Why buy UK?

[GeoffF100]

The mathematics of CAPM goes like this. Assume that all investors have the same objective, taxes and currency. It follows that the optimal portfolio will be the same for all of them. That is possible only if they all have the market weighted portfolio. CAPM is a simplified model. Nonetheless, it illustrates why market weighting works.

Given that most fund managers fail to beat a market weighted portfolio after costs, and nobody has identified any way of predicting which managers will succeed, it is no brainer: market weight (but do not put all your money in a small regional market like the UK).

[Lootman]

For example, ss an individual investor I can set up a portfolio, equal weighted at inception and then left alone. That's not possible for a fund manager.

Your hypothesis here seems to be that buying and equal weighted portfolio and leaving it alone is a market beating strategy. If that were so, it would be a market beating strategy not only for the original investor, but any investor who replicated that portfolio later on. It would also follow that any portfolio that I can construct that was equally weighted at some time in the past, would also be market beating. I think you would have difficulty selling that one.

It would be perfectly possible for a fund manager to run a fund that equally weighted its constituents, and then did nothing. And in fact there used to be a class of funds in the US that did that - called Unit Investment Trusts (UITs). They were operated as a fixed duration vehicle, which is really the only way you could do it as such a portfolio would become more and more eccentric over time, due to corporate actions and the inevitable changes in market leadership.

So the statement "That's not possible for a fund manager" is not true. Fund managers can create any type of fund that you can conceive of. But they will only do that if there is a demand for such a fund, and there is not. As far as I am aware, UITs are now extinct.

[GeoffF100]

A company's earnings per share is completely irrelevant. If a company does a two for one share split, that halves the earnings per share, but it does not affect the valuation of the company, its total earnings or its prospects of future earnings growth.

Sorry, posted that in haste. It should read earnings per amount invested that matters. If I invest £5000 in either Tesco or Shell then it's the return on that money that matters, not the earnings/return on the whole company.

Companies with higher earnings yields do not necessarily outperform the market. When they do, people buy more of them, they become overpriced and then underperform until they become underpriced...

[JohnW]

If so, can we act on it to make better than market returns without adding risk (or getting more returns for not so much more risk)? Is there something to suggest I or the next mug could pull it off?

Sorry, don't know about beta.

If it worked, why couldn't a fund manager do it? Are they excluded from investing approaches that really work?

There might be a mixing of expressions here: risk adjusted return, and cap weighted index. The index or fund isn't 'risk adjusted'; the returns are the best, or not the best risk adjusted returns.
But that wasn't the argument; the argument was put as 'cap weighting should give the best risk adjusted returns'.

I don't think I know the answer, but the risk you mention is measured from past results, it's past risk; the market is forward looking to what returns are anticipated. If the market thinks Shell has better prospects, in pours the money.

As an input to a strategy, correlation needs considerable care with its use I think. It's measured on past data; future data can make correlations change, and change they certainly do. I don't think they're to be relied on.

Moderator Message:
Please follow the rules and quote correctly, including the attribution of your quotes. Despite searching, I am unable to find the source of your quotes. This also means that the original OP(s) are not notified of your comments. If they are all quotes from a single post, at least give one attribution.

TJH

Thanks. I'll have a look for the rules, or some kind person might copy/paste the relevant one here for me.
I find the keyboard shortcut <control + F> brings up a dialogue box where I can paste/type some text to have the computer search the page I'm on for that text.

[JohnW]

Isn't the rationale the efficient market hypothesis, that cap weighting should give the best risk adjusted return of any stock allocation?

beta refers to the shares volatility compared to whole market volatility - the higher beta is the more volatile vs the market. A beta of 1 is taken as equivalent volatility to the market.



It would be tricky because each individual investor would have a different portfolio depending on when they invested - market evolution would force this. You are then into the territory of wealth, rather than fund, management with all the higher costs that go with that.



Sure, to the point where the expected return matches that of Tesco. With similar expected returns and risk (you only have the past volatility to go on here) the question once again is 'why invest 10X as much in Shell?' I haven't seen anyone give a satisfactory answer to this.

Maybe I don't understand your question, but haven't you described the answer?
Assume Tesco and Shell have the same (past) volatility measure; even that is fraught, because is it the same for the period of the last decade but in the last 2 years one is bigger than the other, or all sorts of variation on that. Next, the market anticipates Shell will have much bigger profit in the future, so the money pours in such that the anticipated returns for an aliquot of investment are reduced to the level of Tesco. Then the money stops pouring in, at 10x. All the while investors have also been cogitating about the risks for both companies, and it's not past measured volatility they're thinking of it's global warming or starvation incomes that can't afford three meals.

Nothing can be totally relied on but selecting shares from different business sectors should continue to work to reduce risk by minimising correlations. Unless you think Tesco are going to start drilling for oil? And, yes, I know they sell petrol!

It might indeed, and it also reduces idiosyncratic risk specific to any sector.

There are many examples of stocks with similar (volatility) risk but very different market caps. For example, Shell and Tesco have similar beta (0.57 and 0.52 respectively) but Shell has MC of £182bn whilst Tesco has a MC of £19.6bn. For a private investor what is the rationale for investing almost 10X as much in Shell as in Tesco?

Moderator Message:
I can see that this got scrambled in the quoting. I have edited it to reflect what I think was intended.

TJH

[tjh290633]

Moderator Message:
Please follow the rules and quote correctly, including the attribution of your quotes. Despite searching, I am unable to find the source of your quotes. This also means that the original OP(s) are not notified of your comments. If they are all quotes from a single post, at least give one attribution.

TJH

Thanks. I'll have a look for the rules, or some kind person might copy/paste the relevant one here for me.
I find the keyboard shortcut <control + F> brings up a dialogue box where I can paste/type some text to have the computer search the page I'm on for that text.

You appear to have found a way, but the easiest is to click on the icon top right of a post which gives the option to quote that post.

You can then edit the quoted text if you wish. Alternatively I think that you can highlight the passage that you wish to quote then click on "quite". You can also quote from several posts at the same time by highlighting text in those posts, which appear below your posting, then click on the "quote" link in the icon top right of each post.

Hope that is helpful.

TJH

[GeoffF100]

Another aspect is to consider what happens if you equal weight. That will work well if the small caps outperform the large caps. The opposite has been true in recent years, so you would have underperformed. Prior to that, small caps had done well and people overweighted them in the hope that would continue,. It did not. If equal weighting ever becomes popular, that will lead to the small caps being overpriced, which will be bad news for anyone who equal weighted. Are the mega caps overpriced now? Many people believe they are, but betting on that has not done them any good so far.

[Bubblesofearth]

Another aspect is to consider what happens if you equal weight. That will work well if the small caps outperform the large caps. The opposite has been true in recent years, so you would have underperformed. Prior to that, small caps had done well and people overweighted them in the hope that would continue,. It did not. If equal weighting ever becomes popular, that will lead to the small caps being overpriced, which will be bad news for anyone who equal weighted. Are the mega caps overpriced now? Many people believe they are, but betting on that has not done them any good so far.

If you start from the principle that you don't know which shares will outperform, regardless of their market cap, then why overweight any share in a portfolio?

BoE

[Lootman]

Another aspect is to consider what happens if you equal weight. That will work well if the small caps outperform the large caps. The opposite has been true in recent years, so you would have underperformed. Prior to that, small caps had done well and people overweighted them in the hope that would continue,. It did not. If equal weighting ever becomes popular, that will lead to the small caps being overpriced, which will be bad news for anyone who equal weighted. Are the mega caps overpriced now? Many people believe they are, but betting on that has not done them any good so far.

If you start from the principle that you don't know which shares will outperform, regardless of their market cap, then why overweight any share in a portfolio?

BoE

The problem is that the term "outperformance" is defined in terms of the underlying index of that market. And that index is cap-weighted.

So if you want a market performance, as presumably most buyers of passive funds do, then that means buying in proportion to market cap.

Anything else and you are effectively pursuing an active strategy and not a passive one. You are making bets contrary to how the index is constructed in the belief that you know better than the market and can do better than the market.

[1nvest]

Another aspect is to consider what happens if you equal weight. That will work well if the small caps outperform the large caps. The opposite has been true in recent years, so you would have underperformed. Prior to that, small caps had done well and people overweighted them in the hope that would continue,. It did not. If equal weighting ever becomes popular, that will lead to the small caps being overpriced, which will be bad news for anyone who equal weighted. Are the mega caps overpriced now? Many people believe they are, but betting on that has not done them any good so far.

If you start from the principle that you don't know which shares will outperform, regardless of their market cap, then why overweight any share in a portfolio?

BoE

Consider the existing Index as a set of prior equal weights that have discovered its own out-performers. Original HYP (leave as-is) style. Not rebalancing back to equal weightings is lower cost than rebalancing. For a large/lump-sum there are indications that you may do better by creating your own such Index of initial equal weightings and leaving that as-is.

Why UK - there's not much incentive when the entire market cap of the FT100 is only relatively little larger than the single largest US individual stock.

[GeoffF100]

[If you start from the principle that you don't know which shares will outperform, regardless of their market cap, then why overweight any share in a portfolio?

Absolutely yes. Just stick to the market weight. Do not over or under weight.

[GeoffF100]

A new all-time high:

https://www.bbc.co.uk/news/business-68877506

UK stocks do not pay withholding tax on their dividends, and some of the earnings are in GBP, which reduces volatility. There is a case for some home bias, but not too much.

[Lootman]

A new all-time high:

https://www.bbc.co.uk/news/business-68877506

And it has only take 25 years for the FTSE-100 to go from 7,000 to 8,000!

[GeoffF100]

A new all-time high:

https://www.bbc.co.uk/news/business-68877506

And it has only take 25 years for the FTSE-100 to go from 7,000 to 8,000!

Yes quite so. Perhaps it is now cheap enough to do better. It had good times previously.

[JohnW]

There are funds that use equal weightings of their components, adjusting to reflect changes in stock values. They can't be as broad as cap weighting because the smaller companies don't have enough stock for the fund to hold an equal weight if the fund gets too big. But it was enlightening for me to see that the performances of those two approaches didn't differ very much, one a little better/worse in the good/bad times, the other the opposite, attributed I think to the overweighting of small cap in the equal weighted fund. God works in mysterious wasy.

[GoSeigen]

[If you start from the principle that you don't know which shares will outperform, regardless of their market cap, then why overweight any share in a portfolio?

Absolutely yes. Just stick to the market weight. Do not over or under weight.

My daughter's ISA which I manage is about 66% invested in UK/EU bank stocks and hybrids. Is that overweight or about right?

LOL

GS

[Lootman]

Absolutely yes. Just stick to the market weight. Do not over or under weight.

My daughter's ISA which I manage is about 66% invested in UK/EU bank stocks and hybrids. Is that overweight or about right?

Criminally so, in my opinion. Not just geographically, but sectorally. I would fire any adviser who chose such concentrated bets.

And why even post that on the Passive Investing board?

[GoSeigen]

My daughter's ISA which I manage is about 66% invested in UK/EU bank stocks and hybrids. Is that overweight or about right?

Criminally so, in my opinion. Not just geographically, but sectorally. I would fire any adviser who chose such concentrated bets.

And why even post that on the Passive Investing board?

Forgive me feeding the troll* but... Why post about which ETF to choose in which geographic location on the Passive Investing board?? Everyone just buy a world tracker and be done with it.

Simples!

GS
(*)I note that he failed to quote my "LOL"; if he recalled "Educate, Enrich and Amuse" it might not be such a mystery, but selective quoting to evoke a reaction seems to be what it is about, almost 19000 posts and counting...

P.S. For the record I mistook the thread for the similar discussion I was involved in on the Investment Strategies board... sorry for the OT.

[Lootman]

Criminally so, in my opinion. Not just geographically, but sectorally. I would fire any adviser who chose such concentrated bets.

And why even post that on the Passive Investing board?

For the record I mistook the thread for the similar discussion I was involved in on the Investment Strategies board... sorry for the OT.

Fair enough.

[Bubblesofearth]

[If you start from the principle that you don't know which shares will outperform, regardless of their market cap, then why overweight any share in a portfolio?

Absolutely yes. Just stick to the market weight. Do not over or under weight.

Why should you stick to market weighting? Just because Shell is worth 10X Tesco doesn't automatically imply that you should invest 10X as much of your money in it. The only reason to invest more in Shell is if you believe it will do better over time. Massively better if you are prepared to invest so much more. Is that a reasonable assumption? Why when the measurable risks are similar and, if EMH is to be believed, expected return should also therefore be similar?

BoE