've affected would've been Japan simply because no other EAFE country was ever in a giant bubble big enough to make it upwards of 30% of the index (a bubble which I might add put Japan's cap weight at far greater than its GDP weight or weight relative to the world economy at large); Japan was at around 65% of the EAFE at its peak weighting in late 1988 or early 1989!

Before 1970 the only effect of such and index cap weight for any one country in a hypothetical pre-1970 EAFE or ex-US developed index (at least if at 25% or 30% level) would've likely been to underweight Britain somewhat (vs all the other countries in the index) in comparison to the pure market cap weighted version of such an ind..this would have probably been in effect from the early 1900s to maybe the early or mid-1960s. The net result would have been (and to be fair this is just an estimate--and a very crude one at that--from data taken from "Triumph of the Optimists", from the Jorda macrohistory database, from various individual country equity return datasets for France, Denmark, Austria, Switzerland, Australia, the UK, and Canada, and from an excess equity returns by country by decade study from Bridgewater) that the "Britain capped at 25 or 30%" index would've outperformed the cap-weighted index in the 1900s and the 1930s, would've barely underperformed the cap weighted index in the 1920s, would've underperformed the cap weighted index in the 1910s and 1940s (albeit it would've outperformed the cap weighted index in 1940 and 1941 when it was most needed for a US investor---when US equities had two negative years....it was the almost all of the rest of the 1940s where it would've underperformed), and would've outperformed (vs the cap-weighted index) in 1960, barely outperformed the cap-weighted index in 1961, underperformed the cap weighted index pretty hard from 1962-1966 (led by poorer-than-the-UK returns for France, Switzerland, Italy, Germany, and only barely equal to the UK returns for Australia for these years overall), probably lost by a tiny bit to or roughly equaled the cap-weighted index in 1967, and then creamed the cap-weighted index for 1968 and 1969 (led by somewhat-better-than-UK returns for Canada, Italy, France, and Germany, and by much better to in some cases stunningly better returns than the UK for Japan, Australia, and Switzerland....given that Japan by this time would've been a part of the developed markets index since at least 1966 or 1967).

Most of these returns would (at least for the decade as a whole) not differ much from the cap weighted return; they might be plus or minus it by maybe half a percentage point a year or less for the given decade as a whole (albeit some individual years would see some dramatic differences one way or the other....see the part about the 1960s above.

The one exception would likely be the decade I didn't mention above....the 1950s. British equities didn't do badly during this decade, to be sure, but any kind of non-cap weighted index (be it GDP weighted, equal weighted, equal country weighted, or a "cap any one country at 20/25/30 percent of the index regardless of actual market cap weight" ) would've beaten the cap weighted index soundly because it would've allocated relatively more to countries that either barely beat or roughly equaled Britain in returns for this decade (Canada and Sweden), lost to Britain by a hair for the decade as a whole but would've beat it during many years that the alternate weighted index/es would've had a relatively higher allocation to said country (Australia comes to mind) or countries that absolutely pulped (or rekt/pawned/murked/clobbered/insert your choice of adjective for "killed" here LOL) the UK in equity returns from 1950-59; places like Austria, Italy, France, Netherlands, Finland, and most of all Germany (which managed a roughly 25% real CAGR for this decade).

Of course, after 1-1-1970 I don't need to guess how these alternate indexes would've done because I have data (either from MSCI, from NovelInvestor, or from my own calculations using actual indices from MSCI and weightings from other credible sources).

9. One other "alternate EAFE index weighting" bears mentioning here as well (although strictly speaking it technically isn't an actual index per se)....I think it's been mentioned on the Bogleheads board--by Rick Ferri if I recall correctly but don't quote me on that as I'm not 100% sure he's the one that posted it--that simply splitting EAFE into Europe and Pacific and equal weighting them 50/50 and rebalancing each year beat the EAFE pretty nicely; I tried this myself from 1966 to 2020 (1966-69 data for Pacific being roughly cap-weighted Japan and Australia rebalanced each year--I didn't include any other Pacific countries markets' because Singapore and Hong Kong weren't in the developed markets category until 1972 or 1973 and New Zealand wasn't even added until the mid-1980s; Taiwan and South Korea are still classified to this day as emerging markets by MSCI so they weren't included either--and 1966 to 1969 data for Europe being taken from the annual "Europe stock returns" from Ibbotson and Sinquefield's equity risk premium paper published in 1983 or 1984; from 1970 onwards actual MSCI data for Pacific and Europe were used); actually, if I recall correctly from my own experiments in with this in Excel doing ANYTHING from 90/10 to 10/90 (for either Pacific or Europe) beat the EAFE...I think I still have an Excel file with this data on it if you want to see for yourself; this "beating the EAFE despite how exactly it weights Europe and Pacific over a very wide range" phenomenon is likely because it didn't overweight Japan at the height of the bubble! Note that including Canada at a fixed percent (say 10/45/45 Canada/Pacific/Europe, or 16/42/42, or 15/40/45, or 20/50/30, etc) doesn't change much; the "split index" still beats the MSCI EAFE+Canada; again, this is because the index isn't stuck overweighting one country at the arguable height of that nation being in the biggest equity bubble in modern history (I say "modern" because the South Sea Co bubble and Companie Mississippi bubble might've pushed up British and French markets to higher valuations than than Japan in 1988 or 1989; I'll leave that for economic historians to debate)

I would also like to point out that alternate-weighted indices (whether GDP, equal country weight, equal weight, or capping country weighting at a certain fixed percent) aren't a new idea; State Street actually came up with the first "Japan Light" index in mid-1988 when they wanted a more reasonable index to compare their foreign equity portfolios to (they were underweight Japan because they guessed--quite correctly in hindsight--that Japan was in a massive stock bubble....they were just a little early in their guessing) so they simply weighted Japan at half its market cap weight; MSCI soon followed with its own "Japan Lite" index which did virtually the same thing and then for a few years after that even provided what they called "EAFE Lite" indices that--rather than just capping Japan alone (although the practical effect was similar to capping Japan alone since no other country in the EAFE had its cap weight at market cap at such a greater value than its actual GDP-weighted economic weight)--had a hard cap on any country of the lesser of either its market cap or the given percentage; IIRC they discontinued publishing these in 1998 or early 1999. MSCI has also produced GDP weighted indices since at least the late 1990s (and backtested them to 1970 for the EAFE and the early 1990s for the MSCI EM). Equal weighting of course has an even longer history; the first S&P 500 index (the one that Samsonite used for its pension fund circa 1971 or 1972) was equal weighted....but they had to give it up after a few years since equal weighting required much more rebalancing than cap weighting and this was rather expensive given the stock market commissions in effect at the time.....which obviously would be a virtual non-issue today.

Come to think of it, a fixed cap weight for a given entity in an index has at least some history as well; in the late 90s and early 2000s pretty much every Canadian mutual fund--whether index tracking or active-- at the regulatory behest of the Canadian equivalent of the SEC was made to cap exposure to any one stock at 10 percent despite Nortel making up some 34% of the TSX 300 (and almost 45 percent of the TSX 60!); this meant that they missed some of the runup in Nortel during the dotcom boom but also didn't get hurt nearly as badly when Nortel got cut to ribbons during the mid 2000 to late 2002 dotcom crash and eventually traded at a few cents a share and IIRC either went bankrupt or got bought out at a pathetic price. Another example would be the NASDAQ index committees in late 2014 or in 2015 capped exposure to any one stock at a certain amount; this ostensibly applied to any an all companies in the NASDAQ-100 but the practical effect was simply to reduce Apple's weighting so the NASDAQ-100 would consist of a fairly good variety and weighting of stocks rather than just "a bunch of Apple and not quite as much of everything else". Finally, one place where such a maximum fixed weight for any one company (or any one sector), or even an equal weight index, that as far as I know was not tried (but that would've saved investors' bacon big-time if it was) was Iceland in the late 2000s; as of January 2008 just under 85 percent of its market-cap weighted index was in a few big financial stocks and the end result was the Icelandic stock index losing more in one day in late 2008 than US stocks (or for that matter a total world stock index) lost during three whole years in the Great Depression!

Anyhow, I guess that's about it. The link contains a file (in Excel format) for the alternate EAFE indices (equal weight, equal country weight, equal country weight plus Japan 20%, equal country weight plus Japan 25%, GDP-weighted, constant PPP real GDP weighted, RAFI Developed ex-US, and the various 20/25/30 percent country capped EAFE indices; it also has some graphs and charts showing how extreme Japan's weighting in the EAFE was circa 1988 and 1989.

Link: https://easyupload.io/m/vd9na9
seajay
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Re: International stocks?

Post by seajay » Mon Aug 09, 2021 12:42 pm

Many firms hedge their foreign currency exposure. Stocks in other countries might be at a different phase in their economic cycle. Adding in stock + FX factors in place of just stock factor alone is paramount to adding more gold exposure, might adjust from 25 each in stock and gold to more like 16/33. The PP four cylinder/stroke engine likely will not run as well with more fuel injected into one cylinder, less in another, and also invalidates the warranty. Each country should hold stocks, long dated treasury and cash sourced domestically. Failing that maybe go for a all-world stocks, bonds, cash combination, but likely there will be higher costs, such as withholding taxes and costs/fees. As would holding a US based PP FX hedged to ones own currency.
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