Challenge the Indexes
Carl Delfeld, 05.22.06, 12:00 AM ET
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When I called on global equity fund managers in
Tokyo, Hong Kong and Sydney during the 1980s to pitch American
small-cap stocks, I was always struck by the leather-covered ledgers
they would pull out to jot down notes. No doubt the leather ledgers
have been replaced by sleek notebook computers--and the time to
meet with small-cap stock pickers is probably also a thing of the
Why? The enormous size of some global equity funds would make
even a ten-bagger small-cap stock hardly worth the trouble. The
fund managers need big-cap liquid stocks and have little choice
but to take a top-down approach as they attempt to beat their benchmarks.
This presents independent investors with a great opportunity to
the performance of the big global fund managers. How? By ignoring
country index weightings largely based on the size of a country's
Let's look at how a portfolio manager of a large global equity
fund might approach his task of beating a benchmark such as the
All Country World Index or the MSCI Europe, Australasia and Far
East (EAFE) index. The All Country World Index weights 49 countries
on the market value of their stock markets. For example, as of
Apr. 21 the index weights Japan at 11%, the U.S. at 45.5%, Australia
2.3%, Indonesia at 0.13%, Singapore at 0.37% and Germany at 3.1%.
The EAFE index contains 21 countries and excludes emerging-market
countries. 48% of the holdings are accounted for by two countries:
Japan and the U.K. Add in France and Germany and the percentage
climbs to over 64%. Meanwhile, the allocation to more dynamic countries
such as Ireland and Austria is 0.94% and 0.40%, respectively.
Another method fund managers use in allocating assets is to divide
the world into groups such as North America, Europe, Asia and emerging
markets and then to weight countries within these categories differently
than the benchmark does. For example, in the MSCI Asia Index, Japan's
weighting is a surprising 68.6%, India's 3%, Singapore's 2.3%,
while Indonesia's is only 0.78%.
To beat these benchmarks, fund managers allocate assets differently,
but my experience is that many of the larger funds are "index
huggers" that deviate from the weightings only at the margins.
Once the country allocation targets are established, fund managers
evaluate what companies they should invest in or use passive vehicles
such as exchange-traded funds that track a country's stock market
You can see that the whole business is oriented towards the largest
stock markets. But just because the global asset-management business
is wedded to conventional backward-looking benchmarks doesn't
mean that you have to be.
If you want your global portfolio to outperform benchmarks in
a big way, unshackle yourself from the country weightings.
future and weight countries based on their growth potential,
capital flows, prices and pace of market reforms.
It makes little sense to me to have Japan, the U.K., France
and Germany account for 64% of your investments in global
markets, so sell your
MSCI EAFE index fund or ETF and do some independent thinking.
If the goal for your portfolio is long-term appreciation,
India, Ireland, eastern Europe or greater China should
allocations than the U.K. or France. The country-specific
iShare ETFs are
a good tool for this since you can buy into Taiwan (ETF),
or Malaysia (EWM) with a click of the mouse.
What about the risk of investing in smaller stock markets?
It seems to me that investing in a vehicle tracking the
with 48% exposure to Japan and the U.K. is riskier than
of your portfolio in each of ten countries such as Canada,
Singapore, Australia, Ireland, Switzerland and Hong Kong.
Sure, an ETF won't
discriminate against dicey managements in opaque markets.
If you include emerging-market countries, expect your
returns to be a
bit more volatile--but, to paraphrase Warren Buffett
in one of his annual
reports, I would rather have a lumpy 15% than a flat
You can build a portfolio on your own or seek out a smaller,
independent-thinking adviser. Michael Gibbs-Harris
of MGH Asset Management in New Zealand
is one of them. He has built a proprietary model that
ranks 40 countries based on valuation and fundamental
Currently, he has allocations
of 15% for Japan, 14% for Germany, just 1% for the
U.S. and none
for France or the U.K.
So for big gains, ignore the indexes.
Carl Delfeld represented the U.S. on the Asian Development
Bank board and heads the global investment advisory
firm Chartwell Partners (www.ChartwellAdvisor.com).
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