Gyroscopic Investing

Posted: **Thu Oct 14, 2010 3:01 pm**

Hi - I was hoping all you fine folks would give me your opinion about the following idea:

I currently use VTI/SPY for my PP stock allocation. I am thinking about changing to

1/3 VTI/SPY
1/3 PIN (India ETF)
1/3 FXI (China ETF)

and rebalancing them to 1/3 each whenever the time comes for me to rebalance the overall PP or if any of the three hits bands of, say, 20% and 45% within the stock portion.

My hypothesis being that these 3 entities will generally have above average economic/equity performance for the foreseeable future with the US most likely the least dominant of the 3.

Thanks in advance! ;D

Posted: **Thu Oct 14, 2010 4:56 pm**

MeDebtFree wrote: Hi - I was hoping all you fine folks would give me your opinion about the following idea:

I currently use VTI for my PP stock allocation. I am thinking about changing to

1/3 VTI
1/3 PIN (India ETF)
1/3 FXI (China ETF)

and rebalancing them to 1/3 each whenever the time comes for me to rebalance the overall PP or if any of the three hits bands of, say, 20% and 45% within the stock portion.

My hypothesis being that these 3 entities will generally have above average economic/equity growth for the foreseeable future with the US most likely the least dominant of the 3.

Thanks in advance! ;D

VTI: No problem.

PIN (India): India is a good story, but it still has a nuclear neighbor with whom it is likely to have serious disagreements at some point. The government of India is also an inefficient mess that can make doing business there difficult. You are also introducing currency risk to the portfolio. In general, I think that a bet on India is a bet that a third world country will become a first world country, but history shows that all sorts of pitfalls can derail such an effort. For a U.S. investor, media coverage of India is so thin that I would be concerned that I wouldn't be aware of subtle shifts in Indian markets that might make me want to re-think my India commitment. For a "permanent" portfolio I would say it is a non-starter.

FXI (China): What do we know about centrally planned economies? They result in an inefficient allocation of resources. Sometimes this takes a long time to play out, but when the government is in control of capital allocation and credit markets, over time bad things tend to happen. China is currently enjoying the mother of all demographic bulges as the one child generation passes through its productive years. When this generation begins to gray, however, and the lack of a social safety net and decades of misallocated capital begin to come home to roost, the China story may look less exciting. That all assumes that the country doesn't break into chaos at some point before that, since we know that economic prosperity and political tyranny don't play well together. For anyone who was an adult in the 1980s remembers, Japan was talked about in almost exactly the same terms as China is talked about today, but look how the story actually unfolded.

For a PP, I suggest that about 20% in an international index fund should be the limit for international equities, especially since U.S. multinationals in the S&P 500 are already some of the most internationally exposed companies in the world.

Posted: **Thu Oct 14, 2010 10:45 pm**

China has had at least one instance of a business firing their auditor and hiding accounting discrepancies which decimated it's stock and brought no
punishment nor corrective action from the Chinese government. This raises the risk.

India has had significant corruption in many of its industries and stock offerings within the country, at least from reports I've seen last year. I've not
seen any reports this year on such.

FXI is a large cap value etf or blend depending upon who one reads. Ishares indicates that 46% of the etf is financial, which raises the risk as it
puts a significant chunk of the etf in one sector. A problem in that sector will greatly affect the overall etf. And the etf holds only 25 companies.

PIN seems to be a Large cap growth. However, 10% of the etf is held by a single company - Infosys Technologies Ltd.

Given the limited holdings and concentrations of both etfs, they seem fairly risky.

If it were me, and I wanted to target India and China, I'd do the following -

Look into each etf, find the companies that seem to be the most stable, figure out the potential growth possibilities, and what will hurt each one,
then find the ADR on the US stock exchange. Examples (without the necessary financial homework - so I've no idea if the companies would do
well or not) that would provide some diversification -

India -

Infosys Technologies Limited (ADR) (Public, NASDAQ:INFY)
Tata Motors Limited (ADR) (Public, NYSE:TTM)
Vodafone Group Plc (ADR) (Public, NASDAQ:VOD)

(While Vodaphone is not strictly an Indian company, it does operate there.)

China -

CNOOC Limited (ADR) (Public, NYSE:CEO)
ZHONGPIN INC. (Public, NASDAQ:HOGS)
Harbin Electric, Inc. (Public, NASDAQ:HRBN)
A. O. Smith Corporation (Public, NYSE:AOS)

(A. O. Smith is the major vendor of water heaters for all the new middle-class Chinese.)

There are also world etfs that would provide more diverse India and China exposure, along with other markets. The small cap - VWO, is one
such fund.

Posted: **Thu Oct 14, 2010 11:00 pm**

MediumTex wrote:
VTI: No problem.

PIN (India): India is a good story, but it still has a nuclear neighbor with whom it is likely to have serious disagreements at some point. The government of India is also an inefficient mess that can make doing business there difficult. You are also introducing currency risk to the portfolio. In general, I think that a bet on India is a bet that a third world country will become a first world country, but history shows that all sorts of pitfalls can derail such an effort. For a U.S. investor, media coverage of India is so thin that I would be concerned that I wouldn't be aware of subtle shifts in Indian markets that might make me want to re-think my India commitment. For a "permanent" portfolio I would say it is a non-starter.

FXI (China): What do we know about centrally planned economies? They result in an inefficient allocation of resources. Sometimes this takes a long time to play out, but when the government is in control of capital allocation and credit markets, over time bad things tend to happen. China is currently enjoying the mother of all demographic bulges as the one child generation passes through its productive years. When this generation begins to gray, however, and the lack of a social safety net and decades of misallocated capital begin to come home to roost, the China story may look less exciting. That all assumes that the country doesn't break into chaos at some point before that, since we know that economic prosperity and political tyranny don't play well together. For anyone who was an adult in the 1980s remembers, Japan was talked about in almost exactly the same terms as China is talked about today, but look how the story actually unfolded.

For a PP, I suggest that about 20% in an international index fund should be the limit for international equities, especially since U.S. multinationals in the S&P 500 are already some of the most internationally exposed companies in the world.

Thanks for the usual thought provoking insights, MT. GREATLY appreciated.

I know it's anecdotal but I work for the mother-of-all-US-multinationals and based on the massive (and accelerating) investments in India and China I have seen taking place over the last 5-10 years (and the decelerating/non-existent investment taking place in the US) I firmly believe China and India will continue to be THE growth economies for the coming decades (exploding middle class, huge job growth, net exporters, etc). I often reflect on what Jimmy Rogers once said, "If you were smart in 1807 you moved to London, if you were smart in 1907 you moved to New York City, and if you are smart in 2007 you move to Asia."

I work directly with dozens of people from China and India and we spend a lot of time talking about geopolitical topics. I am going to engage them more about how they view their native governments with respect to being "equity friendly". I guess I didn't really think of it before but your response now has me wondering, "Ok, China and India will experience world leading economic growth for some time, but does that necessarily mean that buying equities in companies of those countries will provide better returns than US equities, particularly when considering potential risks brought about by their political systems?"

I won't decide for a while yet, but at the very least I am now considering changing my split to

60% VTI
20% China
20% India

Or maybe even better, move all this thought process to my VP and just leave the PP stock allocation in VTI

Posted: **Thu Oct 14, 2010 11:01 pm**

Forgot one that covers both India and China - Yum! Brands, Inc. (Public, NYSE:YUM)

Yum is a big hit from Japan, to China, to Vietnam, and seems to be expanding well in India.

Posted: **Thu Oct 14, 2010 11:32 pm**

MeDebtFree wrote:I guess I didn't really think of it before but your response now has me wondering, "Ok, China and India will experience world leading economic growth for some time, but does that necessarily mean that buying equities in companies of those countries will provide better returns than US equities, particularly when considering potential risks brought about by their political systems?"

Consider also what happens to an export driven economy (i.e., China) when it mis-reads the level of demand from its biggest customer (i.e., the U.S.) due to false signals generated by too many years of central bank generated easy credit.

When you are talking about India, China, Russia, Brazil and any other third world flavor of the week emerging market, you are talking RISK, and that risk has [IMHO] more facets than most investors appreciate...until something bad happens.

Remember when Ireland was getting all the good press? Not so much any more.

Be careful, and remember that the context of this discussion is a permanent portfolio. It's hard for me to imagine investing 66% of my equity exposure in two third world countries, one of which is a communist dictatorship and calling my investment strategy safe and stable.

Posted: **Thu Oct 14, 2010 11:38 pm**

BobS wrote:Examples (without the necessary financial homework - so I've no idea if the companies would do
well or not) that would provide some diversification -

India -

Infosys Technologies Limited (ADR) (Public, NASDAQ:INFY)

Tata Motors Limited (ADR) (Public, NYSE:TTM)

Vodafone Group Plc (ADR) (Public, NASDAQ:VOD)
(While Vodaphone is not strictly an Indian company, it does operate there.)

China -

CNOOC Limited (ADR) (Public, NYSE:CEO)

ZHONGPIN INC. (Public, NASDAQ:HOGS)

Harbin Electric, Inc. (Public, NASDAQ:HRBN)

A. O. Smith Corporation (Public, NYSE:AOS)
(A. O. Smith is the major vendor of water heaters for all the new middle-class Chinese.)

[Moderator Hat On]

BobS, this is a permanent portfolio stock allocation discussion. If you want to discuss individual equities in emerging markets please do so in the Variable Portfolio area.

Thanks.

[/Moderator Hat Off]

In general, I hope that no one is considering loading up their PP equity portion with individual stocks of Chinese and Indian companies.

Posted: **Fri Oct 15, 2010 3:10 pm**

A few more things about China to think about before drinking the sweet and sour kool-aid:

No meaningful rule of law
No democratic institutions
No impartial mechanism for enforcing contract rights
No protection of intellectual property rights

Does that sound like someone you would want your capital to go out on a date with?

Posted: **Fri Oct 15, 2010 6:10 pm**

MediumTex wrote:In general, I hope that no one is considering loading up their PP equity portion with individual stocks of Chinese and Indian companies.

I second this. There is a tremendous amount of hype around these emerging markets. The level of corruption, transparency and accountability for fraudulent activity is much different than in Western nations.

Posted: **Mon Oct 18, 2010 12:29 pm**

MeDebtFree wrote:
I work directly with dozens of people from China and India and we spend a lot of time talking about geopolitical topics. I am going to engage them more about how they view their native governments with respect to being "equity friendly".

Ok, once again anecdotal, but here is a summary of what my Chinese and Indian colleagues had to say:

1) Given only once choice of where to invest in equities, where would it be?

They all said the US would be their first/primary/core-holdings choice.

2) What country(ies) do you believe will have the highest economic growth over the next 10-20 years?

China, then India, then the US (unanimous).

3) So, given that you believe the highest growth will be in China and India, why not invest a significant portion of equity money in China and India?

India - too much corruption (it is changing but it will be a while yet, maybe a generation, before the trust level is acceptable).

China - the government has too much control over the fate of any particular company.

4) Would you invest any of your money in China or India?

Probably not India (yet) but would invest a relatively small portion in China but not in individual companies, would have to be basket of stocks/ADRs something like the FXI.

5) How likely do you think it is that the Chinese government would "screw-over" equity investors?

Very unlikely that they would do it in any direct way unless, of course, there was some major world issue/event along the lines of a war-like scenario (but in which case everybody would have serious problems).

So, my conclusion at this point is to do nothing, i.e., leave VTI and SPY as my PP equity holdings. I may consider "playing around" with these ideas in my VP.

THANKS to all of my colleagues and all of you on this forum that took time to respond.

Posted: **Mon Oct 18, 2010 12:38 pm**

MeDebtFree wrote:
1) Given only once choice of where to invest in equities, where would it be?

They all said the US would be their first/primary/core-holdings choice.

Wow. That really speaks volumes.

Posted: **Mon Oct 18, 2010 1:29 pm**

Fascinating followup, MeDebtFree. Thank you for posting it.

Posted: **Mon Oct 25, 2010 4:30 pm**

Posted: **Mon Nov 29, 2010 9:35 am**

Desert wrote: China thinks of itself as the "factory to the world," and that is true to some extent...The government plays a much larger role in the economy (for better or worse), so it's difficult to predict what industries will be supported/favored in the future.

A government playing a larger role in an economy is virtually always for worse (misallocation of resources, distorted incentives, general inefficiency, etc.).

This part of the China story will become clearer in time.

Posted: **Mon Aug 01, 2011 7:43 am**

Please don't try to predict the market, or, more importantly, predict which countries or sectors will do well in the near term. I do agree with some international exposure. I would recommend that following for the 25% of your portfoilio is stocks:

60% VTI
40% EFA

Here is a good article to read: http://www.vanguard.com/bogle_site/sp20020626.html

Gyroscopic Investing

PP Stock Allocation

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