When constructing a portfolio of global stocks, whether for clients or simply for yourself, it helps to have a reasonable starting point. This month, I’d like to introduce the concept of a “global neutral” equity portfolio, what that looks like, and why it may or may not be the best portfolio you could own. Let’s start with a brief definition:

A Global Neutral Equity Portfolio is one that reflects the world as it is. In other words, a global neutral portfolio looks just like the market portfolio, with each country and each security weighted by its respective market value. It is “neutral” in the sense that it avoids taking large bets (for or against) any particular country, region, asset class, or style.

What does that kind of portfolio look like today?

If you were to sum the dollar values of every individual stock that trades across the world today, you would find that U.S.-domiciled companies represent about 55% of the total world stock market. This percentage has hovered around 50-52% for many years, but recent U.S. stock market outperformance has pushed this figure a bit higher than its 21st century average. 

Foreign developed markets, including countries like Germany, France, Japan, Australia and the UK, make up about 32% of the world total. This percentage has declined in recent years from 37% not too long ago.

And finally, emerging markets, such as Brazil, Thailand, China, South Africa, and India, represent the remaining 13% of the world total. Like the U.S., this figure has been growing, but not because of market outperformance. Mainly, this growth reflects the expansion of investor access to large new public stock markets, primarily in China and India.

Now that we know the regional weights in a global neutral portfolio, which stocks would we need to buy within each country? This answer is surprisingly straightforward – all of them. By owning a tiny slice of every public stock that trades around the world, you are guaranteed to hold the purest representation of the equity asset class. More importantly, you’ve assured that you will own the very top-performing stocks that drive the bulk of equity returns.

We believe that the portfolio as described above, also known as the World Equity Index Portfolio, is not a bad portfolio at all – it is highly diversified and representative of all stocks globally. According to MSCI, this allocation earned about 10.2% annualized over the past ten years. However, it may not be the most optimal portfolio you could construct. One reason is risk – for example, emerging markets are so much more volatile than other stocks that even a 13% weight may be too high for the diversification benefits they add. 

Another reason is valuations. Because markets often “trend” in the short term but “revert to the mean” in the long term, some countries or regions can become “cheap” or “expensive” relative to other countries. These differences can persist for a long time, but by being cognizant of relative valuations, your portfolio might perform better over the long run if you “underweight” expensive regions and “overweight” the inexpensive ones.

And finally, thanks to decades of academic research, we know that some kinds of stocks have higher expected returns than others. In particular, smaller company stocks, “value” stocks, and highly profitable companies tend to do better in the long run. By overweighting these types of companies in a portfolio, you can expect to do even better than a purely neutral portfolio would imply.

Of course, the right portfolio is not the same for every investor—an appropriate portfolio needs to reflect individual goals, time horizon, and risk tolerance. Other asset classes, including bonds and real estate, are also vital components in a well-designed portfolio. But for the stock component at least, knowing what neutral looks like can be a helpful starting point.

Sources: https://www.msci.com/acwi


Disclosure: The opinions expressed herein are those of Vickery Financial Services (“VFS”) and are subject to change without notice. VFS reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. This should not be considered investment advice or an offer to sell any product.  VFS is an independent investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about VFS, including our investment strategies, fees and objectives can be found in our ADV Part 2, which is available upon request.