I found an interesting post from Jim Wiandt in the IndexUniverse blog section about iShares MSCI EAFE Fund (EFA). He was at some sort of ETF conference and he remarked about the buzz created when Steven Schoenfeld said that EAFE was obsolete, and so by extension I take that to mean he thinks EFA is obsolete.
Um, I've kind of been saying the same thing for a couple of years now. The first instance I found in the archives of writing EFA was not a great way to capture foreign diversification was June 28, 2005. There have been many other instances here and once or twice for RealMoney.com. I doubt Jim reads my stuff and I further doubt Steven has ever heard of me but still...
More people have become aware of foreign investing in the last few years and I believe it will become more important as time goes on. But to paraphrase Nassim Teleb, diversification used to work when no one knew about it.
I have never been a fan of EFA, I have preferred stocks mostly or occasionally a country fund and I do use the Wisdom Tree International Energy Fund (DKA) for most clients. The problem as I see it with broad based products is that the benefits of most of the countries get blended away when lumped in with the huge weightings in Japan and the UK.
Certain individual countries, because of their economies, offer the chance for better diversification than others. To the extent there is a fund for a country like that, great, but you may need to be open to the idea of individual stocks as well.
Success in the future will depend on exploring new products and learning about new (to you) destinations. While understanding and accessing Botswana is outside the realm for most folks there countries that should be in the realm if you are going to manage your own portfolio.
Another aspect of this that I have written about a lot is, from the country level, understanding the differences between the various countries owned. A blend of different countries with different attributes provides a chance for diversification without getting crushed if some sort of event happens. For example owning a surplus country and a deficit country is probably a good idea. Or thought of a little differently a carry trade destination country and a funding destination. To be clear I am not saying limit to two countries but do want to point out some of the differences in countries.
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29 comments:
Roger, do you happen to have a link that I can read about Nassim Teleb talking about the reduced benefit of asset allocation. I too hold this theory and would like to see it written somewhere.
geckojb@yahoo.com
I wrote a little bit more here.
You can try the WealthTrack website for more.
Bravo Roger. I have done tons and tons of research on the actual diversification benefits of ETFs using several different softwares and some monte carlo simulations. Specifically, some of the broader EAFE things like EFA prove to be virtually worthless from a portfolio diversification perspective.
It seems to me that as the world becomes ever more globally intertwined the actual indexes that track all these areas and regions are becoming more and more correlated (not a new thought I know). My research bears this out.
I started my research hoping to come up with the "perfect" all ETF portfolio and what I found is that that does not exist. One can only maximize diversification truly by finding many-non/low correlated assets and the only way to do that is to use individual securities in the mix. Even if their risks are higher than an index, the benefit of diversifying with many of these far outweighs combining 10 ETFs that all share correlations greater than .75.
With enough digging, one can find good multinational firms that derive revenue from lots of areas around the globe. These types of firms provide far more diversifiable benefits than owning an index.
My two cents...
I love articles like that.
"EAFE IS OBSOLETE!!11!!! Oh, I won't give you any concrete information as to why. Nor will I point to other international indexes that AREN'T obsolete.
I wonder if, in the panel the article refers to, Steven Schoenfeld went on tout his book.
but... what about those of us who do not have the time to do all of this research. I am sure there are many others, like me, that only have enough time to read a few carefully chosen blogs. I am still a younger investor, and I know that I need international exposure, but I lack the expertise to find that exposure outside of a mutual fund/etf. I appreciate all of the comments so far on this topic, any direction would be helpful.
thank you and great stuff from BlackSwan, SD, very funny.
anon i hear you. I don't know if i have the answer but maybe you should seek out two countries with the lowest correlation you can find among developed nations?
Also, take this with a grain of salt. This is 1 guy saying it's obsolete. I've looked around the web and I can't find any articles where he actually defines that. The guy also has a book to sell called "Active Index Investing".
To anon,
I am a financial advisor and spent the majority of my time managing money for people. I would not expect an individual investor to take the time to research things like us 'freaks' that do this for a living.
Despite my comments above, one can have a diversified portfolio made up primarily of ETFs. It just will not be "optimal" from a statistical standpoint. Does that matter? Not sure. One can plug as much data in to a model as one wants and that still does not guarantee future results. For the do-it-yourselfer, as Roger obviously mentions many times here, it's probably better to keep it as simple as possible.
I do this for a living so I wouldn't expect that someone with a day job would spend as much time on it as I do.
When I have some time in the next couple of days I will publish some of what I've found. Maybe it will be useful to some of you and maybe it will not be?!?
thanks for the responses... this is why I read this website day-in and day-out. I wasnt necessarily seeking a specific answer to the my earlier question. By asking it, I am really looking for direction on the process. I appreciate the starting point roger. Thanks again, this is great.
I am a regular reader and your thoughts about international markets make a lot of sense to me. However, I have not seen any comments about Latin America lately. Any updates on your thoughts?
re:Latam
I continue to own CVRD (RIO) for many, but not all, clients. I used to own a Chilean bank and expect to go back in at some point but for now don't want to add volatility.
I have one or two other things for Latam for a couple of people as well.
Chile is probably a good long term hold, I obviously like Brazil, not a big fan of Mexico and I wnat ot learn more about Peru and Colombia.
To me, asset allocation means more than holding a variety of disparate stocks and bonds. It includes real estate, education, charitable giving,volunteerism, faith, continuous savings from each paycheck and living comfortably beneath your means.
Asset allocation is a lifestyle choice,not a quarterly brokerage statement or an effort to act like Cramer lite.
Hi Roger:
Question regarding currency ETFs.
1. Let us say I invest $ 1000 in the Swedish Krona through the Swedish Krona currency ETF (FXS).
2. Does this mean: My money is converted to the Swedish Krona and the Swedish Krona earns money market interest.
3. If I hold the FXS for say 3 months, then will my net returns equal:
gain/loss due to exchange between US dollars and Swedish Krona + interest on the equivalent Swedish Krona for three months - the ETFs expenses?
Thanks for your time.
yours,
Stranger
Theoretically... I'd be curious for anyone's thoughts, particularly those more knowledgeable about long bond rates... one could short the ten year bond...gold may be blunted by political forces but the market may still jack up yields to more normal levels. Is the move inevitable and coming? Personally, I almost never short but I thought that it may be interesting for a small 3% position that could have legs over a 4 week period.
TMJ
currency ETFs; yes the interest paid corresponds with prevailing rates of that country so Switzerland yields less than UK.
shorting bonds; Rydex has an OEF, I think ProFunds does too and probably direxion funds.
You could short any of the fixed income ETFs. Also options trade on ^TNX, ^TNY and so on but i do not know how easy it is to trade in that market.
roger, direxion was the only one that I could find that shorts directly,so to speak. For me, it would be done in a 401k. Is it fair reasoning that the move to normal levels of yield of the longer bonds have begun? If there is a deep recession starting NOW would the inverted curve be over since it anticipates and does not invert concurrently with a recession?Certainly can not expect you to comment on good or bad trade, but would like your informed about my reasoning or lack of.
thanks.
TMJ
i agree about the curve starting to normalize. i have said a few times I think that means long end goes up and short end goes down. but it could normalize with just the front end moving down.
I don't do this sort of trade for clients so I do not think about it in the way the question is framed.
Roger,
Excellent point about the front end moving down, ergo less the long end has to move up.
If I may ask another question. there is thoughtful concern about the bear mkt starting by smart folks who are not perma bears.Part of the reasoning stems from the rise in gold and speculation in miners. The longest term chart I can find goes back to 1982...not far enough. Do you have access to one that goes back to the early part of last century that can compare precious metals with the dow?....ps thanks again for this responsive and informative blog.
TMJ
i don't have that kind of data maybe someone else will.
Any analysis of gold prices and the Dow is meaningless prior to 1971. Up until then the Bretton Woods agreements (1944) fixed the dollar value of gold. It wasn't until 1971 when those agreements were disbanded that the dollar could no longer be exchanged for actual gold and the value of the two were allowed to float against each other.
http://en.wikipedia.org/wiki/Bretton_Woods_system
Rog,
this makes about as much sense as your buying the double short fund last month....a huge mistake
do clients ever bother to look at your underperformance vs. appropriate risk adjusted indices?
If one is looking for bonds to purchase, I would give consideration to GMAC Smart Notes. The ones I buy are no more than 24 + - months to maturity, to better insure that these discounted notes will pay off. Rates are all over the map because there is a fairly thin market (this the premis of holding until maturity). If you look hard, locking in 8% or better is possibble for a relatively short duration.
GMAC smart notes? You mean unsecured debt of GMAC that is used to fund operations such as REscap and ditech mortgage? geesh that's a heck of a recommendation!
Anon 5:10, alias "The Heckler".
I suppose that Roger's clients look to the long term and not short term moves or performance.
You would do well to do the same. But somehow I doubt if you will. (And are you still sore about him banning you earlier this year from the site? Grow up and get a life please)
Most adults here post in order to add to the site and the information that we graciously share about investing. You only subtract from the site. Please go away and come back in a few years when you (hopefully) grow up.
Now back to sharing information in an adult manner...Roger, what do you think of Dodge & Cox's International Stock Fund (TIVFX)?
For a managed fund it only has a .66 expense ratio, a 4-9% turnover (low taxes), and a 1.8% yield. Not that I care much about Morningstar ratings, but it's 5 stars. They only have about 5 funds and 2 or 3 of them are closed now.
Maybe this fund could be a good replacement for EFA for some folks.
TIVFX is for Tocqueville Intl Value. If you mean that one it has lagged badly this year which may not matter.
The thing with actively managed funds that is difficult for me is what will they own in the future--obviously no way to know, no way to do a forward looking analysis.
If you mean a Dodge and Cox fund, I am guessing it has done better and there could be every reason to have faith in the management but again there is no way to analyze. I am not sure how buying can be anything other than a belief that the manager can repeat past performance. Not saying he can't but that seems like all there is to go on?
I'm sorry, you're right; I meant DODFX for Dodge & Cox's int fund.
so DODFX looks, chartwise, a lot like EFA YTD. It owns a lot of mega caps. This is either a belief we are late in the cycle abroad or they always own mega caps, I don't know.
Same dilemma as with the other fund there is no way to analyze what they do in the future.
I would feel different about an actively managed product that was narrower. A Taiwan fund, for example, is always going to be some sort of proxy for Taiwan, you at least know you are getting that much.
Roger/Blackswan, I get your point but I also think there is a place for an EAFE index fund just as there is a place for an S&P 500 fund, especially for investors who want an easy way to capture large cap equities. I agree that EAFE shouldn't be used as a proxy for "international stocks", just as the S&P 500 isn't a proxy for U.S. stocks - imho.
Most investors simply don't have the time or interest to seek out combinations of non-correlated stocks/ETFs to contruct their own portfolios. Also, I've read a few articles that indicate that correlations between countries/regions/stocks can to shift quite a bit. What may have been two non-correlated securities over the past x years may end up being two closely correlated securities over the next x years.
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