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Building A Globally Efficient Index ETF Portfolio (updated)


Building A Globally Efficient Index ETF Portfolio (updated)

Contributed by: martingale

Investing Last year I recommended building your RRSP with low cost efficient global indexed ETF 's by allocating funds in your RRSP to index ETF's based on global market capitalization. In my opinion there isn't much more to say about equity investment--that's still what most people should do with their RRSP. However, it's time to update the data a little. What's the market cap breakdown look like in 2007? Also, there are three new low cost Vanguard index ETF's available to track foreign markets: VGK, VPL, and VWO. We'll have to revise our approach slightly to work out how to fit VGK and VPL in.

If you did allocate your money along market capitalization lines then you really shouldn't have a lot to do this year: The shifts and changes in world market capitalization should have been mirrored by equivalent shifts in your portfolio. However, if you've been adding or drawing from the portfolio thoughout the year it might be a little bit out of whack.

Last year I posted the article based on data published by The Economist. This year I am unable to find that source again; instead I've got a new source--the Dow Jones Wilshire Global Index data is published online on their site here. It should be roughly the same as The Economist's data, however it might differ somewhat due to the inclusion of a slightly different mix in the different indexes. We are going to come up with an equivalent, but not exactly the same, method of estimating market capitalization as last year's article used.

It's worth pointing out that being close to the global allocation is good enough. None of the indexes exactly capture the true global allocation anyway, so no matter what data source we use, we'll be out by a couple of percentage points. In terms of diversification benefits, you'll be getting almost all of those benefits by being close, so don't worry if your overall allocation is out by a little from what we come up with here. Small errors are fine. Don't spend a lot of money rebalancing every year to match these numbers exactly--be content, and save on trading fees, if you are in the right ballpark.

All that said, let's look at the numbers as at 24 January 2007. I've taken the Dow Jones data and summed up to get a separate total for Canada, the United States, developed nations, and emerging markets. It looks like this:

MarketBillions in USDPercentage

That's the calculation that breaks down the allocation according to the Dow Jones data. However, the funds that are actually available to us use the MSCI indexes instead. While the weight given to each country in the MSCI world is going to be roughly the same as the Dow Jones indexes (close enough for our purposes) there is a problem: the MSCI indexes, which most ETF's follow, classify some of the countries differently than the Dow Jones data does. For example, MSCI treats South Korea as an emerging market, but the Dow Jones index classifies it as a developed foreign nation.

Since we'll probably wind up using ETF's that are based on MSCI indexes (such as Vanguard or iShares ETFs) then we'll want to recalculate the above along the lines of the funds we'd invest in. Using the country classifications from the MSCI index descriptions with the market capitalizations from the Dow Jones index we get this estimate of global market capitalization:

CAN (XIC)3.23%
USA (VTI)44.34%
Europe (VGK)28.41%
Pacific (VPL)14.82%
Emerging (VWO)9.04%

Last year's breakdown combined Europe and Pacific into one EAFE listing, which would be 43.24% if we added them together. This year we're listing Pacific and Europe separately because there are a few new ETF's on the market that we can use to track foreign equities, that are cheaper than the ETF's we had available to us last year. Vanguard has released three new funds: VWO which tracks MSCI emerging market index, VPL which tracks the MSCI Pacific index, and VGK which tracks the MSCI Europe index.

If you followed my advice last year and set up a globally efficient portfolio using EFA, VTI, and EEM there is no need to rush out and sell them. They still have low MER's, just not quite as low as the Vanguard ETF's. Rather than sell your old ETF's and buy new ones (which would cost you a lot of trading fees) just hang on to them--but you might want to put new money into the cheaper Vanguard alternatives that are now available. Who knows, competition may force Barclay's to lower the MER's on the older ETF's anyway so just hold on to what you've bought.

As I mentioned last year as a Canadian investor you might want to play with the portion of your holdings that are held in Canadian stocks. If you hold funds outside of an RRSP there are tax advantages to holding eligible Canadian equities--you get a significant tax break on the dividends. Aside from that you may want to increase the portion of your holdings that are in Canadian dollars just because your retirement will be funded in Canadian dollars.

What you'll want to do is decide on the portion that you would like to hold in Canadian dollars and use the above numbers to determine the ratio of foreign equities you should be invested in. For example, if you decided that you should have 10% Canadian equities (three times the efficient global weight) you would end up with this:

CAN (XIC)10%
USA (VTI)41%
Europe (VGK)26.5%
Pacific (VPL)14%
Emerging (VWO)8.5%

Around this time of year you're going to be bombarded with a lot of advertising trying to convince you that investing is hard, and that you should be entrusting your money to a professional who knows better than you do. Don't believe it. Investing is simple. There's nothing really more to it than throwing your money into a few index funds and forgetting about it. The only thing you're not getting by going for a simple, efficient, cheap global array of ETF's is a lot of fees that pay for someone else's retirement.

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Building A Globally Efficient Index ETF Portfolio (updated) | 5 comments | Create New Account
The following comments are owned by whomever posted them. This site is not responsible for what they say.
Building A Globally Efficient ETF Portfolio (updated)
Authored by: mapsnrop on Saturday, January 27 2007 @ 08:30 PM EST
Hi Martin,

I sent you an e-mail, but didn't receive a reply, maybe it never made it through. At any rate, I'm glad you're still writing articles on your site. I was really interested in your previous article on this, so I did some research. From what I found, I believe that The Economist was using figures from the World Bank Group (World Development Indicators).

I found the updated figures for 2006 here:

(click on 5.4, Stock Markets)

The data from 2005 matches the numbers that you reported from The Economist World in Figures.

Using the data from 2006, I came up with the following:

USA: 37.11%
CANADA: 10.71% (after capitalization was multiplied by 4)
EAFE: 37.73% (using the list of countries as reported by the current MSCI EAFE index)
Emerging: 14.45%

Different sources have different opinions for the "emerging market index", for instance the MSCI classifies Hong Kong and Singapore as developed markets (EAFE), and omits Jordan.

For my data, I classified emerging markets as: China, Taiwan, Korea, Brazil, South Africa, India, Russia, Malaysia, Saudi Arabia, Mexico, Thailand, Chile, Israel, Turkey, Indonesia, Argentina, Poland, Egypt, Phillipines, Czech Republic
Hungary, Pakistan, Peru, Columbia, Morocco, Jordan

And classified the EAFE markets as: Japan, United Kingdom, France, Germany, Spain, Switzerland, Hong Kong, Italy
Australia, Netherlands, Belgium, Sweden, Finland, Singapore, Denmark, Greece, Norway, Ireland, Portugal, Austria
New Zealand


Chris Myden

Building A Globally Efficient ETF Portfolio (updated)
Authored by: wpautz on Friday, February 02 2007 @ 11:36 PM EST
Hey, speaking of RRSPs, I'm looking everywhere for info about which index funds (or ETFs) to include within my RRSP. The adviser at RBC was useless, trying to steer me back to higher MER mutual funds. The book All About Index Funds is interesting so far, but does not mention RRSPs as it is written for Americans.
I do not know which Index Funds and ETFs I am allowed to include in my RRSP. Are there any restrictions? If so, why is it so hard for me to find a list of RRSP eligible Index funds?
The only help I have found so far is the filter on, but the list it provides is rather short (just over 100).

Can you point me in the right direction for a COMPLETE list? I have just signed up for a self-directed RRSP account at RBC.

Thanks you.
Building A Globally Efficient Index ETF Portfolio (updated)
Authored by: altgeld88 on Tuesday, February 27 2007 @ 11:32 AM EST
Dear Mr. Gale,

I'm an American who moved to Canada when I married my Canadian wife. Just wanted to say that your site is a beacon of light amidst the darkness of the Canadian financial services sector. This is the only intelligent investing site I have discovered thus far in Canada. I am appalled at the fees that the investment cartel is able to inflict on Canadian invstors while delivering nothing positive in return to clients on a risk-adjusted basis.

As a lifelong Vanguard investor in the States I thank you for pointing me toward a proper discount brokerage and exchange-traded funds from Vanguard and Barlays iShares. Before I found you I despaired of finding an investment vehcile for my wife that wouldn't leech away her returns via management, marketing and commission expenses.

Thanks again and keep up the good work!

Kind regards,
Building A Globally Efficient Index ETF Portfolio (updated)
Authored by: niagarak on Monday, March 05 2007 @ 10:41 AM EST
Strictly as far as MERs are concerned, the situation seems to be the following as of March 2007:

Vanguard VGK (Europe) - 0,18%
Vanguard VPL (Pacific) - 0,18%
Vanguard VWO (Emerging) - 0,30 %

Which I think comes to a weighted combined MER of 0,2 %
(that is, with 26.5, 14 and 8.5% respectively for VGK, VPL, and VWO).

iShares CDN MSCI EAFE (XIN) - 0,15, which is lower than the Vanguard's.
Building A Globally Efficient Index ETF Portfolio (updated)
Authored by: drpeabody on Thursday, March 08 2007 @ 11:00 PM EST

if you are expecting to make 6-7% over time in an intelligently allocated, appropriately diverse global portfolio, how do you factor in the cost of currency conversion within a canadian RRSP? you are charged a spread at every buy and sell. using a wash mitigates it for that trade but eventually it comes out of US dollars again (unless you move).

one needs to truly estimate the cost on the conversion spread charge here. i dont know if folks discussing the bmo lawsuit are accurate at estimating this at 2-3% if this is true, one could argue simply for sticking with cdn versions of the foreign ETFs until there are us dollar rrsp accounts available to us.

any one find this depressing? (or... please...wrong)
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