This week I was in Montreal for the Inside ETFs Canada conference. It was a wonderful experience. I had the opportunity to meet so many folks who are readers and followers and supporters and generally ‘internet friends’. It was so nice to be able to meet, in person, so many leaders who drive the industry in regards to the innovations and awareness. The ETF industry is certainly an exciting space with an incredibly positive message and mission.
Once again, my main take away is that indexing/ETFs, an industry born of simplicity, is having a run in with complexity. The investment professionals can’t help themselves, that’s what they’re trained to do. While some of us will feel that in the investment landscape the less you do, the better your performance, others will work incredibly hard to improve upon the passive core indices and improve upon simple rebalanced asset allocation models. On that please have a read of my take on Day 1 of the conference From inside The Inside ETFs Canada conference – the state of the ETF nation.
What is truly passive investing?
I had the pleasure of participating in a panel discussion on ETF Model Portfolio construction with Rob Duncan of Forstrong Capital and Mike Philbrick of ReSolve Asset Management. Our moderator was the engaging Arthur Salzer of Northland Wealth Management. Yes, Rob and Mike were also entertaining and very knowledgeable, it was a more than interesting debate.
While Rob and I arrived armed with some model portfolio constructs, Mike Philbrick brought a monkey wrench that he threw into the ‘passive’ ETF portfolio debate. Apparently most of us are making very drastic active moves in regards to our passive ETF portfolios. And I’d have to agree that Mike is largely right. I’ll admit to my own guilt and guilty pleasures later.
Mike argued or suggested that the only truly passive approach is to own the investable assets around the globe in the proportions of their current value. It would be called The Global Market Portfolio. Any distortions from that approach is ‘an active bet’.
From Mike’s presentation …
Highlighted in the text is that even the “ubiquitous 60/40 ‘balanced’ portfolio of (mostly domestic) stocks and bonds, represent very substantial active bets relative to this global passive benchmark.”
If you have 10% Canadian equity exposure vs 3-4% – that’s an active bet. Like the US market and have 40% US exposure vs the 25% range? An active bet. No emerging market debt? Well, you know what we’re going to call you.
Mike demonstrated that an investor could grab most of the world’s investable assets with just 10 ETFs with a weighted MER of .30%.
A more than interesting suggestion with this portfolio is that is requires no rebalancing. If an investor would choose to own the ‘world’s asset allocation’ they would buy and hold to reflect the fluctuating percentages. If Canada moves from 3% of the global economy to 5%, you go along for the ride.
The problem with the Global Market Portfolio.
Of course, in the real world we have to break away from the global asset mix. It does not account for the investor’s risk tolerance level, goals and tax situation and consequences. The Global Portfolio is quite conservative with more bonds than stocks. There might not be enough growth to meet one’s goals. Of course, that’s an easy fix one could simply keep the same stock mix and dial that up as we dial down the bond exposure. By definition that would be an ‘active move’. But of course, it’s not. It’s simply adjusting the growth potential of the portfolio to match the goals of the investor. Many investors will accept the risk of a 100% equity allocation. Other investors will need to be at 80% bonds.
Adjusting for goals and risk tolerance is not active management. The world’s asset allocation does not know our goals and tolerance for risk.
And certainly Mike would and did offer that this is not an approach that would be put into play for clients. It all has to be nuanced to account for the almost endless considerations for a real life scenario.
Considerations for Canadian and US equity allocations.
During the session I did refer to research from Justin Bender of PWL Capital that the sweet spot for Canadian allocation (with respect to optimizing risk for a Canadian investor) is about 30%. There was no disagreement on that ‘fact’.
With respect to the US allocation we would have to take into account the fact that the US large cap multinationals derive considerable revenues and earnings overseas. There is embedded International exposure within the US indices. Is that taken into account within the Global Portfolio? Certainly not.
The Dividend Guy suggested that he doesn’t need International stocks, at all. From that article link, here’s the breakdown for the source of S&P 500 revenues.
I’ll admit to being a guilty party to the above line of thinking. And more.
Is the Global Portfolio passive or an asset allocation suggestion?
To tell you the truth, this is an argument that is not worth ‘having’. We’ll get lost in semantics and we’ll spin ourselves into the ground. Many will argue that there is no such thing as passive investing. Sure, I’ll have to go along with that. Every index or fund has a set of rules. Heck, the S&P 500 index has a committee that makes decisions for inclusion. Even the idea to cap-weight the index vs equal-weight is an active decision. The concept of the Global Portfolio as passive falls apart just as soon as the passive S&P 500 cap weighted index as a passive investment falls apart.
That said, there is a sizable distinction between simple rules based investing and pure active management. But it all doesn’t matter that much in the end if one has a sensible mix of the core portfolio building blocks and they keep their fees low. Most will hold Canadian, US and International equities. Most will hold Canadian bonds, and perhaps US and International bonds as well.
The most important consideration is can you be passive? Can you get out of your own way? While asset allocation is obviously important, nothing is more important than investor behaviour.
What we can learn from the Global Portfolio.
The Global Portfolio shines a light on the investable universe. Our portfolios might have some big holes. Some of the major considerations for that are REITs, US bonds, developed and developing market bonds and developing market stocks. Is there a way for you to access private equity? My readers will know that is possible by way of the Canadian Robo Advisor WealthBar. Please have a read of WealthBar review: get treated like you’re rich even when you’re not.
If you play around with portfolio modelling tools you’ll discover that the shading of the rebalanced portfolio between US, International and Canadian equities does not matter ‘that much’. But yes, we should pay attention to our Canadian home bias. Most of us are guilty of holding too much at home. That certainly is a big bet. Know the risks.
What do you think? Is the Global Portfolio the true passive portfolio? Is there even such a thing as passive investing? Fire away in the comment section.