Diversification and haystacks

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AlwaysLearningMore
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Diversification and haystacks

Post by AlwaysLearningMore »

Mr. Bogle famously suggested "Don't look for the needle in the haystack. Just buy the haystack!” And in his formal writings making investment recommendations to the public he also famously advised US-centric investing (with up to 20% international "if you must.") This is not to rehash these suggestions. Reasonable people can disagree.

John Rekenthaler wrote a Morningstar article Chinese Stocks: The Road to Nowhere - Where are the shareholders’ yachts?
https://www.morningstar.com/articles/10 ... to-nowhere

"The key point is that, despite the country’s unprecedented economic boom, its stocks have flopped. Investors were better off owning U.S. Treasury notes."

Question: Other than the oft-repeated "It's all baked in to current prices" and "the future is unknown," how does an individual (or institutional?) investor gauge the diversification benefit when dealing with non-capitalistic economies?

Comparing haystacks....
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Last edited by AlwaysLearningMore on Tue Mar 22, 2022 8:53 pm, edited 1 time in total.
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Re: Diversification and haystacks

Post by muffins14 »

Define non-capitalistic?

I’m on team “it’s all priced in” anyway
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Re: Diversification and haystacks

Post by arcticpineapplecorp. »

this has been known for a long time. I first read about this phenomenon (the disconnect between GDP and a country's stock market performance) from Larry Swedroe Articles perhaps a decade ago (?)

As far as China goes, it is a capitalist country (despite it's communist label "CCP"). It's autocratic rule, it's not democratic, but it's capitalistic now (for the most part). It's not North Korea or Cuba where everything is state owned. There are private companies. They may be hamstringed by the government, etc.

William Bernstein wrote in one of his books (think it was towards the end of Birth of Plenty) that generally countries become more democratic as a result of increased capitalism, rather than the other way around. So there's hope for countries like China after all, if they continue to become ever more capitalistic in nature, democracy may follow. We'll see.

That said, if you own the total stock market index fund, you're owning countries stocks according to their market cap weighting. I don't see that you'd want to exlude countries just on the basis of their GDP growth. Then you're getting into active management. You may be right, you may be wrong.

By the way, here's an interesting podcast that explains how China started its road down capitalism:
The Secret Document that Transformed China
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AlwaysLearningMore
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Re: Diversification and haystacks

Post by AlwaysLearningMore »

muffins14 wrote: Tue Mar 22, 2022 7:25 pm Define non-capitalistic?
Preponderance of state-owned enterprises
MIxed ownership enterprises
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Re: Diversification and haystacks

Post by muffins14 »

AlwaysLearningMore wrote: Tue Mar 22, 2022 7:41 pm
muffins14 wrote: Tue Mar 22, 2022 7:25 pm Define non-capitalistic?
Preponderance of state-owned enterprises
MIxed ownership enterprises
What if a nation subsidizes some companies via buying their goods instead of others, or has tariffs to favor local rather than foreign companies for some goods?

Is there a level at which a subsidy or penalty becomes anti-competitive and non-transparent such that it’s hard to judge the company on its finances alone? How do you know where the line is such that you know its ownership is “mixed”? For example if I’m the government and my contracts are responsible for 90% of your revenue, does it matter if I don’t have ownership? What if I have the power to regulate you as I wish?
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AlwaysLearningMore
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Re: Diversification and haystacks

Post by AlwaysLearningMore »

muffins14 wrote: Tue Mar 22, 2022 7:47 pm
AlwaysLearningMore wrote: Tue Mar 22, 2022 7:41 pm
muffins14 wrote: Tue Mar 22, 2022 7:25 pm Define non-capitalistic?
Preponderance of state-owned enterprises
MIxed ownership enterprises
What if a nation subsidizes some companies via buying their goods instead of others, or has tariffs to favor local rather than foreign companies for some goods?

Is there a level at which a subsidy or penalty becomes anti-competitive and non-transparent such that it’s hard to judge the company on its finances alone? How do you know where the line is such that you know its ownership is “mixed”? For example if I’m the government and my contracts are responsible for 90% of your revenue, does it matter if I don’t have ownership? What if I have the power to regulate you as I wish?
To avoid getting into politics, I suggest you compare and contrast free-market capitalism vs the Chinese economy. That should answer most of your questions.
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Re: Diversification and haystacks

Post by muffins14 »

AlwaysLearningMore wrote: Tue Mar 22, 2022 8:10 pm
muffins14 wrote: Tue Mar 22, 2022 7:47 pm
AlwaysLearningMore wrote: Tue Mar 22, 2022 7:41 pm
muffins14 wrote: Tue Mar 22, 2022 7:25 pm Define non-capitalistic?
Preponderance of state-owned enterprises
MIxed ownership enterprises
What if a nation subsidizes some companies via buying their goods instead of others, or has tariffs to favor local rather than foreign companies for some goods?

Is there a level at which a subsidy or penalty becomes anti-competitive and non-transparent such that it’s hard to judge the company on its finances alone? How do you know where the line is such that you know its ownership is “mixed”? For example if I’m the government and my contracts are responsible for 90% of your revenue, does it matter if I don’t have ownership? What if I have the power to regulate you as I wish?
To avoid getting into politics, I suggest you compare and contrast free-market capitalism vs the Chinese economy. That should answer most of your questions.
My point is that free-market capitalism doesn’t exist. Every country is on a spectrum
Crom laughs at your Four Winds
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AlwaysLearningMore
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Re: Diversification and haystacks

Post by AlwaysLearningMore »

muffins14 wrote: Tue Mar 22, 2022 8:17 pm
AlwaysLearningMore wrote: Tue Mar 22, 2022 8:10 pm
muffins14 wrote: Tue Mar 22, 2022 7:47 pm
AlwaysLearningMore wrote: Tue Mar 22, 2022 7:41 pm
muffins14 wrote: Tue Mar 22, 2022 7:25 pm Define non-capitalistic?
Preponderance of state-owned enterprises
MIxed ownership enterprises
What if a nation subsidizes some companies via buying their goods instead of others, or has tariffs to favor local rather than foreign companies for some goods?

Is there a level at which a subsidy or penalty becomes anti-competitive and non-transparent such that it’s hard to judge the company on its finances alone? How do you know where the line is such that you know its ownership is “mixed”? For example if I’m the government and my contracts are responsible for 90% of your revenue, does it matter if I don’t have ownership? What if I have the power to regulate you as I wish?
To avoid getting into politics, I suggest you compare and contrast free-market capitalism vs the Chinese economy. That should answer most of your questions.
My point is that free-market capitalism doesn’t exist. Every country is on a spectrum
The point of this thread is judging the diversification benefit of economies on that "end of the spectrum" as you've described it.
How do investors react (and potentially adjust their portfolios) to the fact that a booming Chinese economy hasn't produced robust investor returns?

Another recent M* article: Autocracy Is a Bad Investment - Russia, China highlight the need to consider 'regime risk.'
https://www.morningstar.com/articles/10 ... investment
Last edited by AlwaysLearningMore on Tue Mar 22, 2022 8:54 pm, edited 2 times in total.
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Re: Diversification and haystacks

Post by visualguy »

muffins14 wrote: Tue Mar 22, 2022 8:17 pm My point is that free-market capitalism doesn’t exist. Every country is on a spectrum
Right, but there are points on the spectrum which are conducive to shareholders making money, and points where shareholders lose their pants.
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Re: Diversification and haystacks

Post by muffins14 »

visualguy wrote: Tue Mar 22, 2022 8:36 pm
muffins14 wrote: Tue Mar 22, 2022 8:17 pm My point is that free-market capitalism doesn’t exist. Every country is on a spectrum
Right, but there are points on the spectrum which are conducive to shareholders making money, and points where shareholders lose their pants.
Do you not think the market prices those countries stocks appropriately to account for that risk?

If that’s the case, you can avoid them or short them, I guess
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Re: Diversification and haystacks

Post by richard.h.gao »

AlwaysLearningMore wrote: Tue Mar 22, 2022 7:19 pm Question: Other than the oft-repeated "It's all baked in to current prices" and "the future is unknown," how does an individual (or institutional?) investor gauge the diversification benefit when dealing with non-capitalistic economies?
Pretty sure China is more capitalistic than US, and Hong Kong is even more capitalistic than China, yet Hong Kong stocks are down significantly more than China stocks. 🤷
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Re: Diversification and haystacks

Post by Alex Frakt »

First, you can't invest in non-capitalistic societies by definition. Without capitalism, you don't have stocks or bonds to invest in. OTOH, there are no pure capital market. Every country regulates what companies can do and constantly tinkers with monetary policy, financial regulation, tax policy, etc. So where do you draw your line between what you find sufficiently and insufficiently capitalist?

But none of this matter if you are an efficient market purist as then you would believe that specific country risks are already incorporated into the prices from the relevant markets. If you aren't an EM purist, then go ahead and make whatever allocation changes you feel will increase your risk-adjusted returns. But first you should be asking yourself if there is evidence for your beliefs. Changing allocations based on gut feelings has a very poor historical track record.
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Re: Diversification and haystacks

Post by Northern Flicker »

Most of the Chinese equity in major indices today did not exist pre-2001/2002, so backtests that go back to the early or mid-1990's are measuring a different asset class pre-2002.

I don't have an opinion about the future prospects for Chinese equity, but backtests must be interpreted carefully.
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Re: Diversification and haystacks

Post by gougou »

Chinese stocks were considered growth stocks in the 2000s. Shanghai Stock Index was trading at around 40x to 50x P/E ratio for most of the early 2000s and then there was the massive boom and bust from 2005 to 2009.

In the 2010s, SSE mostly traded at 10x to 16x P/E ratio. Today it’s at 16x P/E ratio. When growth stocks get reevaluated and multiple contracts, they typically perform very poorly.

Dual listed Chinese stocks trade at massive discount in HK/US vs in mainland China, so the valuation is even cheaper for non-Chinese investors.

There are indications that Chinese stocks are undervalued, such as posts like this one talking about non-capitalistic risks, non-democratic risks or you-name-it risks. People like to find or even invent excuses to avoid the undervalued stocks and chase performance. I don’t think you should sell off/avoid Chinese stocks just because they had a mediocre performance in the past 20 years.
The sillier the market’s behavior, the greater the opportunity for the business like investor.
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Re: Diversification and haystacks

Post by pseudoiterative »

AlwaysLearningMore wrote: Tue Mar 22, 2022 7:19 pm how does an individual (or institutional?) investor gauge the diversification benefit when dealing with non-capitalistic economies?
I don't know how professional or institutional investors might think about this, but here are two naive ideas:
  1. ignore the financial markets, try to estimate how tightly coupled the economy in question is with economies in the rest of the world. If the society has a relatively self-sufficient economy, perhaps economy-driven local market behaviour will be rather decorrelated from the market behaviour of other economies. Which is perhaps good in terms of diversification, and maybe bad for economic efficiency! Extreme example: suppose there's an economy on Earth and an economy on Tau Ceti e, but no trade between both economies. Earth gets erased by a gamma ray burst, but Tau Ceti e doesn't. Obvious diversification benefits. Less obvious how you even invest if no trade.
  2. ignore diversification, focus on what rights and protections the economy offers to foreign investors, in terms of historic behaviour, current laws, and potential future actions. if the level of protection to foreign investors is not very high, maybe you want to look somewhere else. Some organisations publish metrics ranking countries by this kind of thing.
There might even be direct conflict between the above two ideas. If a country has a very self-contained independent economy, and it takes foreign investment, then gets into some kind of financial mess where it has to prioritise domestic creditors versus foreign investor creditors, if it prioritises the domestic creditors at the expense of foreign investors, what are the unhappy foreign investors gonna do? If the country is independent and doesn't much need foreign investors in future, maybe there's little downside in "burning the goodwill". Whereas a country that heavily depended on _future_ foreign investment for whatever reason might be much more reluctant to do that.

I'm hazy about how strong a connection there would be with needing foreign financial investment and needing to integrate with foreign economies through trade, and how to think about the two.
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Re: Diversification and haystacks

Post by rossington »

AlwaysLearningMore wrote: Tue Mar 22, 2022 7:19 pm
Question: Other than the oft-repeated "It's all baked in to current prices" and "the future is unknown," how does an individual (or institutional?) investor gauge the diversification benefit when dealing with non-capitalistic economies?
Your premise is correct. So best to avoid them.
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Re: Diversification and haystacks

Post by rkhusky »

The market is efficient, but it is not omniscient. The market price is correct for that moment in time, but the market cannot reliably predict the future. That being said, are you a better analyst or prognosticator than the majority of investors that make up the market? I'm not, so I don't deviate much from the total market. And that includes what the market thinks about China and other such countries.
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Re: Diversification and haystacks

Post by jshaffer740 »

rkhusky wrote: Wed Mar 23, 2022 7:12 am The market is efficient, but it is not omniscient. The market price is correct for that moment in time, but the market cannot reliably predict the future. That being said, are you a better analyst or prognosticator than the majority of investors that make up the market? I'm not, so I don't deviate much from the total market. And that includes what the market thinks about China and other such countries.
Actually, to be more precise, the market price isn’t even necessarily “correct” at any point. It’s just that (according to the efficient markets hypothesis) any pricing errors are random, and so you can’t reliably profit from them.
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Re: Diversification and haystacks

Post by rkhusky »

jshaffer740 wrote: Wed Mar 23, 2022 7:40 am
rkhusky wrote: Wed Mar 23, 2022 7:12 am The market is efficient, but it is not omniscient. The market price is correct for that moment in time, but the market cannot reliably predict the future. That being said, are you a better analyst or prognosticator than the majority of investors that make up the market? I'm not, so I don't deviate much from the total market. And that includes what the market thinks about China and other such countries.
Actually, to be more precise, the market price isn’t even necessarily “correct” at any point. It’s just that (according to the efficient markets hypothesis) any pricing errors are random, and so you can’t reliably profit from them.
What would be a pricing error? Someone typing in the wrong offer price? Or network problems not allowing all the buyers/sellers to get their orders in at the same instant? etc
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Re: Diversification and haystacks

Post by burritoLover »

In my 80/20 US/ex-US portfolio, I’d like to eliminate Tesla from the US total stock portion. I think it’s very risky stock and valuations are way too high. Since Tesla makes up the same percentage as China in this portfolio, I figured it would be fair game to discuss. :oops:
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Re: Diversification and haystacks

Post by JoMoney »

I have no idea what the returns will be from any grouping of stocks.
There are some that have clear risks that others are not exposed to, or less exposed to.
One can hope that the market is efficiently pricing a "risk premium", which might persuade one to be more willing to take a chance on it, but nobody has to take the risk, and we can all have different risk preferences.
Same goes for stock/bond allocation.
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Re: Diversification and haystacks

Post by Robot Monster »

burritoLover wrote: Wed Mar 23, 2022 8:00 am In my 80/20 US/ex-US portfolio, I’d like to eliminate Tesla from the US total stock portion. I think it’s very risky stock and valuations are way too high. Since Tesla makes up the same percentage as China in this portfolio, I figured it would be fair game to discuss. :oops:
Yes! Let's analyze the diversification benefit of each and every straw in the entire haystack.
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Re: Diversification and haystacks

Post by SimpleGift »

AlwaysLearningMore wrote: Tue Mar 22, 2022 7:19 pm Question: Other than the oft-repeated "It's all baked in to current prices" and "the future is unknown," how does an individual (or institutional?) investor gauge the diversification benefit when dealing with non-capitalistic economies?
The concern is whether companies under state-controlled capitalism can ever be accurately priced. As we have seen over the past year in China, whenever a private enterprise interferes with the social goals of the government, that enterprise is regulated, taken over (in whole or in part), or forced to turn non-profit. This is a partial list of the Chinese stock market sectors that have experienced regulatory crackdowns over the past year, all in the name of anti-trust, data security, or eliminating "foreign-related rule of law" :
  • - Fintech companies
    - E-commerce and social media companies
    - Celebrity and fan club culture
    - High-income individuals who avoid taxes, or make “excessively high incomes”
    - Tutoring and education companies, private schools
    - Gaming companies
    - Ride-sharing, car-hailing, bike-sharing, and power-bank-sharing companies
    - Companies that want to IPO in the U.S.
    - Companies that make heavy use of algorithms
    - Cloud computing firms that sell services to state and Party organizations
    - Bitcoin miners and crypto exchanges
    - Real estate companies and landlords
    - Private investment funds
    - Online insurance providers
    - Online short-term rental platforms
    - Cosmetics and packaged food brands
    - High-frequency stock traders
    - Virtual reality
    - Casinos
In many cases, once the crackdowns were announced, companies lost 50%-90% of their value. Sure, all countries regulate private enterprise, but how can this degree of state control and market interference ever be accurately "priced in" ahead of time?

Just as some folks avoid junk bonds, this investor has come to avoid stocks in state-controlled markets.
Last edited by SimpleGift on Wed Mar 23, 2022 10:31 am, edited 2 times in total.
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Re: Diversification and haystacks

Post by rkhusky »

SimpleGift wrote: Wed Mar 23, 2022 10:26 am
In many cases, once the crackdowns were announced, companies lost 50%-90% of their value. Sure, all countries regulate private enterprise, but how can this degree of state control and market interference ever be accurately "priced in" ahead of time?
About as well as natural disasters, wars, and pandemics can be priced in.
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Re: Diversification and haystacks

Post by Scott S »

SimpleGift wrote: Wed Mar 23, 2022 10:26 amJust as some folks avoid junk bonds, this investor has come to avoid stocks in state-controlled markets.
Perhaps we could say that we're not obligated to invest in every haystack, but we can pick the haystacks we understand and believe in. :beer
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Re: Diversification and haystacks

Post by gougou »

SimpleGift wrote: Wed Mar 23, 2022 10:26 am
AlwaysLearningMore wrote: Tue Mar 22, 2022 7:19 pm Question: Other than the oft-repeated "It's all baked in to current prices" and "the future is unknown," how does an individual (or institutional?) investor gauge the diversification benefit when dealing with non-capitalistic economies?
The concern is whether companies under state-controlled capitalism can ever be accurately priced. As we have seen over the past year in China, whenever a private enterprise interferes with the social goals of the government, that enterprise is regulated, taken over (in whole or in part), or forced to turn non-profit. This is a partial list of the Chinese stock market sectors that have experienced regulatory crackdowns over the past year, all in the name of anti-trust, data security, or eliminating "foreign-related rule of law" :
  • - Fintech companies
    - E-commerce and social media companies
    - Celebrity and fan club culture
    - High-income individuals who avoid taxes, or make “excessively high incomes”
    - Tutoring and education companies, private schools
    - Gaming companies
    - Ride-sharing, car-hailing, bike-sharing, and power-bank-sharing companies
    - Companies that want to IPO in the U.S.
    - Companies that make heavy use of algorithms
    - Cloud computing firms that sell services to state and Party organizations
    - Bitcoin miners and crypto exchanges
    - Real estate companies and landlords
    - Private investment funds
    - Online insurance providers
    - Online short-term rental platforms
    - Cosmetics and packaged food brands
    - High-frequency stock traders
    - Virtual reality
    - Casinos
In many cases, once the crackdowns were announced, companies lost 50%-90% of their value. Sure, all countries regulate private enterprise, but how can this degree of state control and market interference ever be accurately "priced in" ahead of time?

Just as some folks avoid junk bonds, this investor has come to avoid stocks in state-controlled markets.
I think it’s interesting to see what companies tend to get cracked down. These companies generally operate in a grey area that hasn’t been regulated. None of these companies can raise money in mainland China. Chinese IPOs require approval and Chinese authority just won’t approve them because of the businesses they do. So these companies get creative and list their stocks overseas, utilizing VIEs if necessary to circumvent Chinese laws.

So it’s not surprising these companies get cracked down when new regulations come into place. Chinese authority generally doesn’t care about Chinese stocks that only trade in a foreign market because Chinese don’t invest in those anyways. I can’t seem to recall any mainland China-listed companies that got cracked down and lost 50% to 90% in a short period of time.

So I don’t know if the market is efficient enough to price such regulatory risks. But I’m definitely not touching any Chinese stocks that can’t IPO in mainland China.
The sillier the market’s behavior, the greater the opportunity for the business like investor.
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Re: Diversification and haystacks

Post by NoRoboGuy »

arcticpineapplecorp. wrote: Tue Mar 22, 2022 7:38 pm this has been known for a long time. I first read about this phenomenon (the disconnect between GDP and a country's stock market performance) from Larry Swedroe Articles perhaps a decade ago (?)

As far as China goes, it is a capitalist country (despite it's communist label "CCP"). It's autocratic rule, it's not democratic, but it's capitalistic now (for the most part). It's not North Korea or Cuba where everything is state owned. There are private companies. They may be hamstringed by the government, etc.

William Bernstein wrote in one of his books (think it was towards the end of Birth of Plenty) that generally countries become more democratic as a result of increased capitalism, rather than the other way around. So there's hope for countries like China after all, if they continue to become ever more capitalistic in nature, democracy may follow. We'll see.

That said, if you own the total stock market index fund, you're owning countries stocks according to their market cap weighting. I don't see that you'd want to exlude countries just on the basis of their GDP growth. Then you're getting into active management. You may be right, you may be wrong.

By the way, here's an interesting podcast that explains how China started its road down capitalism:
The Secret Document that Transformed China
Ask me again if they are capitalist when China allows the Yuan to free-float in currency markets.
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Re: Diversification and haystacks

Post by SimpleGift »

gougou wrote: Wed Mar 23, 2022 11:58 am I can’t seem to recall any mainland China-listed companies that got cracked down and lost 50% to 90% in a short period of time.

So I don’t know if the market is efficient enough to price such regulatory risks. But I’m definitely not touching any Chinese stocks that can’t IPO in mainland China.
Don't follow the Chinese stock market closely, but I did see these articles and charts from Bloomberg in the past year:
  • 1) Education Sector. Chinese regulators forced the entire private education and tutoring sector to turn non-profit, which pretty much obliterated the market value of TAL Education Group, New Oriental Education & Technology Group, Gaotu Techedu Inc. — with 60% losses overnight (chart below):

    Image
    Source: Bloomberg
  • 2) Tech Sector. And the extensive regulation of the tech sector over the past years caused the Hang Seng Tech Index to lose almost 50% of its value (chart below):

    Image
    Source: Bloomberg
Agree that these regulatory risks, coming by sudden government decree, are quite difficult to price accurately.
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Re: Diversification and haystacks

Post by TheoLeo »

Sorry but nobody knows how to gauge it ahead of time. I do know that you dont need every little bit of diversification out there. You could propably buy and hold 10 established companies and be fine.
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Re: Diversification and haystacks

Post by Northern Flicker »

10 stocks are entirely inadequate to diversify away uncompensated idiosyncratic risk.
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Re: Diversification and haystacks

Post by TheoLeo »

Northern Flicker wrote: Wed Mar 23, 2022 2:49 pm 10 stocks are entirely inadequate to diversify away uncompensated idiosyncratic risk.
You pick Coca Cola, Berkshire, Exxon, Apple, P&G, Nestle, Alphabet, ASML, Unilever and Amazon. Then you wait 40 years. Just dont buy 10 biotech stocks...
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Re: Diversification and haystacks

Post by jshaffer740 »

rkhusky wrote: Wed Mar 23, 2022 7:54 am
jshaffer740 wrote: Wed Mar 23, 2022 7:40 am
rkhusky wrote: Wed Mar 23, 2022 7:12 am The market is efficient, but it is not omniscient. The market price is correct for that moment in time, but the market cannot reliably predict the future. That being said, are you a better analyst or prognosticator than the majority of investors that make up the market? I'm not, so I don't deviate much from the total market. And that includes what the market thinks about China and other such countries.
Actually, to be more precise, the market price isn’t even necessarily “correct” at any point. It’s just that (according to the efficient markets hypothesis) any pricing errors are random, and so you can’t reliably profit from them.
What would be a pricing error? Someone typing in the wrong offer price? Or network problems not allowing all the buyers/sellers to get their orders in at the same instant? etc
Let me start with my own question: What do you mean by a “correct” market price? By “pricing error,” I meant that the price was “wrong” in hindsight—that is, new information caused a change in price.

If by “correct” you mean “fully reflects all known information,” then I think we’re on the same page.
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rkhusky
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Re: Diversification and haystacks

Post by rkhusky »

jshaffer740 wrote: Wed Mar 23, 2022 3:04 pm
rkhusky wrote: Wed Mar 23, 2022 7:54 am
jshaffer740 wrote: Wed Mar 23, 2022 7:40 am
rkhusky wrote: Wed Mar 23, 2022 7:12 am The market is efficient, but it is not omniscient. The market price is correct for that moment in time, but the market cannot reliably predict the future. That being said, are you a better analyst or prognosticator than the majority of investors that make up the market? I'm not, so I don't deviate much from the total market. And that includes what the market thinks about China and other such countries.
Actually, to be more precise, the market price isn’t even necessarily “correct” at any point. It’s just that (according to the efficient markets hypothesis) any pricing errors are random, and so you can’t reliably profit from them.
What would be a pricing error? Someone typing in the wrong offer price? Or network problems not allowing all the buyers/sellers to get their orders in at the same instant? etc
Let me start with my own question: What do you mean by a “correct” market price? By “pricing error,” I meant that the price was “wrong” in hindsight—that is, new information caused a change in price.

If by “correct” you mean “fully reflects all known information,” then I think we’re on the same page.
By correct price, I meant the best price you could get at that moment. I would not consider a pricing error to be due to new information.
jshaffer740
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Re: Diversification and haystacks

Post by jshaffer740 »

rkhusky wrote: Wed Mar 23, 2022 3:19 pm
jshaffer740 wrote: Wed Mar 23, 2022 3:04 pm
rkhusky wrote: Wed Mar 23, 2022 7:54 am
jshaffer740 wrote: Wed Mar 23, 2022 7:40 am
rkhusky wrote: Wed Mar 23, 2022 7:12 am The market is efficient, but it is not omniscient. The market price is correct for that moment in time, but the market cannot reliably predict the future. That being said, are you a better analyst or prognosticator than the majority of investors that make up the market? I'm not, so I don't deviate much from the total market. And that includes what the market thinks about China and other such countries.
Actually, to be more precise, the market price isn’t even necessarily “correct” at any point. It’s just that (according to the efficient markets hypothesis) any pricing errors are random, and so you can’t reliably profit from them.
What would be a pricing error? Someone typing in the wrong offer price? Or network problems not allowing all the buyers/sellers to get their orders in at the same instant? etc
Let me start with my own question: What do you mean by a “correct” market price? By “pricing error,” I meant that the price was “wrong” in hindsight—that is, new information caused a change in price.

If by “correct” you mean “fully reflects all known information,” then I think we’re on the same page.
By correct price, I meant the best price you could get at that moment. I would not consider a pricing error to be due to new information.
What do you mean by the “best” price you can get at that moment? Isn’t market price by definition the only price you can get at that moment?

I agree that pricing “error” is not a good word to use here. I was using it to respond to the idea of a “correct” price, which I think is also misleading.
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rkhusky
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Re: Diversification and haystacks

Post by rkhusky »

jshaffer740 wrote: Wed Mar 23, 2022 3:26 pm
rkhusky wrote: Wed Mar 23, 2022 3:19 pm
jshaffer740 wrote: Wed Mar 23, 2022 3:04 pm
rkhusky wrote: Wed Mar 23, 2022 7:54 am
jshaffer740 wrote: Wed Mar 23, 2022 7:40 am

Actually, to be more precise, the market price isn’t even necessarily “correct” at any point. It’s just that (according to the efficient markets hypothesis) any pricing errors are random, and so you can’t reliably profit from them.
What would be a pricing error? Someone typing in the wrong offer price? Or network problems not allowing all the buyers/sellers to get their orders in at the same instant? etc
Let me start with my own question: What do you mean by a “correct” market price? By “pricing error,” I meant that the price was “wrong” in hindsight—that is, new information caused a change in price.

If by “correct” you mean “fully reflects all known information,” then I think we’re on the same page.
By correct price, I meant the best price you could get at that moment. I would not consider a pricing error to be due to new information.
What do you mean by the “best” price you can get at that moment? Isn’t market price by definition the only price you can get at that moment?

I agree that pricing “error” is not a good word to use here. I was using it to respond to the idea of a “correct” price, which I think is also misleading.
And my original point was to counter the idea that the market price is somehow incorrect. Usually because sometime in the future the price has changed. I did mean that “correct” is the same as “fully reflects all known information,” so I do think we’re on the same page.
Northern Flicker
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Re: Diversification and haystacks

Post by Northern Flicker »

TheoLeo wrote: Wed Mar 23, 2022 3:00 pm
Northern Flicker wrote: Wed Mar 23, 2022 2:49 pm 10 stocks are entirely inadequate to diversify away uncompensated idiosyncratic risk.
You pick Coca Cola, Berkshire, Exxon, Apple, P&G, Nestle, Alphabet, ASML, Unilever and Amazon. Then you wait 40 years. Just dont buy 10 biotech stocks...
A portfolio of those 10 stocks has uncompensated risk-- each company had unique risk specific to that company. Such risks are unconpensated because they can be diversified away. The market does not give you a discount when you buy Coca-Cola because you are not planning to hold it in a diversified portfolio.

Why isn't GE in your list? Maybe because it experienced the materialization of idiosyncratic risk? It was once one of the ultimate blue chip stocks.
Last edited by Northern Flicker on Thu Mar 24, 2022 11:33 am, edited 1 time in total.
Topic Author
AlwaysLearningMore
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Re: Diversification and haystacks

Post by AlwaysLearningMore »

burritoLover wrote: Wed Mar 23, 2022 8:00 am In my 80/20 US/ex-US portfolio, I’d like to eliminate Tesla from the US total stock portion. I think it’s very risky stock and valuations are way too high. Since Tesla makes up the same percentage as China in this portfolio, I figured it would be fair game to discuss. :oops:
Some investors employ "direct indexing" and cull unwanted companies from their portfolio, if that's what you mean.

Here's how they've performed over the past 10 years:
Image

IMHO the risks of owning Tesla are different in quality than investing in China:
Tesla
A single stock
Does not need to raise capital with VIE structure
Domiciled in a nation with a floating exchange rate
Domiciled in a Republic
Its CEO has not disappeared for 3 months under mysterious circumstances
Has not had to deal with severe government crackdown on technology due to tension with government authorities


China
Like Russia, an autocracy https://www.nytimes.com/2021/03/29/worl ... ussia.html
No floating exchange rate
Tension with government authorities can lead to crackdowns: e.g., suspension of Ant Group IPO soon after Jack Ma criticized China’s state-dominated banking system https://supchina.com/2020/11/03/ant-gro ... egulators/
Retirement is best when you have a lot to live on, and a lot to live for. * None of what I post is investment advice.* | FIRE'd July 2023
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AlwaysLearningMore
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Re: Diversification and haystacks

Post by AlwaysLearningMore »

Robot Monster wrote: Wed Mar 23, 2022 9:12 am
burritoLover wrote: Wed Mar 23, 2022 8:00 am In my 80/20 US/ex-US portfolio, I’d like to eliminate Tesla from the US total stock portion. I think it’s very risky stock and valuations are way too high. Since Tesla makes up the same percentage as China in this portfolio, I figured it would be fair game to discuss. :oops:
Yes! Let's analyze the diversification benefit of each and every straw in the entire haystack.
Or, an investor can analyze various haystacks. Should they feel that the straw that makes up certain haystacks is not to their liking, they can avoid them. Some investors have funded a comfortable retirement with this approach.
Last edited by AlwaysLearningMore on Wed Mar 23, 2022 7:57 pm, edited 1 time in total.
Retirement is best when you have a lot to live on, and a lot to live for. * None of what I post is investment advice.* | FIRE'd July 2023
Ferdinand2014
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Re: Diversification and haystacks

Post by Ferdinand2014 »

The bigger point is settling on something that you the investor can be comfortable sticking with through thick and thin. There is no point in owning a global market cap equity allocation based on theory and diversification if you can't stick with it (or not even feasible depending on where you live). What is likely way more important is finding the compromise of a good plan that you can stick with, a high savings rate and low costs held over an investing lifetime. What works for a physician living in rural Maine who owns his own practice and is near retirement may be entirely different from a 22 year old in India starting his career in the tech industry. It seems highly improbable that owning or not owning equities in autocratic countries will make or break a sound plan.
“You only find out who is swimming naked when the tide goes out.“ — Warren Buffett
Nathan Drake
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Re: Diversification and haystacks

Post by Nathan Drake »

Scott S wrote: Wed Mar 23, 2022 11:33 am
SimpleGift wrote: Wed Mar 23, 2022 10:26 amJust as some folks avoid junk bonds, this investor has come to avoid stocks in state-controlled markets.
Perhaps we could say that we're not obligated to invest in every haystack, but we can pick the haystacks we understand and believe in. :beer
Yes, but by limiting the haystack to the one you’ve specifically selected you’re more exposed to the possibility of prolonged poor performance.
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OnTrack
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Re: Diversification and haystacks

Post by OnTrack »

See YouTube of Intel CEO Gelsinger congressional testimony on March 23, 2022.
https://m.youtube.com/watch?v=K-nXemGs3YY
See 1:25:00 on the YouTube video. The statement is made that currently American companies are expected to stop doing business with Russia. Then the statement is made that the same thing will happen when communist China decides to invade Taiwan. If this plays out as suggested, it could certainly be a problem for Americans with investments in the PRC.
Robot Monster
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Re: Diversification and haystacks

Post by Robot Monster »

AlwaysLearningMore wrote: Wed Mar 23, 2022 7:34 pm
Robot Monster wrote: Wed Mar 23, 2022 9:12 am
burritoLover wrote: Wed Mar 23, 2022 8:00 am In my 80/20 US/ex-US portfolio, I’d like to eliminate Tesla from the US total stock portion. I think it’s very risky stock and valuations are way too high. Since Tesla makes up the same percentage as China in this portfolio, I figured it would be fair game to discuss. :oops:
Yes! Let's analyze the diversification benefit of each and every straw in the entire haystack.
Or, an investor can analyze various haystacks. Should they feel that the straw that makes up certain haystacks is not to their liking, they can avoid them. Some investors have funded a comfortable retirement with this approach.
I was just teasing, a little. I don't have any problem with it.
NiceUnparticularMan
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Re: Diversification and haystacks

Post by NiceUnparticularMan »

AlwaysLearningMore wrote: Wed Mar 23, 2022 7:34 pm
Robot Monster wrote: Wed Mar 23, 2022 9:12 am
burritoLover wrote: Wed Mar 23, 2022 8:00 am In my 80/20 US/ex-US portfolio, I’d like to eliminate Tesla from the US total stock portion. I think it’s very risky stock and valuations are way too high. Since Tesla makes up the same percentage as China in this portfolio, I figured it would be fair game to discuss. :oops:
Yes! Let's analyze the diversification benefit of each and every straw in the entire haystack.
Or, an investor can analyze various haystacks. Should they feel that the straw that makes up certain haystacks is not to their liking, they can avoid them.
Somewhat ironically given the context, if you believe there is idiosyncratic risk risk associated with in which country stocks are listed, then that is actually more, not less, reason to diversify across countries.
Some investors have funded a comfortable retirement with this approach.
Some investors have done that mostly with their own company's stock. And some worked for Enron.

The logic of diversification does not dictate that no investors will do better with a more concentrated strategy. Indeed, you can roughly assume about half of such investors will do better, and some will do much better.

But roughly half of such investors will do worse, and some will do much worse.

The point of diversification therefore is to get around average returns but with much less tail risk.

I am mentioning all this because I sometimes think these basics of diversification do get lost in these conversations. And in practice, it can be hard for some people to observe some more concentrated investors doing better than more diversified investors without thinking those investors doing better must have used some sort of reasonable filter or other method to pick their more concentrated position. But even if diversification does exactly what it is supposed to do, that will always be the case, that many concentrated investors will have done better. But others will have done worse.
Jack56
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Re: Diversification and haystacks

Post by Jack56 »

The issue is the future not the past and we don't know the future -- which is why we diversify. The US was an emerging market in the 19th century, all sorts of shenanigans & corruption, lots of defaults. Britain was the top dog. We know the situation today but what about tomorrow?
Topic Author
AlwaysLearningMore
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Re: Diversification and haystacks

Post by AlwaysLearningMore »

NiceUnparticularMan wrote: Sun Mar 27, 2022 5:12 am
AlwaysLearningMore wrote: Wed Mar 23, 2022 7:34 pm
Robot Monster wrote: Wed Mar 23, 2022 9:12 am
burritoLover wrote: Wed Mar 23, 2022 8:00 am In my 80/20 US/ex-US portfolio, I’d like to eliminate Tesla from the US total stock portion. I think it’s very risky stock and valuations are way too high. Since Tesla makes up the same percentage as China in this portfolio, I figured it would be fair game to discuss. :oops:
Yes! Let's analyze the diversification benefit of each and every straw in the entire haystack.
Or, an investor can analyze various haystacks. Should they feel that the straw that makes up certain haystacks is not to their liking, they can avoid them.
Somewhat ironically given the context, if you believe there is idiosyncratic risk risk associated with in which country stocks are listed, then that is actually more, not less, reason to diversify across countries.
Sorry, I don't see autocracies without a free-float currency as "more, not less reason" to invest in them. YMMV.
Some investors have funded a comfortable retirement with this approach.
Some investors have done that mostly with their own company's stock. And some worked for Enron.
I daresay the investors who've followed the investing tenets laid out by Mr. Bogle in tomes such as The Little Book of Common Sense Investing can't be logically compared to those who invested in a single company stock; it strikes me as something of a false equivalence. https://www.amazon.com/Little-Book-Comm ... 119404509/
For those who favor investing in scenarios replete with VIE's, lack of free-float currency, the occasional 3-month disappearance of notable CEO's, limitations on foreign-investor ownership, and under the auspices of autocrats, it's a free country (the USA, that is).
Retirement is best when you have a lot to live on, and a lot to live for. * None of what I post is investment advice.* | FIRE'd July 2023
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packer16
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Re: Diversification and haystacks

Post by packer16 »

I don't know if folks have seen this study which shows that since the 1970s investments in autocracies have had 50% of the returns of democracies: https://papers.ssrn.com/sol3/papers.cfm ... id=3198561. This intuitively makes sense & I have heard at a CFA EM conferences that if you could avoid the nationalization countries, EM returns would be similar to DM returns.

Given this result, I was surprised at the allocation to autocracy (or countries with poor disclosure - like China, India & Brazil) in Vanguard exUS ETFs & funds (25%). If you add in Japan (another poor disclosure country), the exUS ETF & funds are close to 40% exposure. The biggest issue with efficient markets in these poor disclosure/autocratic markets is market participants don't have data (& insiders do) to make the market efficient. Russia is an extreme example of this.

John Bogel's wisdom of sticking with the US (or an equivalent political/economic system) makes alot of sense given these findings.

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