Emerging Markets in your SAA

Hi all,

I have been pondering about emerging markets for some time, and while I think having some exposure to it is a great idea especially when you can stomach the volatility as a young investor, I wanted to see what everyone thinks and their reasoning behind their allocation (p.s. I am just an amateur investor so much of what i said could be wrong!)

I see many people here have a small allocation for either VGE or VAE, and I suppose the biggest reasoning behind it is to avoid regret of missing out on a big run (p.s. I do understand they are different products but I feel it is a matter of preference and whether you wanted to take a punt on Asia).

I know the US Bogleheads do not seem to typically include EM in their portfolio (heck most of them advocate just US equities in the two fund portfolio), but the idea of catching on a big growth train in EM is quite appealing. Places like China and India have been thought to have significant growth still ahead.

However, I do see many arguments against EM. Due to the poorer regulations and high government influence, and also more frequent share dilutions, the returns of their stocks could be quite poor even if the economy grows well. The inefficient market could also cause passive indexing to return inferior results compared to active management in those places.

Higher MER, tax consequences, and risk of government policies being unfriendly to international shareholders could all play a part in under performance relative to developed markets. Another thought is that if they grow their economy well enough they would eventually be included in developed indices anyway, but then again you would potentially have missed out on the growth beforehand.

Why do you choose to/not to keep an allocation of EM? And what made you decide on the allocation? If you only keep a very small allocation of it, would it really effect your portfolio in a meaningful way in the long run? Or is it more a psychological FOMO decision?

Keen to learn everyone's thoughts!

 

While I can't add anything about EMs specifically, firstly, considered thoughts - congrats (I too am a novice investor so can't comment on the specific comments).

FWIW, I have very small holding of IXJ - Healthcare ETF, which doesn't have any income return, but I bought for the same reasons you are indicating your interest in EMs. I see healthcare as an emerging/growing sector (mind you IXJ is US domiciled so not good at all in that respect, and that it is growth focussed rather than income, but I know my (proposed) end game for this stock so understand it's purpose in the portfolio).

 

Your survey doesn't allow multiple votes but I hold both VGE and VAE. Between them they make up approx 20% of my portfolio.

I am quite comfortable holding them, if you look up the makeup these funds you are holding companies throughout China, Asia, Russia, India, South America, Africa, etc, while the risks you have highlighted are real there is inherently a broad amount of geographical diversification in these funds to reduce this.

I hear people spruiking speculative microcap statups all the time, I would put my money in VAE/VGE over these any day of the week.

 

I originally had a VTS/VEU mix but over the years new funds have gone into VGS

China and India are the fastest growing economic nations but the major western brands have large exposure there also (and judging by rich kids of <insert country here> Instagram pages) they seem very brand-conscious

Had a look at Vanguards Total International Stock market holdings to see EM share

Vanguard Total International Stock Index Fund seeks to track the performance of a benchmark index that measures the investment return of stocks issued by companies located in developed and emerging markets, excluding the United States.





How Much Should We Invest in Emerging Markets?
Burton G. Malkiel

One of the most enduring and best-documented behavioral biases in investing is called “The Home Country Bias.” Despite the availability of well-regarded and highly profitable corporations located throughout the world, investors tend to limit their investments to those companies domiciled in their own country. At one time, a survey of institutional investors in France found that 97% of their equity investments consisted of French companies despite the fact that France represented only 3% of the world’s total equity capitalization. Such a bias is found all over the world. British investors prefer British companies, Japanese investors prefer Japanese companies, and U.S. investors prefer companies domiciled in the United States. Despite the substantial risk-reducing benefits of international diversification, investors all over the world exhibit a home country bias.


Then there's stories like this...

China Wealth Proves Elusive as Stocks Earn 1% in 20 Years

China’s 20-year economic boom has boosted the wealth of its 1.3 billion citizens at the fastest pace worldwide and spawned some of the biggest companies in history. Foreigners earned less than 1 percent a year investing in Chinese stocks, a sixth of what they would have made owning U.S. Treasury bills.

The MSCI China Index has gained about 14 percent, including dividends, since Tsingtao Brewery Co. became the first mainland company to sell H shares to international investors in Hong Kong in July 1993. That compares with a 452 percent return in the Standard & Poor’s 500 Index, 322 percent in the MSCI Emerging Markets Index and 86 percent from Treasuries. Only the MSCI Japan Index had a weaker performance among the 10 largest markets, losing about 1 percent.

 

Couple more interesting articles on the subject (pro)

Why Should You Invest in Emerging Markets?

Gregg S Fisher (CPA)

Why Diversification Works

Ben Carlson (Money Manager)

 

Everyone loves a bit of home country bias, not just the yield chasing Aussies

 

Am I correct that VGE has a lot more expenses compared to VAE?

Looking through the fact sheet, VAE has a MER of 40bps with no indirect costs.
VGE has MER of 56bps, plus 1 bps indirect costs and 25bps buy/sell spread costs.

Does anyone know if there is a buy/sell spread cost for VAE as well?

 

VAE is a bet on a region, whereas VGE is global EM. Different things.

I've changed my view on EM over time. Really coming at it from a portfolio top down approach. EM has high volatility and in theory should have higher return (equity risk premium). When running index approach you need to just trust the markets to get things broadly right in the long run - risk will be priced. I dont buy the argument around missing out in high growth economies - domestic stock market performance is not a close proxy for economic growth. I do buy the high volatility/risk = higher return argument over the long term. I really try to suspend my views around individual countries and soothsaying about what will happen in the future.

 

Tend to agree with that. Although on the second point I’ve seen differing views on how valid that is in relation to EM? Regardless probably one of the strongest reasons for owning it is the usual diversification benefit of correlation in that when one asset is doing well another isn’t.

This is a US asset allocation quilt but it highlights my above point in regard to the diversification benefit of EM:



Updating My Favorite Performance Chart for 2018 - A Wealth of Common Sense

Personally I don’t hold EM as:
1. I’m an older retired investor with less time potentially to reap the reward of increased risk and don’t want additional higher risk anyhow.
2. One needs to hold a decent allocation of an asset class (eg 7 - 10% or more) to have a noticeable benefit which I’m not prepared to do.
3. Correlation is of less concern to me as I have enough assets to live off the natural yield of the portfolios.
4. If a constituent of the EM index reaches a high enough standard in relation to rule of of law and regulatory environment etc (reduced risk) then it will likely be added to the Developed World index which I hold through VGS. Nothing for me to do.

That said, if I was younger I’d definitely include EM in the portfolio at around 10% allocation.

PS: I’m now more in favour of EM rather than a regional bet on Asia. As @The Falcon said, trust the markets to get it broadly right. By investing only in a regional market the investor is making a personal bet on an expected outcome.

 

I hold VAE in conjunction with VGS.

VGE and VAE have virtually the same emerging Asia exposure @ 57%

The remainder of VGE is 15% developed Asia and everything else represents 28%.

The remainder of VAE is 43% developed Asia.

VAE has a MER of .40%, VGE has a MER of .48%. when you crunch the numbers the 28% that is different in VGE compared to VAE costs you a MER of .68%

The 28% exposure in VGE gives you the rest of the emerging markets outside Asia.

The 28% exposure in VAE is mainly represented by 14.3% exposure to South Korea (Samsung etc), which you don’t get with VGS + VGE combo because of a mismatch between vanguard using MSCI as benchmark for VGS and FTSE for VGE. And 13% Hong Kong (developed market exposure to China) compensating this extra china exposure is VAE has less direct exposure to emerging domestic China market than VGE does.

For me VGS and VAE is the most logical fit. I Give up 28% exposure to rest of emerging market at effective MER of .68 and gain developed exposure to Korea and Hong Kong. I am happy with that trade off.

If I really wanted VGE I would investigate pairing it with VESG or another ETF provider to get rid of the benchmark mismatch that leaves Korea out.

https://www.ftse.com/products/downloads/FTSE_South_Korea_Whitepaper_Jan2013.pdf

 

Korea is not missing from VGE, it’s is 2nd largest exposure behind China. The index is MSCI EM.

https://api.vanguard.com/rs/gre/gls/1.3.0/documents/7687/au

 

I'm thinking there may be a difference in the ETF and wholesale fund.
It seems like the ETF comes with 48 bps management fees without Korea, and the wholesale fund includes Korea with 56 bps. Not sure why the wholesale fund use MSCI and the ETF use FTSE, makes no sense at all.

https://api.vanguard.com/rs/gre/gls/1.3.0/documents/8300/au

 

See @blob2004 answer. He nailed it. I also have no idea why the difference in benchmark between wholesale emerging and ETF.

VGE is a subfund of NYSE. VWO not sure what the basis of the wholesale fund is.

 

WTF.

I stand corrected! Apologies.

 

I hold FEMX, CNEW & ASIA.

FEMX for its exposure to India.
CNEW for its bias towards the consumer discretionary stocks in China (I just topped up yesterday after the latest 'Trump Dump')
ASIA as an Asia technology play.

I am aware that there are cross overs in stock holdings across these 3

 

Would holding the ETF IEM - iShares MSCI Emerging Markets be a better match with VGS - Vanguard MSCI Index International Shares ETF ?

The MER of IEM being .69% seems quite high though.

 

Some interesting analysis by Ashley Owen:

https://stanfordbrown.com.au/wp-con...fa8e4381bd784680f8914173f9191b1c0223e68310bb1 (Page 7 - 8, but the full report is worth a look):

 

@dunno, thoughts on Ashley Owen’s analysis of EMs in my previous post please?

 

Hi @Nodrog

I like Ashley Owen’s stuff on history.

Nothing in there that Is a surprise. EM converges and overshoots rest of market especially in volatile times. It falls further in bad markets and it also rises further in good. Underlying country fundamentals are a very loose rubber band, capital flows dictate short term moves.

It would seem these days Owen’s is more of a tactical allocator than he used to be. (his employment and requirement to attract funds to manage probably depends on it) His conclusion appears to be to time EM volatility.

My conclusion is that I want permanent exposure to it (at least the Asian part of it) for its asymmetrical risk return relationship. (ie take his example of Australia and Argentina – had you held them both equally long term, you would have lost half your money on Argentina but multiplied the other half many, many times with Aus until it was eventually declared developed.)

It’s also this asymmetrical risk relationship that makes smaller companies and other risk factors etc potential rewarding. But nothing comes easy – If you want to harvest asymmetrical risk/reward you have to be prepared to wear volatility and run the full course – unless you can “time” these volatile markets (which I can’t) then you could just harvest wealth at will.

EM increases volatility beyond 100% developed diversified large cap volatility. Before you add it you really need to ask is that what I really want? 100% developed equity is aggressive already.

My exposure to emerging is via VAE.

 

Thanks very much for that @dunno. The bolded part of your above quote is exactly what I asked myself. Given our circumstances, stage of life as somewhat older retirees and being near 100% equities my wife and I felt it unnecessary to invest even more aggressively than Developed Global Equities. Yes with EM / Asia there’s the possibility of higher growth but that comes with greater risk which is just not necessary for our circumstances.