The diversification distraction MatthewAinsworth

When you have different indices of similar long term total return, diversification is a free lunch, so easy and cost free that it'd be inexcusable not to do it

But when one of your options ought to do far better long term (even if recent years are weaker), it's nolonger such a free lunch. Approaching drawdown however safety trumps growth.

Consider that even just by tracking one index you're already far more diversified than the individual companies inside the index, and this income is probably safer than employment income

Was the above supposed to be a question? Are you trying to tell us how the world works or find out how it works?

My suspicion from the first sentence of your second paragraph is that you are looking for people to tell you that the BS investment strategy you have espoused in other threads whereby you invest your entire pension in a global smallcap tracker because 'they ought to do better in the long term', is perfectly sound, and you can ignore the benefits of diversification because you have found the holy grail of something that not just 'ought to' do far better long term, but 'definitely will'.

Not all indices are created equal. Buying a MSCI World Index tracker would give you a diversified portfolio. Buying a NASDAQ US Small Cap Biotechnology Index tracker would not. Most other indicies would lie somewhere in between.

In my opinion, investing in single country emerging market indices ought to generate the best long term returns, but that's something I would not risk all of my own money on.

How do you know that one option should do far better long term than another? Are your powers of prediction good enough for you to completely ignore one sector or country and focus your money overwhelmingly on others?

How long term is long term? Is your chosen sector actually going to deliver in your investing lifetime?

Even if you choose your sector correctly, does it mean you are going to make a fortune? Look at the tech boom when a company could gain a high rating merely by adding .com to its name. Almost all the red hot tips of that period collapsed in the subsequent crash and many people made massive losses. Most of the companies that have won out in the longer term were of little significance then.

There is often much to be gained from areas that you may have thought have a poor long term future. Tobacco is an example for those so inclined. Oil is perhaps another.

Diversification is not achieved simply by holding many companies. Holding 10 major oil companies isn't very different to holding one. You need to hold shares and other investments that behave independently of each other, as far as this is possible. Not only does this help reduce volatility overall, it allows you to benefit from the unexpected. For example after many years of major falls raw materials was perhaps the best performing sector last year.

The answer I believe is to aim to invest in every asset type/ sector/ geography/ company size etc etc. If you have a view that some will do better than others you can play with the %s, otherwise keep your portfolio evenly balanced.

Bowl -learning by fielding

40-50 years of compounding to consider

And gains offsetting risk of loss

Masonic - I like msci world small for that reason and I believe the developed world should outdo emerging due to richer customers, and lower fees. Small often overlooked, and I believe has more fundraising ability to grow than micro


Masonic - I like msci world small for that reason and I believe the developed world should outdo emerging due to richer customers, and lower fees. Small often overlooked, and I believe has more fundraising ability to grow than micro
Originally posted by MatthewAinsworth

So you believe these factors are not known to the big institutional investors and already priced into the share prices of smaller companies in developed countries? Smaller companies in developed countries already have richer customers - how much richer will their customers get in the future? Their fees are already lower - how much lower can they get in the future?

It seems to me you are seeing these things for the first time and making the error of thinking they are things that others have not seen yet.

Some believe that smaller companies will generate lower returns over the next 10 years because they are more overvalued (taking US large caps, CAPE is 28 compared with 56 for US small caps - in other words you are paying twice as much for the same earnings from the smaller companies on average). They also have less ability to grow their customer base overseas and are less resilient to domestic economic problems.

I agree with the OP that small companies are a very valuable source of higher returns. They also add significantly to a portfolio's diversification as they tend to be far more influenced by local economic conditions than the large global companies that dominate the major indexes.

However it would be foolish to ignore larger companies. In some industries, one is either a large global player or one is pretty irrelevant. Car manufacturing for example. Oil production and distribution as opposed to exploratory drilling is another. Banks generally have to operate globally. Those that don't are different in kind to those that do. Consumer electrical goods (TVs, washing machines etc) are dominated by global companies. Small companies in that sector tend to be very high-end focusing more on a luxury market.

So one needs to achieve a suitable balance. For my growth portfolio the target is 25% small, 25% mid cap, and 50% large.


Bowl -learning by fielding
Originally posted by MatthewAinsworth

Seriously, revisit your attitude. You do not seem to be learning at all. Almost all your threads can be characterised by you telling us what you are planning to do, inviting thoughts and opinions, then receiving feedback from a majority of experienced voices telling you the flaws in your plan, and you defending your position because you want to believe you can phrase it in a different way and somehow your proposals will be more sound. Eventually when nobody is convinced, the thread dies a death and a new one appears a bit later.

I am struggling to see how you are "learning by fielding" the challenges to your assertions that are being made, or the questions posed. What you should be learning by doing that is that some of your logic is quite shaky, which is why you are getting so many comments which you feel you have to defend. However, you do not seem to be learning that, you are merely hearing it, paying it lipservice, and then rejecting it and going along with your own flawed way.

Per one of your threads six months ago you are seeing your global smallcap fund as something that gives 15% annualised return thus doubling your money every five years and you do not seem to have moderated that view. However, as I pointed out on another of your threads yesterday, the FTSE World Smallcap index has only done 4.4% annualised for the last three years (translating to 4.0% annualised in an index fund after fees) when viewed in USD, with a peak to trough drawdown within the last ten years of 62%. As it focuses only on certain company types [limited size range] and ignores emerging markets, it has potential to underperform other world indices for multi decade periods.

You still love it though and can't bear to be told that you might be shortsighted because it is embarrassing to be told that your ideas have flaws. Surely, you think, you will be right in the end that all the gains will offset the risk of any losses, and this fund will do just as well as all the others, plus a bit because its smaller companies and smaller companies are great (unless, as you contend, they are micro companies which are bad because they are unproven).

And when challenged that it's impossible to say that your index of choice will come out on top of a broader portfolio rebalanced, your answer is just that hopefully you won't need this money anyway and your son will inherit it and deal with it for himself. That does not make it a Good Plan. It just sounds like someone is religiously sticking to his ideals in the face of any criticism, even though the religion is flawed, and he only learned the ideals from a kids version of the bible, and there were pages missing from it anyway so he is making up the gaps as he goes along.

Masonic - I like msci world small for that reason and I believe the developed world should outdo emerging due to richer customers, and lower fees. Small often overlooked, and I believe has more fundraising ability to grow than micro

Small is not 'overlooked'; it forms part of most balanced portfolios except for those with relatively fewer assets to invest where any differences in returns are largely inconsequential.

Six months ago the subject of your steadfast belief that small developed companies will intuitively be outdoing everything else for the next decades came up in another thread of yours. I wrote a couple of lengthy rebuttals and gave up on the thread. I do occasionally come back and try to help out with your latest misapprehensions here and there but it gets pretty frustrating when you say it is all part of your learning experience and then do not show any evidence that you've taken a scrap of insight on board.

To avoid repeating the same comments on "why a developed smallcap fund with thousands of holdings is not the ultimate all-in one solution", you could just go back and read my reply to you from September. Here it is.

Masonic - small companies don't need their customers to become richer as much as they simply need more customers and to grow. I don't doubt institutions are aware but I think they are encouraged to be cautious and not overly rewarded for a risk that paid off. I don't expect small cap fees to change but I expect it will remain cheaper than micro or emerging, as the reasons will stay the same

Perhaps cape is due to growth over 10 years?

Bowl - I do factor in what you say that the recent performance was not so good, I didn't realise that was happening but I expect times to be worse sometimes, I'm just going for average. I can't get over the power of compounding and I think that that can make a bad ting good,I reassert that because I feel it's underacknowledged - I am stubborn because I'm trying to lay out a theory I have - that compounding can be the most important thing long term

Linton -im considering vls100 for ISA for extra stability when I come to draw, note Morningstar reckons vanguard global small cap is almost half medium ☺

Have you considered chicken manure? It is typically produced by very small economic units; is highly tax-efficient; and benefits from compounding over the long term. So far as I know there are no estimates of Shiller's CAPE available for global chicken manure, but other measures of its price/earnings ratio are highly favourable.

And if that proposition does not smell too pleasantly to you, you might consider diversification into global infrastructure. Can I interest you in the Brooklyn Bridge?

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