World stock fund for equity portion?

[Indices]

What do the people here think about a "world" stock fund for the equity portion instead of TSM? Pros and cons? Currency issues?

[AdamA]

Why do you want to do this?

[Indices]

Why do you want to do this?

I know the argument is that US stocks are made up of US companies that invest heavily overseas. That same argument was probably made in Japan circa 1989. If we ever have a big bull market again I could see American companies dropping everything foreign and investing locally causing an enormous bubble. At that point international stocks would add diversification. While foreign indices generally move with the US ones, that doesn't mean it will always happen.

But the flipside is the issue with currency risk.

Harry Browne was ok with someone owning foreign stocks, so long as they lived overseas (you add a dollop of US stocks). So he wasn't against the idea of owning foreign stocks per se.

[KevinW]

I wrote out my objections to international stocks in this thread:
http://gyroscopicinvesting.com/forum/ht ... ic.php?t=6
and I think all those objections also apply to "world" stock funds.

However I think one could build a coherent globalized PP by using world stocks, AND world bonds AND world cash.  In that case "the economy" is consistently defined as the total world economy.  But the expenses and taxes would be worse, so I don't see the point.

[Indices]

What are the tax issues with a world fund? Fees are higher but will probably come down as these funds grow.

You get a tax credit for foreign taxes you pay on foreign funds.

[KevinW]

The tax issues with a world stock fund don't seem bad.  But AFAIK there is no global long term sovereign bond fund.  So you'd have to buy and sell individual foreign bonds yourself, which seems like a big mess with regards to taxes.

[Indices]

Browne always thought you should hold your own country's bonds rather than foreign ones. I don't know enough about the movements of bonds to say with any certainty that they don't move in close correlation.

[AdamA]

I know the argument is that US stocks are made up of US companies that invest heavily overseas.

I don't think it's so much that they invest overseas as it is they actually do business overseas.

[KevinW]

Browne always thought you should hold your own country's bonds rather than foreign ones. I don't know enough about the movements of bonds to say with any certainty that they don't move in close correlation.

As I said in the other thread, my biggest objection to mixing foreign stocks (relative to whatever your home economy is), is that "the economy" is defined one way for bonds, cash, and gold, and a different way for stocks.  Specifically, global stocks capture "global prosperity" but T-bonds protect against US deflation and T-bills against US recession.  A period of global non-prosperity coinciding with US prosperity is conceivable, and in that scenario a portfolio of global stock, US bonds, US cash, and gold will lag a conventional PP.

I think you could build an acceptable PP out of world assets at all four corners: global stock, global bonds, global cash (currencies), and gold bullion.  That portfolio defines "the economy" as "the global economy" consistently and should handle global prosperity, global inflation, etc.  However the expenses and hassle is greater than a domestic PP so the global PP seems pointless IMO.  Maybe that will change if world bonds become easier to transact.

[Indices]

Browne always thought you should hold your own country's bonds rather than foreign ones. I don't know enough about the movements of bonds to say with any certainty that they don't move in close correlation.

As I said in the other thread, my biggest objection to mixing foreign stocks (relative to whatever your home economy is), is that "the economy" is defined one way for bonds, cash, and gold, and a different way for stocks.  Specifically, global stocks capture "global prosperity" but T-bonds protect against US deflation and T-bills against US recession.  A period of global non-prosperity coinciding with US prosperity is conceivable, and in that scenario a portfolio of global stock, US bonds, US cash, and gold will lag a conventional PP.

I think you could build an acceptable PP out of world assets at all four corners: global stock, global bonds, global cash (currencies), and gold bullion.  That portfolio defines "the economy" as "the global economy" consistently and should handle global prosperity, global inflation, etc.  However the expenses and hassle is greater than a domestic PP so the global PP seems pointless IMO.  Maybe that will change if world bonds become easier to transact.

I think bonds are refuge from stocks, not something to diversify in, so I don't see the need for foreign bonds at all. When local markets crash there are local flights to quality and some flights to US treasuries. You get the flight to quality benefit if you invest in your local country's bonds (developing countries excluded). There doesn't seem to be a need to buy foreign bonds IMO because of that.

The point of diversifying stocks with international stocks is for the very possible scenario of the country you live in having a market crash and no other country having a market crash, which we saw in Japan in 1989. On the other hand, when the US had a crash in 2008, virtually every foreign index crashed too.

[KevinW]

The point of diversifying stocks with international stocks is for the very possible scenario of the country you live in having a market crash and no other country having a market crash, which we saw in Japan in 1989.

Sure, but a market crash happens due to inflation, deflation, or recession, and the PP already has other assets to protect against those problems.

It seems to me that mixing in international stocks transforms the stock allocation from a pure prosperity play, to a hybrid prosperity/inflation play.  A prosperity/inflation tilt is a great idea for a portfolio that otherwise has poor inflation protection, which is why IMO international stocks help a stock/bond policy portfolio.

However, in the context of the PP, the international stocks water down the stock allocation's tie to domestic prosperity.  Which tilts the portfolio toward inflation and makes the whole package riskier.

I think bonds are refuge from stocks, not something to diversify in, so I don't see the need for foreign bonds at all.

I guess I don't understand why an argument for global stocks doesn't apply at all to bonds.  It seems like a consistent position would be pro-global or anti-global for all assets. 

[cowboyhat]

If I were building an ideal Global PP I would want the bond and cash portions to reflect quality rather than diversification, because these two assets are suppose to perform in environments where people are in panic mode and credit risk is a paramount concern.

So in picking debt I would go for traditional flight to safety countries like USA, Germany, and Japan. Japan is so sick now, though, I don't know if I could bring myself to buy their debt. China might be the alternative, but it hasn't even been one generation since the Great Cultural Revolution. Even the Swiss have caved in to this craziness.

[cabronjames]

But AFAIK there is no global long term sovereign bond fund.  So you'd have to buy and sell individual foreign bonds yourself, which seems like a big mess with regards to taxes.

I also afaik there is no US-based fund of ex-US >=30 yr sovereign Bonds, by individual nation or as ex-US combination of different nations.

What's more, the sense I get is that only a few nations "have sufficient confidence of intl investors" to offer 30 yr bonds.  Probably to be a nation to offer a 30 yr bond, you have to be somewhat of an at least minor "reserve currency".  For example, on Bloomberg.com, it appears that Australia & Brazil do not sell 30 yr bonds, whereas UK, Germany & Japan do.

[Kshartle]

Sure, but a market crash happens due to inflation, deflation, or recession, and the PP already has other assets to protect against those problems.

However, in the context of the PP, the international stocks water down the stock allocation's tie to domestic prosperity.  Which tilts the portfolio toward inflation and makes the whole package riskier.

I know we've covered this in other threads but I think this is a common problem that people who adopt the HBPP are running into. Namely, how do we keep gains if the US economy falls in the toilet for whatever reason. It's far more likely that the US economy/stocks/bonds/dollar will do poorly in a given time period than the entire global economy/stocks/bonds/currencies will do poorly. It only makes sense to diversify your stocks and bonds globaly.

As far as the portfolio being set up to deal with very high inflation or even runnaway inflation, it definately is not. Runnaway US inflation will devastate stocks that derive most of their revenues in US dollars and will obviously crush the 50% that is dollar-denominated debt.

You don't neccesarily need have half your cash in foreign ST bonds and half in LTT. Since there is no good global deflationary alternative to the 30 year US treasury I think keeping all your "cash" in foriegn currency definately mitigates risk. Some are risk-on currencies and some are risk-off so just hold them in equal amounts say, 25% Yen, 25% Aussie, 25% Euro and 25% SGD or something like that. Yuan is a good alternative I think with very little downside in USD terms since they print just to keep pace with us not because they have crushing debt to pay for.

Global stocks, Gold, LTT and foreign ST bonds protects you properly against serious dollar devaluation much better and takes advantage of global economic growth wherever it may be much better than the HBPP IMHO.

Does anyone really expect the US to be the major wealth producer in the 21st century? I know it's possible but my God it seems unlikely. Yes the dollar may rally here and there but the problems in the US economy are so bad and understated that I think the dollar is toast compared to other fiat and gold.

I haven't got the quote function down yet 

[Lone Wolf]

As far as the portfolio being set up to deal with very high inflation or even runnaway inflation, it definately is not. Runnaway US inflation will devastate stocks that derive most of their revenues in US dollars and will obviously crush the 50% that is dollar-denominated debt.

I expect that the PP would do a much better job here than you might think.

In a high inflation scenario, gold (in all likelihood) will do extremely well.  I imagine we agree there.

I think we also agree that long-term bonds will almost certainly be flattened in high inflation.

Stocks and cash, while they will likely not be "stellar" investments, may do more or less "okay".  With inflation, you have currency falling quickly in value against "real stuff".  As the currency falls in value, the nominal value of stocks generally rises.  During Weimar's hyperinflation, for example, stocks did "okay", pulling back and ultimately posting gains in spite of completely horrific inflation.  Nowhere near as good as gold, obviously, but the "real stuff" here held value far better than the currency did.

Cash that is on the short end of the yield curve (which should rise in high inflation) should be paying enough interest to hopefully defray the losses due to inflation.  This isn't perfect and certainly isn't pleasant (as the 1970s showed) but it does generally prevent cash from falling anywhere near 0.  Nobody likes a 70s-style environment of 13% inflation with 11% short-term interest rates, but it does mean cash can "survive".

This leaves you with long-term bonds getting annihilated, cash doing poorly (but probably not catastrophically so), stocks probably doing "okay", and gold performing amazingly well.  I suspect that the PP would again do a great job in high inflation, just as it did in the 1970s.

[moda0306]

I'd also point out that we're definitely in a "what else" scenario when looking at good inflation protection.

Are these typical 60/40 stock/bond funds going to do any better?  The stocks, as LW says, will likely bobble, and the typical bond-fund, made up of various durations and classes of debt, will very likely lose value.

Remember, treasury rates may be lower than other bonds, but if you look at what happens to yield-spreads when the economy starts looking shaky and people start wondering if companies are going to be solvent (even if it's due to inflation), then spreads rise.  So this means that corporate bonds are going to jump in yield more than treasuries, meaning the mid-term corporates you have in your "Total bond fund" are going to get hit pretty hard.

So what else are we left with... REITS... foreign stocks & bonds?  I definitely think one could argue that holding a few safe-haven (non-pegged, stable country) currencies COULD be a good diversifier in cash, as a small piece of it, and likewise with some foreign stocks, but really when you add foreign stocks you are moving your portfolio FROM domestic prosperity INTO inflation...

Now I have qualms with gold at 25%... it just seems like too much over a lifetime, so maybe these moves into foreign currencies and stocks should reduce the gold ortion as much as the other assets, but I'm getting into some real PP blasphemy here so I'll just stop thinking.

[Kshartle]

As far as the portfolio being set up to deal with very high inflation or even runnaway inflation, it definately is not. Runnaway US inflation will devastate stocks that derive most of their revenues in US dollars and will obviously crush the 50% that is dollar-denominated debt.

In a high inflation scenario, gold (in all likelihood) will do extremely well.  I imagine we agree there.

I think we also agree that long-term bonds will almost certainly be flattened in high inflation.

Stocks and cash, while they will likely not be "stellar" investments, may do more or less "okay". 

I agree with the gold point. It should do very well in nominal terms and hopefully in real terms too.

I agree with the Long-term bond assesment because it's dollar denominated.

Stocks (Especially domestic) will likely not do well in high inflation as they will suffer much higher real tax rates and a host of other problems. Look at stocks in the 70s and the last decade. In nominal terms they made no gains and in real terms they were a big loser, even worse than treasuries.

Cash isn't good in high inflation. Personally I think it will be even worse than LTTs. The fed has promised to keep interest rates low. They do this by purchasing bonds which creates inflation. I would take them at word since this seems to be all they know. If rates remain low at least the 30 treasuries will be paying 2-3% more per year than cash. Not that this will help much.

Even if rates do go up they have to be higher than inlfation or you're still losing your purchasing to the governement (this is what they want all along and they're very good at it).

I think where we disagree is the assumption that rates will go up during high or runaway inflation. I think the interest rate assumption is a separate issue and could go either way.

The point of all this is that rising inflation will really hurt any fixed dollar instruments and hurt business, particularly business in the home country. Only gold will be safe and non-domestic currency.

Globally diversified stocks are really a play on global productivity and prosperity/growth, not an inflation play.

Foriegn ST bonds are definately an inflation play and will probably do marginal during serious US deflation. Hopefully any dollar decrease will be offset by falling prices so that you don't lose real value.

FYI in his 1981 book "Inflation-proofing your investments" HB laid out his performance expectations in different economic environments.

In high/rising inflation:

US Stocks will do poor to marginal
Gold will do excellent
Silver will do good
Real Estate will do good
Cash will do marginal
LT Bonds will do poor

In runaway inflation:

US Stocks will do poor
Gold will do excellent
Silver will do marginal
Real Estate will do medicore but uncertain
Cash will do very poor
LT Bonds will do very poor

[FarmerD]

As far as the PP portion of my holdings(80% of my total portfolio), I stick pretty much to doctrine.  However, my variable portfolio is heavy in emerging market stocks.  When looking at how the PP has fared in other countries, the only time the PP hasn't produced a good ROR is in Japan in the 1990-2010 timeframe.  A japanese PP would have done better with a geographically diversided portfolio variable portfolio. 

Looking at the US economic situation, I think a Japan type stagnation is certainly possible.  If so, holding stock in countries with growing economies may be a better alternative.     

[BearBones]

Agree. Also agree with all that KevinW has posted on this topic here and in other threads. Read his posts carefully before you do this.

We want the 4 components of the PP to be as volatile, uncorrelated, and tied to specific economic conditions as possible. The gains come from the REBALANCING. Adding international to the domestic equity component potentially reduces this volatility and/or inverse correlation. The result may be watered down returns and a bias toward domestic inflation.

I, like many of you, are concerned about my domestic economy and the possibility of eventual high inflation and/or currency collapse. So I keep international equities in a VP, along with some gold mining stocks, energy ETFs, and some land (eventually). However, this is for speculation, not investing.

[moda0306]

I think there is room for a foreign VP play where you invest in foreign currencies, bonds and stocks.

Maybe even without there being a 5th economic condition, one could benefit by creating a 5x20 PP with all 4 of the original assets with a foreign basket of stocks, bonds and cash, the latter two only from countries that we hope to behave like a sovereign fiat currency should... maybe the same for stocks... Japan being one of the major ones.

I just don't like goofing with the stock portion alone when trying to diversify your currencies.  Maybe adding that 5x20 approach keeps you diversified enough to do better in a high-inflation period and/or foreign prosperity period without sacrificing much of your other economic cycle safety.

I'm just thinking out loud.  I still like the PP as is.

Maybe holding some of the currency of the nearest country to you (Canada or Mexico for most of us) in your safe next to your gold and "mattress cash" wouldn't be a bad idea either.