Building A Globally Efficient Index ETF Portfolio (updated)
EfficientMarket.ca

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:

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:

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:

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.