Recently,I decided to look into allocatig a portion of my funds into the emerging markets. Currently, I DCA into UOB United International Growth fund for my Global Allocation. It is a global fund with an emerging market tilt. However, I believe the future growth could come from emerging markets rather than developed markets.
Having emerging market stocks in your portfolio will provide a different correlation to the developed economies. You can find some the he articles over here on this. However, what shoul dbe the right mix?
Research normally shows that one should limit their exposure in emerging markets stocks. This is due to their higher volatility which could cause your overall returns to fluctuate wildly. Risk adverse investors should take note of this. We have seen in the recent May 2006 correction how much your portfolio could go down if your portfolio is heavily skewed towards emerging markets.
In contrast, developed markets corrected less (Still hurts though…) Judging by this, we should be having closer to 30% of our allocation to emerging markets than 50% of our allocation to emerging markets. However, I would choose the later.
Volatility is a double edge sword. When market irrationally correct downwards, your existing holding suffers. Not many who check their portfolio regularly would like to see their 40K worth of investment go down by 10K. This is the kind of short term view most average human being will hold.
In the long run, these dips will enable you to buy more units for the same price. $1000 bucks at $1 gets you 1000 units. $1000 bucks at $0.75 gets you 1333 units. What a deal!This is good if you are in the accumulating phase of your portfolio. But what about your existing holdings??? Wouldn’t it be better if you sell them before they fall and then by them back near the bottom? If not, your portfolio will look ugly as hell!
For the folks who are skilled enough or who think they can anticipate well, great, go ahead by all means. No one stopping you. I for one must admit my bottom fishing and top fishing skills are not top notch ( If you are please email me, i must learn from you.) I would rather spend my time doing something more worthwhile than anticipating and researching the markets everyday.
Being in the market has risks, but being out of market contains enormous risks as well. My experience with anticipation, couple with my risk adverseness has resulted in me missing out on alot of run ups. ( I got out on alot of shit as well btw..) Looking at it in another way, those are HUGE LOSSES.
The best way to systematically do this in my opinion is through an RSP program. There is a difference between RSP and volunteered DCA. I fyou manually add to your funds yourself, ou might be more susceptable to market timing as comopared to forced DCA through RSP. Your emotions will overwhelme your rationality in the face of hugh portfolio loss.
I have decided to go for a 50% developed markets and 50% emerging markets allocation. I will use 2 funds to do this. The re are disadvantages of having 2 funds as a model for the global allocation. For one, rebalancing bloated region (i.e. China according to the index constitutes now 40% of world equity. remember Japan?) is a problem.
The advantages of having less funds in your portfolio is that it is easier to manage. When one learns much about investment it makes you feel like you are IN CONTROL. You want to DIY and construct your portfolio so that it gives you flexibility to add here add there. To me i find the benefits of smaller portfolio to be better. They are as diversified as one that is constructed using 4-5 funds yet you only have to RSP into 2 funds. For an investor with less capital to start with, having 5 funds is difficult to execute. It will be easier to monitor them as well. Active funds need attention to make sure that their performance dun lag behind too much. If you have 5 funds, you will need to monitor what are the best 5 out of these categories. If your global allocation uses infinity global index fund, then its even better cause you dun have to worry about underperforming the benchmark. It tracks the benchmark!
Less to monitor, Less problems in calculating expense cost, at the same time it covers the global region well enough.
Currently, I have started RSP 500 bucks every month to UOB United International Growth Fund. I will be RSPing 300 bucks every month into an emerging market fund.
I still haven’t made up my mind which fund to use. Do note that if I were to use ETFs which although has much lower expense cost, I cannot RSP every month cause the cost will kill the portfolio. It also depends on whether you are comfortable accumulating and investing annually. Based on MSCI World Data, baring expense cost, performance if you add every month is better than annually ( with expense thats another nightmare story). I shall not bring up the US ETF vs Spore Unit trust debate here.
- Expense Cost (Its a drag. Wish we can have less than 1% ones but fuck,we live in singapore)
- Fund Size ( You dun want to get caught when the fund close down on you. I experience that. It ain fun. Further more the bigger the fund size the expense as percentage to NAV tends to go down as well)
- Track Record (These 2 funds have the best long term records. Yeah fidelity does. Take a look at the Funds-sp illustrations. Not the FSM ones. It has an illustration in USD)
- Turnover (The greater the turnover, the more cost incurred by u investors. Market timing by managers for returns are most of the time grossly overrated)
- Anymore? (may be you folks can fill me in.)
500 and 300. Where will that bring me? Lets take a look at these 3 funds. By using $500 and $300, the ratio is 62.5: 37.5. Taking the recent fund fact sheet as reference, UOB fund has an allocation as such:
Fidelity Emerging mkt has an allocation as such:
Schroder has an allocatioin as such:
By RSPing this way, I am effectively allocating:
- 28% US
- 17% Europe
- 10% Japan
- 45% Emeringing Mkt
Thats close enough to a 50:50 allocation. IS this high risk? I think the RSP should make volatility work in my favor. (NOte: if you are near or projected to retire soon, dun do this. This global allocation is more for accumulation by takimg more risks. Retirement goals and strategies are different.)
This plan is not full prove. I can think of a few things that can throw this plan haywire.
- IT would be good if Singaporeans have access to low cost index funds locally. Although in inefficient markets as those of emerging markets, my research have shown that both Fidelity and Schroder do not faired better than Vanguard emergin mkt ETF and iShares emerging market ETF. However, the transaction costs and estate duty consideration makes investing in US ETFs risky. I would rather earn less than my folks not able to get 50% of my estate.
- Good active funds will underperform once in a while. That is why it is important that our criterias be well defined.You have to periodically monitor the 2 funds to make sure they do well in the long run. I said that I would prefer to let the porftolio autopilot more but normally funds that used to be in the top 5% quatile will not be in there.
My plan isn’t the best solution. Please do not take this as correct. I hope by putting my constuction here, you can contrast this against how you do it. See whether it makes sense or not.