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This past February, based on a review of some investing wisdom from John C. Bogle and Peter L. Bernstein, I offered Seeking Alpha readers my take on the perfect portfolio for the next 10 years.
In combination, the two linked articles, one on my personal blog and one right here on Seeking Alpha, offer a thorough grounding in the argumentation offered by Mr. Bernstein in favor of a portfolio comprised of 60% stocks and 40% bonds, followed by a more recent recommendation from no less than John C. Bogle that, given the present environment, a 50/50 allocation may be even more prudent.
What, though, did I recommend as the ‘perfect portfolio?’ Here is how I summarized it in my Seeking Alpha article:
Without further ado, then, here is my “base” allocation for the next 10 years.
- 30% U.S. Stocks
- 20% Global ex-US Stocks
- 50% Long-Term U.S. Treasuries
In summary, we are talking about a 50/50 allocation in stocks vs. bonds, with the stock allocation being broken down 60/40 between U.S. stocks and foreign stocks.
In this article, we will look at suggestions to fill the allocation to international stocks. I am going to take a look at the question of filling that allocation with either a single international total-market ETF or separate ETFs representing developed and emerging markets.
Seeking Alpha Over The Next 10 Years
Before we dive into the specific ETF selections for this segment of the portfolio, I want to be upfront about one thing. This is the segment of the portfolio in which I am hoping to find alpha over the next 10 years.
In my ‘perfect portfolio’ article (linked in the first paragraph), I offered the following observation:
First of all, you may have been surprised at my 20% allocation to foreign stocks. Certainly, if one goes to Portfolio Visualizer and compares a 50/50 allocation of purely U.S. stocks and long-term treasuries against the allocation I am proposing over, say, the last 10 years, this portfolio will look pretty bad.
The challenge, however, is that we are not looking backwards. We are looking to the future. We aren’t quite as concerned with what happened in the last 10 years as we are with what will happen in the next 10 years.
In a previous article here on Seeking Alpha, I featured the potential for emerging markets. I later suggested 2 ETFs for focused investment in China, one here and the other on my personal blog.
However, there are two more pieces of information you may wish to consider.
First; in the ‘perfect portfolio’ article, I featured a recent Vanguard article recommending that investors increase their non-U.S. holdings to 40%. Related to that, there is a second ‘wrinkle’ suggested to my by my reader Lake OZ Boater. He featured the concept that Vanguard, with its impressive research department, is ‘putting its money where its mouth is’ by including a serious allocation to international stocks in their target date retirement funds. As an example, take a look at the allocation for the 2045 iteration of that fund (apologies for the slightly irregular hand-drawn highlighting).
Source: Vanguard Target Retirement 2045 Fund Information Page
As my reader points out, if Vanguard’s allocations prove unfortunate, it could have a significant negative impact on their reputation.
Second; in the article from my personal blog linked in the first paragraph, there is a link to a video from John C. Bogle. Starting at roughly the 56:45 mark, in discussing an endowment he manages, while making the general observation that he is happy to stay away from international investments, he makes this comment:
And then, against two contingencies, just in case, I put 5% in an emerging market index and . . . I hope you are sitting down . . . 5% in gold. (Bold mine, for emphasis)
To sum up this section, then, I am including a 20% allocation to international stocks in my ‘perfect portfolio’ for three reasons:
- Because I believe there is a good chance that their relative underperformance to U.S. stocks over the past 10 years may reverse.
- Even if this does not happen to a dramatic extent, this exposure may well reduce the overall volatility of the portfolio.
- A common thought expressed by both Bogle and Bernstein: No one knows how all of the variables will play out. The only constant is surprise.
With that, let’s move on to the ETFs.
Option One: One International Total Market ETF
My selection in this space is the Vanguard Total International Stock ETF (VXUS).
Just one quick comment before I go any further. In my analysis, I also seriously considered two other stellar ETFs: the Vanguard FTSE All-World ex-US ETF (VEU) and the iShares Core MSCI Total International Stock ETF (IXUS). In this section, I will make some brief comments as to why I ultimately picked VXUS over VEU. I will touch briefly on IXUS in an “honorable mention” section a little later in the article.
VXUS tracks the FTSE Global All Cap ex US Index. This comes from the same overall FTSE index used by VEU. However, as opposed to the 2,573 constituents in the variant used by VEU, this variant of the index contains 5,990 holdings. Whereas VEU focuses on large-cap and medium-cap companies outside the U.S., VXUS adds additional exposure to small-cap companies.
Vanguard recently dropped the expense ratio on VXUS to .09%. It has an inception date of 1/26/11 and AUM of $12.0 billion.
Take a look at the graphic below to get a nice snapshot of some comparative portfolio composition data between VXUS and VEU. Even though I will touch on IXUS later, I included it in this graphic as well, for simplicity.
Source: Vanguard Product Comparison Tool
Next, here’s a high level look at the regional exposure of VXUS. As one key item of interest, you will quickly note that you are getting a 21.3% exposure to emerging markets as part of the overall package in this ETF.
Source: Vanguard VXUS Product Information Page
My work on Portfolio Visualizer revealed a very slight out performance of VXUS as compared to VEU. That, combined with its recently-lowered expense ratio of .09% tipped the scales in its favor over both VEU and IXUS.
Option Two: Separate ETFs for Developed and Emerging Markets
As featured in the section above, as of this writing VXUS contains an effective exposure of 21.3% to emerging markets. In other words, your emerging market exposure is set for you.
Could there, however, be a benefit in separating your international exposure into two ETFs? Sure! Here are at least three reasons you may wish to ponder.
- Control over your weighting in emerging markets. Depending on your perspective, you could eliminate any exposure to emerging markets. Or, given that our portfolio is anchored by a 50% allocation to long-term U.S. Treasuries, you could take a gamble on growth with emerging markets, perhaps splitting your international allocation 50/50 between developed and emerging markets. Since your international allocation is 20% of the overall portfolio, even a 50% allocation to emerging markets would “only” be 10% overall.
- Control over rebalancing the portfolio. Even if, for example, you allocated funds to our two ETFs in exactly the same ratio as VXUS, you have the opportunity to rebalance if either developed or emerging markets vary dramatically in their relative performance over some period of time.
- Lower expense ratio. If you decide that you wish less than 21.3% exposure to emerging markets, you may be able to slightly lower your overall expense ratio. More on that below.
If you decide to go this route, my selections in this space are the Vanguard FTSE Developed Markets ETF (VEA) and the Vanguard FTSE Emerging Markets ETF (VWO).
First of all, let’s get the matter of expenses out of the way. Both of these ETFs carry rock-bottom expense ratios for the types of exposure they offer. VEA sports an expense ratio of .07%. And VWO was one of the ETFs that recently benefited from a drop in expense ratio, now down to .12%. As featured above, then, if you do not wish to have any exposure to emerging markets, you could save .02% on your expense ratio by selecting VEA instead of VXUS.
To keep this article from getting way too long, I will simply offer links to the Vanguard product pages for VEA and VWO. Feel free to browse the specifics all you want. Take note of the inception dates (well in excess of 10 years) and their respective AUM (#6 and #8 on the current list of world’s largest ETFs). In the big picture, you are essentially getting something very similar to VXUS, but broken into two pieces such that you can control your own allocations.
Honorable Mention: IXUS and IEFA/IEMG
Before I finish this piece, I do want to leave you with two other excellent options you can consider.
The other set of ETFs come from the iShares family from BlackRock (BLK). The direct competitor to VXUS would be IXUS, already briefly referenced above. With an inception date of 10/18/12, while slightly newer than the Vanguard competitors, IXUS has established a solid track record.
IXUS tracks the MSCI ACWI Ex-USA IMI Index. According to the fact sheet for the index, with 6,272 constituents it “covers approximately 99% of the global equity opportunity set outside the US.” Please note that this index is extremely complete, including small-cap companies.
Looking at the table above, however, you might notice that IXUS “only” contains 4,419 holdings, approximately 70% of the number in the index. This is because BlackRock makes use of statistical sampling techniques to replicate the index. This technique is used when the ETF provider takes the view that the trading costs involved in attempting to purchase every security in the index would lead to a greater tracking error (or divergence from the index) than their actual practice of sampling the index.
If you wish to select option two, but use the iShares family of ETFs, my selections would be the iShares Core MSCI EAFE ETF (IEFA) and the iShares Core MSCI Emerging Markets ETF (IEMG).
Similar to IXUS, both of these ETFs are a little newer than their Vanguard counterparts, with an inception date of October 18, 2012 in both cases. With expense ratios of .08% and .14%, respectively, they are slightly higher than their Vanguard equivalents, but certainly not to any extent worth discussing. Further, in this fluid and competitive marketplace, that could change at anytime.
Again, to keep the length of this article from becoming totally unwieldy, I will simply offer links to the iShares product pages for IEFA and IEMG.
With respect to IEFA, however, there is one little note I want you to be aware of. If you were to compare the country list against Vanguard’s competitor VEA, you would notice that Canada is missing. Interestingly, Canada is included in iShares’s total-market option, IXUS. But it is left out of IEFA (and no, it’s not because it’s in IEMG). For me, the omission of one of the world’s sizeable economies is a small mark against IEFA, so I wanted to at least flag this for readers.
Final Thoughts
With that, my 5-article series on my proposed ‘perfect portfolio’ for the next 10 years, based on wisdom from Peter L. Bernstein and John C. Bogle, comes to completion. If somehow you stumbled on the series via this article for the first time, I do encourage you to go back and look at the other pieces, particularly the two foundational articles, linked in the opening paragraph of each of the 3 ETF-specific articles. Love it or hate it, at least you will know the genesis of the ideas I shared.
The work that went into this series of articles became very personal for me, as it caused me to reevaluate my own portfolio. I truly, truly, appreciate the multitude of excellent comments from readers that can be found in the comments section of the articles. There is some healthy debate around certain specifics, and that is good, because from that you may form opinions and draw conclusions of your own. In the final analysis, that it what I hope you will do, because each of our situations can be varied, and very personal.
As always, until next time, I wish you . . .
Happy investing!
Disclosure: I am/we are long IEFA, IXUS, VWO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes, and to consult with their personal tax or financial advisors as to its applicability to their circumstances. Investing involves risk, including the loss of principal.
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