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international allocation between europe and pacific
Old 08-31-2007, 10:53 AM   #1
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international allocation between europe and pacific

I'm trying to figure out my international allocation and have noticed differences in the balance between europe and pacific vary if they are held through a total index or individually.

In a total international index, such as Vanguard's Total International Stock Index Fund (VGTSX), the balance is about 70% europe and 30% pacific after emerging markets is taken out.

But when I look at allocations holding them individually, it's always 50/50 between the two. I tend to have a preference to overweight europe, since it consists of more countries, unlike pacific which is primarily Japan/Australia and I'm trying to understand why this isn't reflected in other's asset allocations.

Thoughts?
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Old 08-31-2007, 12:51 PM   #2
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I am not sure what you are asking.

The world equity index is based on the weight of market capitalization. Here is the composition:
North America 46.2 Europe 30.09 Asia pacific 15.1 Emerging markets 8.61
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Old 08-31-2007, 02:25 PM   #3
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Personally I would have a strong preference to underweight Europe (economic growth very low, government has IMHO way too big a role in society, population declining etc.) and overweight Asia and EM...which have all the opposite characteristics.

Also not exactly sure what you're asking...
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Old 08-31-2007, 03:39 PM   #4
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IMO, it makes sense to start with cap weighting. An argument could also be made for GDP weighting or other types of weighting. But random weighting is hard to justify unless you're making a specific directional bet on some component of the allocation.
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Old 08-31-2007, 06:34 PM   #5
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For international I go with active funds (DODFX, HAINX). Let them make the allocation decisions. The Economist has estimated the Euro is overpriced by 15% and Asian currencies are underpriced by probably an equal amount (as I recall). They base their comments on a PPP view. The currency situation makes me think leaning a little more towards Asia is not a bad idea.

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Old 09-01-2007, 11:17 AM   #6
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Sorry, I should have been more clear but then again, I might be missing something obvious (I'm still learning).

When I look at the asset allocations in lazy portfolios, they always have an equal allocation between Europe and Pacific (for example, Bernstein usually allocates 5% to both). Doesn't this result in being overweighted in Pacific and underweighted in Europe?

What I'm really trying to figure out is if there is a benefit to holding Europe and Pacific separately, or just buy then in an EAFE fund. I assumed a 50/50 allocation between the two if I held them individually (based on lazy portfolios), but then I looked at the actual holdings in the EAFE fund which are around 70/30, making me think that 50/50 is not the right balance.
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Old 09-01-2007, 11:36 AM   #7
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kiki,

Only time will tell. As Bernstrin says, the exact proportions are less important than picking an allocation and sticking with it.

Cheers
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Old 09-01-2007, 11:39 AM   #8
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Kiki,

Here's what Rick Ferri [an investment advisor] said back in March:

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In All About Asset Allocation I have several examples of using one fund. It is convenient, but if you have more time, here are a few reasons for slice and dice:

1) Using Vanguard ETFs is less costly than one investor class fund, plus no redemption fees or loss of foreign withholding taxes.
2) Having fixed allocations between Europe, Pacific, EM diversifies currencies better than one fund.
3) The rebalancing of those currencies could provide a diversification benefit in the future as it has in the past.

For complete information, see Chapter 7 of All About Asset Allocation.
right after he said:

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Most of the stuff you see about optimal allocation is garbage. It is trash. In the long run, the best allocation is typically the lowest cost one. That is the truth. You only need a few asset classes in your portfolio, and after that there are diminishing returns. The mutual funds you choose to represent those asset classes should be the lowest cost funds you can buy.

All of this nonsense about finding the ideal allocation is non-sense. The ideal portfolio can only be known in retrospect. We can only know what we should have done, not what will happen. So, choose a few low cost index funds in different asset classes, rebalance occasionally, and forgetaboutit.
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Old 09-01-2007, 11:46 AM   #9
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FWIW, this weeks The Outlook (from S&P) states that the P/E of Europe is lower than US which in turn is lower than Japan. They advocated a European ETF.

So there you have it: recommendations to overweight Europe, to overweight the FarEast, to just go with market weights, and to let a fund manager make the decision for you. To me, that means it doesn't matter what you do, but you gotta do it.
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Old 09-01-2007, 11:50 AM   #10
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FWIW, this weeks The Outlook (from S&P) states that the P/E of Europe is lower than US which in turn is lower than Japan.
And next year, the positions could be reversed. So, pick a position and stick to it.
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Old 09-01-2007, 01:08 PM   #11
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Originally Posted by LOL! View Post
So there you have it: recommendations to overweight Europe, to overweight the FarEast, to just go with market weights, and to let a fund manager make the decision for you. To me, that means it doesn't matter what you do, but you gotta do it.
That sums it up nicely.

Thanks for the feedback.
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Old 09-01-2007, 05:24 PM   #12
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Just one more -- equal split between the two.
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Old 09-01-2007, 11:51 PM   #13
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Originally Posted by Spanky View Post
Just one more -- equal split between the two.
I've been spending the last few hours thinking about this. My original thought after reading LOL's comments was to go with a 70/30 split between Europe and Pacific, instead of the EAFE, to give me the opportunity to rebalance if I want to. My rational was Europe has a larger market cap, etc, but I'm wondering how much of that is relevant and how much is my personal bias.

If I understand your thinking - and I admit, I might be reading into it too much - buy equal %'s into all (most) assets and let the markets run their course and then rebalance occasionally to make sure the %'s are maintained.

Is that along the lines of what you're thinking?

I'm not sure if that's what your proposing, but the more I'm thinking about that strategy, the more I like it. I thought about the total market approach, but I have a strong inclination towards a slice-and-dice allocation (still reading on that one, but odds are that's how I will go).

Btw, right now, I'm thinking of something along the lines of:
20% - S&P500
20% - Large Value
10% - Small Cap
10% - Small Cap Value
10% - Europe
10% - Pacific
10% - Emerging Markets
10% - REITS

Any comments are appreciated on the allocation. I've changed the percentages so many times now, I wouldn't be surprised if they changed again.
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Old 09-02-2007, 08:12 AM   #14
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The thinking behind a portfolio of equally weighed asset classes is to avoid "betting" on over weighting any one asset class. On the other hand, a portfolio of weighted asset classes is not to against the market. Either approach should produce similar return in the long term, but the equally weighted approach may exhibit lower volatility.
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Old 09-02-2007, 08:20 AM   #15
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I'm about 10% Europe (VGK), 10% Asia (VPL), and 5% EM (VWO).
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Old 09-02-2007, 09:13 AM   #16
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Originally Posted by kiki View Post
....Any comments are appreciated on the allocation. I've changed the percentages so many times now, I wouldn't be surprised if they changed again.
Your equities AA looks to be a "classic" slice-and-dice portfolio a la Paul Merriman or Rick Ferri. What's missing is small cap international and perhaps international value and emerging market value. Whether you deem these as necessary is your call.
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Old 09-02-2007, 12:29 PM   #17
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kiki,

Here's what Rick Ferri said about tilting to small and value [from the previous linked conversation]:

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My method is pretty simple. Using TSM as the core, I get some exposure to all market caps and can easily adjust the tilt to value and small cap using a small value fund and a micro cap fund (you can even drop the micro cap if you want).

Using the TSM as the starting point and adding small and value tilts as desired is the correct way to engineer a portfolio of index funds using the Fama/French three factor model. That is the way FF envisioned the method to work. A simple study of the FF research makes is point clear.

Let's face the facts. The 4X25 idea came about because DFA does not have a total stock market fund, so advisors could not build a classic FF portfolio using an All DFA portfolio. Nonetheless, a few enterprising investment advisors who are heavy promoters of DFA funds slapped together the 4x25 idea and sold that as "The Model".

The problem is, the 4x25 is not a good model. It is certainly not DFA's model, and the advisors who came up with it did not do any research on it, and from a practical standpoint and cost standpoint it does not make much sense. BUT, from a marketing standpoint, it makes great spin. It sells portfolio management services for those advisors who gain business by marketing their access to DFA, and that is what those advisors really care about.
IMHO, value is value no matter where you get it, large cap or small cap, int'l or domestic. So, is the 4x25 US portfolio more or less the same as 50-60% TSM + 40-50% SV? I think it's pretty close, plus you get similar small/value tilt with less funds, and for those with taxable accounts, probably more tax efficiently.

IIRC, DFA's new core and vector strategies are basically tilting towards small and value from the TSM in one fund, which should be better than the 4x25 because it's cheaper to do, requires less rebalancing, and probably more tax efficient. It's certainly your choices, but why do similar things with 4 funds when you can acheive similar btm + size characterstics with 2 funds?

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Old 09-02-2007, 01:15 PM   #18
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It's certainly your choices, but why do similar things with 4 funds when you can acheive similar btm + size characterstics with 2 funds?
I haven't spent much time thinking about this approach, because it's one I can't implement. In my 401k - where we currently have a majority of our funds - the only two index options are Vanguard LV and SP500 (and small cap growth - yuk). Someday, I might decide to go that route, but only after much more education on my part, because I do tend to favor the slice-and-dice model.

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Originally Posted by LOL! View Post
What's missing is small cap international and perhaps international value and emerging market value. Whether you deem these as necessary is your call.
This is coming down to actual implementation of our asset allocation. Right now, all of my funds are at fidelity and everything is in Vanguard index's or etf's, except for the spartan eafe index. My wife's 403b is currently at Fidelity and at the time, I decided to use the spartan eafe for international exposure. I figured in order to maintain our AA, I'd mix the spartan EAFE with Vanguards equivalent ETF, but when I look at the holdings, they really aren't the same. This led me set two constraints for choosing our investments:

1. It should be available in both an open ended index fund and ETF.
2. Stick only with Vanguard.

#2 came from the realization that everything I held at Fido was Vanguard, so why not make it a constraint.

Fortunately, my wife has the choice of Vanguard for her 403b and I'm in the process of transferring it over. I expect with time, we'll eventually move all our assets to Vanguard. The hard part is the cost of buying ETF's at Vanguard. It would be nice if they charged less if you were purchasing Vanguard ETF's. Right now, I get $8 trades at Fido (through my work, not from asset value) and couldn't justify moving to higher priced trades, but once I hit a million, then I could see transferring and using the 25 free trades.

So this has become a long answer to LOL's comment on holding international value/small-cap/em value, but the jist is, it breaks either 1 or 2 of my constraints. But I just looked and Vanguard does offer an International Value fund, so maybe I'll add 10% to that and decrease SP500/LV by 5%. I think I can still maintain that easily enough...oh the choices.

Thanks again for all the help. I finally feel like I'm starting to get closure on an allocation.
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Old 09-02-2007, 01:25 PM   #19
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I have about a 40/40/20 weighting in Europe, Asia and diversified emerging markets, and international stocks are about 30% of my portfolio.
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Old 09-02-2007, 02:47 PM   #20
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Originally Posted by kiki View Post
Thanks again for all the help. I finally feel like I'm starting to get closure on an allocation.
Not to open a can of worms, but the best personal free asset allocation advice on the web can be found at the free Vanguard Diehards forum: Bogleheads :: View Forum - Investing and Personal Finance This will be especially true if you wish to go predominantly with Vanguard. Check it out.

Of course, with new products coming out like the Beaver Cheese Futures (ticker: BCF) you will have to do your AA all over again.
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