VEU: Total International ex-US as 100% of the Equity Portion

[MiniB]

I'm considering putting together a PP sometime next year with my money after I do a couple things first.

I'm thinking of using VEU as 100% of my PP equities.

Here is my reasoning:

With TSM as 100% of equities, the PP is 75% USD based and 25% nonUSD based.  With VEU, the PP is 50% USD based and 50% non-USD based.

VEU has a higher beta than TSM, considering TSM as the beta baseline of 1 against itself.  Higher Beta = lower correlation with the other 3 parts, and theoretically lowers Standard Deviation and raises overall return of the PP.

VEU is indexed and thus has the same "indexing" benefit of TSM.  Harry likes to use an index for low cost and reduced manager counter party risk.  While the VEU is a different index, it's still an index and the indexing benefits are preserved.

VEU has a higher beta than TSM but is still correlated with US Stocks because the US is a major global economic player.  This means that it doesnt matter whether I pick TSM or VEU, either way, a global downturn is going to hurt.

I live and work in the US so investing in VEU means that a major US economic downturn wont effect my investments as much.  Sure due to global linkage an isolated US based downturn will hurt VEU, but not as much as TSM.  Harry says your wealth should be created from human capital.  I want my stocks invested outside of where I work.

I like EM for volatility within the equity portion.  VEU gives me a large weighting of EM.  I believe it's around 15% to 20% of the fund.

I like currency risk for reasons I mentioned above with diversification.  50% of my PP would still be in USD.

[foglifter]

I agree on the importance of including ex-US equities in the PP. I do that differently: by "watering down" TSM with emerging markets. Since developed markets are highly correlated with US I believe TSM captures enough of developed stocks exposure. I think there's nothing wrong with choosing VEU, it's an excellent product. The only (perhaps slight) downside is a higher expense ratio compared to a pure TSM or large-cap fund with addition of international fund.

On the other hand, if you look at the performance chart of VTI, VEU and VWO you'll see that in some periods VEU almost perfectly behaves like a median of VTI and VWO, but  in the most recent rise of the market off March 2009 lows VEU goes in-line with VTI and sometimes even underperforms, in spite of having EM in its portfolio, although VWO does pretty good.

VEU hasn't been around for very long so it all may be data mining, but still we can see both market down and up phases  over the course of the last 3 years. I think VEU's underperformance can be explained by eurozone issues.



The purists might tell you that TSM is the best option and they will be basically right: if you consider that your equities constitute only a quarter of your portfolio, then any slicing-n-dicing won't be very harmful or profitable. Some slice-n-dice their equities bucket within PP, others do a pure TSM bucket and do international in their VP. But it all looks more like accounting tricks: whatever you do just remember that there is no free lunch. And expenses do matter!

[foglifter]

Hurray, I'm a senior member!

[MiniB]

if you consider that your equities constitute only a quarter of your portfolio, then any slicing-n-dicing won't be very harmful or profitable.

I agree with the reduced effects of slicing and dicing what is only 25% of overall PP.  This is another reason why I am arguing for 100% VEU.  It almost doesn't make sense to slice the 25% into half TSM and half VEU.  And for reasons I mentioned above I like VEU better than TSM for the equity portion of PP.  Thus my way of not slicing is to get rid of TSM and go all VEU.

[melveyr]

For an easy compromise you could go with VT which is 40% US, 60% international. You also have the benefit of the entire thinking being market cap weighted reducing any need for future tinkering. This way you just let the market choose where your money goes. Personally, I am fine with just using VTI. American companies get enough of their revenue overseas so I don't feel the need to use an international index.

Also, I have read many articles stating that the main factor in international returns vs. domestic is based on currency fluctuations. In Common Sense on Mutual Funds, Jack Bogle states that in the long run foreign currency fluctuations are a wash and doesn't believe investors get compensated for the exchange rate risk they take on.

[SmallPotatoes]

I am using the VT mutual fund and it's fine for me. The idea is to soften the volatility of PRPFX a bit, since Cuggino actively picks the funds stocks. About half my PP is in PRPFX, so using VT for my 4x25 gives me about a 65/35 US/International allocation.

If I weren't holding any PRPFX I might just do TSM for simplicity. But consider this: while many US companies have a presence abroad the opposite is also true. What make is your car?  Your television?  Where are your vacations? Greece, Paris, Mexico?

I'm not saying there's any good reason to do a TW index, but at the same time there's hardly a reason not to.

[foglifter]

I just realized that I should have mentioned another reason for holding TSM+EM:
As many investors I'm constrained with limited 401(k) choices so I have to use a TSM fund for my equities portion. I don't have access to total world or world ex-US funds in my 401(k) and I use my IRA for gold and LT Treasuries.

In an ideal situation I might think about using a total world fund. But still with a tilt to EM.

[Austen Heller]

As a US investor, my preference for the stock portion of the PP is to keep it all in the US Total Stock Market (VTI).  I personally view foreign stocks, and especially emerging markets stocks, as significantly more risky than US stocks.  My primary goal is to minimize the total risk level for the PP, which will help me to stick with the PP strategy if times get tough.  Initially I did maintain a 25%/75% allocation to VEU/VTI, but I recently switched to 100% VTI.  I did this for 3 reasons:

1) If VTI underperforms VEU, I can live with that.  But if VEU underperforms, I just know that I'll be upset with myself for taking on extra complexity and risk, while suffering lower returns.

2) According to Morningstar, VEU contains 25% Financial Services companies, while VTI only has about 16%.  After everything that has happened over the past few years, I have very little confidence in the ability of these companies to be run fairly and honestly, so switching to VTI reduces my exposure to that sector.

3) Since I bought VEU in early June 2010, it had done about 10% better than VTI over that time period, so I wanted to lock in those gains before they disappear  (Market timing = a tough habit for me to break).  So it made sense for someone like me to just go 100% VTI, and now is a good time to do it.

[KevinW]

I am one of the purists who thinks the stocks should only be domestic.

The idea of the economy being in one of four states, or a combination of them, is all relative to your home, domestic economy.
Cash is valuable in a domestic recession.
Bonds rally in a domestic deflation.
Gold rallies in a domestic inflation.
Domestic stocks rally during domestic prosperity.

Do international stocks rally during domestic prosperity?  Maybe, maybe not.  It's true that domestic stocks and developed ex-US stocks are highly correlated, but if the correlation is strong enough that it doesn't matter which you use, you might as well go US-only to minimize expenses.

As stated above, any time domestic and foreign stocks are not moving in lockstep, most of the difference is due to currency effects.  A "classic" lazy portfolio of TSM/bonds is 100% in USD-denominated securities, which offers no protection against a weakening dollar.  In a "modern" lazy portfolio of TSM/international/bonds, the international stocks offer a currency hedge, which adds safety and reduces volatility.  Investors need some kind of protection against a weak home currency (inflation), so adding international stocks to a lazy portfolio makes sense.  I agree completely that a lazy/Boglehead portfolio needs international stocks.

For what it's worth, my second favorite portfolio is
50% total world stock
50% intermediate treasuries
which has a lot in common with the PP, but seems more palatable to orthodox investors.  And easier to implement in mediocre 401(k)s.

Anyway, I don't think the currency-hedge argument carries over to the Permanent Portfolio context.  The PP already has an even stronger currency hedge from the hefty 25% gold allocation.  The gold is a bulletproof inflation hedge, and adding more protection to an already-bulletproof system seems like a wasted effort.  And as stated above, int'l stocks may fail to "carry the portfolio" during a domestic stock rally, which is just the time when the PP's tracking error is hardest to overlook.

[craigr]

I am one of the purists who thinks the stocks should only be domestic.

The idea of the economy being in one of four states, or a combination of them, is all relative to your home, domestic economy.
Cash is valuable in a domestic recession.
Bonds rally in a domestic deflation.
Gold rallies in a domestic inflation.
Domestic stocks rally during domestic prosperity.

Do international stocks rally during domestic prosperity?  Maybe, maybe not.  It's true that domestic stocks and developed ex-US stocks are highly correlated, but if the correlation is strong enough that it doesn't matter which you use, you might as well go US-only to minimize expenses.

I don't know what I can add to what was said above. I think excluding US stocks entirely with the VEU fund is looking for problems. The US economy is still 40% or so of the world's economic output.

I know a lot of investors are infatuated with emerging markets, but I'm not one of them. I've traveled to around 20 countries in my life and several of them were emerging markets. I think if investors saw how many of these emerging market economies operated they wouldn't be so keen to dump a lot of their money into them. I know I'm not and I actually enjoyed visiting those places. But I don't trust the governments and investor protections enough to put a lot of money there. There is a reason many of these places are perpetual third-world economies and it's not because the man is keeping them down. It's because of how they conduct business and how their governments work (or don't work as is usually the case). Caveat emptor.

[Reido]

if you consider that your equities constitute only a quarter of your portfolio, then any slicing-n-dicing won't be very harmful or profitable.

I agree with the reduced effects of slicing and dicing what is only 25% of overall PP.  This is another reason why I am arguing for 100% VEU.  It almost doesn't make sense to slice the 25% into half TSM and half VEU.  And for reasons I mentioned above I like VEU better than TSM for the equity portion of PP.  Thus my way of not slicing is to get rid of TSM and go all VEU.

I don't really agree here...
The changes you make to your version of the stock portion of the PP GREATLY effect the outcome and the effectiveness of the portfolio.

For example: Lets assume that there are no changes to the STBond, LT bond, and Gold portion of the portfolio:
A TSM gives a yield of 9.53% with a Std. Dev. of 8.17%
S+P is similar at 9.50% and 8.12% respectively
Small cap blend jumps it to 10.12% (a gain of over 1/2%) and 8.82% on std. dev.

And finally my favorite is 5% SCB, 5% LCB, 5% REIT, 5% Mid cap blend, and 5% Emerging markets: 10.38% and Std. dev. of 8.26% - which, interestingly is a lower Std. than the others

I used the Simba spreadsheet for these calculations.

It's definitely worth planning pretty carefully - an extra .8% saved over the course of 30 years translates to 27% more money - and while the market variations may account for some of this difference - I doubt one could write it all off as "market noise."

I was convinced by Craigr to minimize international stocks.  Gold will be a less effective part of the portfolio when international stocks are introduced.  The correlation between gold and US stocks is -0.24 vs. -0.04 for internationals. 

I agree that a small portion of EM might help, but lets look at the numbers for Int'l developed in a PP: 9.59% return with Std Dev. of 9.19% - basically a very marginally higher return with more risk attached, as the Std. Dev. goes up by more than 1%.

Historically it's safer going with Domestic small-caps and that can improve your return