For near my entire investor life I've been a follower of Paul Merriman's Ultimate Buy and Hold approach, which essentially takes the entire global stock market and divides it up into 8-10 equal slices. Here's the table, if you're curious. My only edit to Merriman's portfolio is his value tilt. Despite a lot of research, I've never really come to understand the purpose of a value tilt because the definition of what constitutes a value stock is so subjective. Geography is easy. Either a stock is international (ex-US) or it isn't. Large vs. small cap is easy too. But value? So my portfolio has essentially been equally divided up into US (large/mid/small cap & REITs) and International (large/small cap & REITs), and then I rebalance once a year. Sometimes investors on this subreddit, particularly those religiously devoted to market cap weighting of passive index funds, will critique my portfolio, because I supposedly have a "small cap tilt". I disagree. I think my portfolio is tilted in the direction of diversification. It has a diversification tilt. No asset class (intl small cap or US large cap) is larger than the other, because each has the potential to outperform in the coming decade. Indeed, I would argue that market cap weighted index investors (including all those who just throw it all in VOO or VTI) essentially have a large cap tilt. They are the ones undiversified. And what happened to large cap tilters in the 2000s? They made no money for 10 years while virtually every other equity asset class on earth (including small and mid cap US funds) did at least beat inflation. In short, I invest equally in all asset classes because I have no idea what the future will hold. I rebalance once per year in May.
This rebalancing is coming up quickly in a few weeks. And I'm making a sizable change to my portfolio this year. I am selling my 12% slice in emerging markets, and distributing this slice equally among the rest of my international allocation. I'm done with emerging markets. This has been a decision I've come to after a lot of consideration, so I thought people on this sub might be interested to hear my rationale.
The truth I've come to believe is that we've all been the victims of a hopeful but naive marketing term: emerging markets. This term, we've all come to agree, adequately describes any stocks in countries that are not yet developed, but soon will be. They are "emerging". Developed markets almost seem to be called this way because the easy money has been made. The "developed" economies almost sound mature, too mature for growth, but an "emerging market" has yet to realize its potential. It sounds like getting rich.
I have come to believe that the vast majority of "emerging markets" aren't emerging at all. They are developed too. Just not the same kind of development as the USA. The Chinese economy is the second largest economy in the world. So obviously something isn't emerging from being small or poor. China is massive, yet it's still "emerging"? So then, an emerging market is something that is unregulated, something where the price that the stock is at is not necessarily representative of the underlying company. In short, an "emerging market" is a sort of unregulated market. But this also doesn't seem to describe China either, since the state has intense control over its affairs. Indeed, one could argue that China's stock market is far far more regulated than the American stock market. So "emerging market" must mean something else. What could it be?
Maybe we can arrive at a conclusion by examining its opposite. So: what is a "developed" market? It is a market where, when I buy a share of stock, I can have some degree of certainty that my share of stock is equal to every other share of stock out there. Essentially, that the company or the regulatory body behind the stock market isn't giving preferential treatment to one person over another. There is regulation in place that assures me that the price of the stock accurately represents the market cap of the company, and all information about each public company is equally available.
I'd like to give an even simpler definition of a developed market: it is a stock market that criminalizes the sharing of non-public information about public companies. That's it. So the US and France and Japan are more likely to arrest people who peddle non-public information about their stock market, and China, Russia, and Brazil are less likely to arrest people who peddle non-public information about their stock market.
This is a big deal. It means that the hundreds of thousands of investors who have an allocation in Vanguard's, SPDR's, or iShares' "emerging" market funds have less ROI than others more local to the countries who are more, uh, intimately known to the underlying companies.
I would like a new definition of Emerging Markets. It is Corrupt Markets. And the USA, Europe, and Japanese stock markets are somewhat more Honest Markets. In this age is such a sentence too brutal to utter aloud? I want to say yes, but that's where my logic has led me. I've suddenly been asking myself: u/TimeTheRevelator, why the hell are you invested in Corrupt Markets? And my weak answer is: diversification and long-term returns. But if, long term, I know that there will be those more local to the underlying companies who will be benefiting more than I will, what assurance do I have that Vanguard's Emerging Market $VWO ETF will meet or exceed the returns of developed market ETFs like $VEA? And the answer to this question is: these corrupt markets will hopefully flower into honest markets like South Korea did. In short, my hope lies in the narrative many of us investors have told ourselves, that emerging markets are just developed markets who haven't had enough time. They just need time and patience, right?
I'm not so sure anymore. Perhaps South Korea is the rare exception to the more unpleasant truth: that China will continue to grow for hundreds and hundreds of years, and this economic growth will never result in a stock market that isn't corrupt, rife with bribes and inside information. In fact, if I go down the list of "emerging" market countries, it is extremely hard for me to see one that looks like it about to flower into an honest "developed" stock market. Russia, for example. Is Russia honestly ever going to stop being corrupt at its highest levels? Perhaps. But am I willing to entrust my retirement account around that hope?
The answer to this question is a solid no. I don't have a lot of confidence that Vanguard's Emerging Market ETF's holdings in Russia will ever benefit me equally to those more in bed with the Russian stock market itself. So I'm out. I thought people on this sub might find this information interesting, so that's why I wrote this out.
As a side note, this realization is startling, considering how ubiquitous investing in Emerging Markets is. I mean, every Vanguard Target Date fund (one of the most common retirement plans in the world) has an international allocation, and a sizable portion of this international allocation (near 22%) is in Emerging Markets. So I've come to ask: how is it that investing in corrupt stock markets has become common practice for the average American? Who made this decision and why do we remain doing it?
Submitted April 28, 2019 at 03:44PM by TimeTheRevelator http://bit.ly/2ISvc3l
