My Index Based Investments

I have mentioned in my investment bucket overview that index investing has a significant role and receives 30% of my total investment capital allocation. Although my blog is focused on dividend growth investment, today I will take liberty to discuss index based investing for my investment portfolio. As of today, I have invested a very small portion of my portfolio in SPY, EEM, and EPI. The total cumulative capital allocation for index-based portfolio is less than 8% of my original capital (against my target of 30%). This under funding for index portfolio was on purpose because of my investing rule to never invest at historical highs. While I initiated position, I did not continue to build it. I took a pause.

Now indexes all over the globe have fallen of the cliff across different markets, across different countries, and across different focus-based indexes. If not all, then the majority of them have fallen by at least 50% from their peak. With this reduction, I believe it is a good time to position myself with my choice of index funds and availability of sufficient funding. I am in the preliminary stage of identifying candidates and mentioned below are the ones to look at (with expense ratio and number of securities in the fund as of February 2009).

The objective of my index portfolio is to capture the general performance of a given market. I would like my index portfolio to capture three basic global markets viz. (1) US equity market; (2) Foreign developed market; and (3) Foreign emerging market.

US Equity Market:

Here I already have a starter position in SPDR’s S&P500 index fund (SPY). I continue to believe this is an optimal index fund for my portfolio. This gives me the representation of general equity market for the United States. At this point in time, I will not be adding into my new position. I am continuing to wait for any signs of stability in the US economy or any intangible visibility that will drive the next growth cycle.

Foreign Development Market:

This is one area where I have no index investments. I am invested in PID, which is a dividend focused investment rather than a passive market capturing position. I am evaluating the following index funds.

iShares MSCI EAFE index fund, EFA: (0.34% ER, 834 securities)

The Fund seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the MSCI EAFE Index. The Fund has been created by Morgan Stanley Capital International Inc. as an equity benchmark for international stock performance. The index includes stocks from Europe, Australia and the Far East.

Vanguard Europe Pacific ETF, VEA: (0.12% ER, 968 securities)

The Fund seeks to provide a tax-efficient investment return consisting of long-term capital appreciation. The Fund purchases stocks included in the Morgan Stanley Capital International Europe, Australasia and Far East Index. The Index is made up of approximately 1,164 common stocks of companies located in 21 countries in Europe, Australia, Asia and the Far East.

WisdomTree DEFA Fund, DWM: (0.48% ER, 640 securities)

The Fund seeks to track the price and yield performance before fees and expenses of the WisdomTree Dividend Index of Europe, Far East Asia, and Australasia. This is WisdomTree’s own developed DEFA Index.

PowerShares FTSE RAFI Developed Markets Portfolio, PXF: (0.75% ER, 1004 securities)

The Fund seeks investment results before fees and expenses that correspond generally to the price and yield performance of the equity index called the FTSE RAFI Developed ex-US Index.

Foreign Emerging Market:

Here I have a starter position in WisdomTree’s India Earning Funds (EPI). In general, when we look at emerging market index funds, one will find that India has a very low representation (more on this in a future post). I am interested in capturing the full potential of growth in India’s economy and its leading corporations. In one of my earlier posts, I provided a review of my analysis on why I selected EPI as my investment vehicle for the Indian market. In addition, I am also evaluating the following index funds.

Vanguard Emerging Markets ETF, VWO: (0.27% ER, 784 securities)

The fund seeks to track the performance of the MSCI Emerging Markets Select Index which consists of stocks that can be bought free of restrictions in 18 emerging markets in Europe Asia Africa and Latin America.

iShares MSCI Emerging Markets Index Fund, EEM: (0.72% ER, 342 securities)

The Fund seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the MSCI Emerging Markets Free Index. The Index is designed to measure equity market performance in the global emerging markets.

WisdomTree Emerging Markets Equity Fund ETF, DEM: (0.63% ER, 296 securities)

The Fund seeks to track the price and yield performance before fees and expenses of the Wisdom Tree Emerging Markets High Yielding Equity Index.

SPDR S&P BRIC 40 ETF, BIK: (0.5% ER, 40 securities)

The objective of the Fund is to replicate as closely as possible the total return performance of an equity index based upon the emerging markets. The Fund is based on S&P’s BRIC 40 Index. The Index is a market capitalization weighted index that defines and measures the investments in the universe of companies domiciled in the emerging markets of Brazil, Russia, India, and China.

iShares MSCI BRIC Index Fund, BKF: (0.72% ER, 176 securities)

The Fund seeks investment results before fees and expenses that correspond generally to the price and yield performance of the MSCI BRIC Index. The Index is a free float adjusted market capitalization index that is designed to measure the combined equity market performance in Brazil, Russia, India and China.

These will provide a good starting point for additional research. Some of the key areas that need further analysis are factors such as number of securities, exposure to ADRs/GDRs or equities in native currency, expense ratio etc. I will analyze the structure of the funds vis-à-vis my objective of capturing general market performance. I will provide updates for each market (or asset class) as I move forward with the research.

Disclosure: Long on SPY, EEM, and EPI

Comments

[sivleyd:]

Your rule to "never invest at historical highs" sounds like genius today. Most of us would like to take back our investments we held at the highs of 2007. However, I suspect you have not actually used this rule, because it doesn't really work. If you look at a long term chart of SPY, for example, you will see that almost all of the gains have generally come from highs that just keep coming. You also say that 50% down is a good time to get in. Yep! But how many times in history has that happened? There's only been one since 1871 - the Great Depression. And yes, if you were alive back then and had money to invest in 1932, you would have seen a full recovery of that 84% drop (if you got in at the very bottom moment). But then you would have sold at the next historical high. And you would have been sitting out the market since then. Yes, this is a great time to invest after a 50% drop. And ETFs are fine. Better rethink your investment rule. It hasn't worked in over 70 years!

Mar 11 07:19 AM

[donzelion:]

Your picks look a lot like my own! I've gone with VTI for US, VEA for developed market, and DEM for emerging markets.

For emerging markets, avoid any market cap weighted index and go straight for a dividend index. Here (I live, work, and rescue investors in emerging markets), unlike in the U.S., the Madoffs and Stanfords of the world are routine facts of life, rather than unusual events. The same reasons investors demanded dividends in the 30s and 50s, they should demand them here, since the regulatory regime in most of these countries compares with the capabilities of the SEC 40-60 years ago.

Mar 11 09:33 AM

[vidro3:]

how are EEM and VWO different? I would think there is a good amount of overlap between the two, no?

Mar 11 10:31 AM

[donzelion:]

There is massive overlap between VWO and EEM, and the correlation between them so tight that there's no point in picking both. Last I checked, VWO had lower fees, a much broader actual diversification, and a higher yield than EEM. However, EEM is older, bigger, and more broadly traded.

If you only want one or the other, pick the one with lower fees (try etfconnect.com for current fees). For me, I like DEM because I don't trust market cap weighted indexes in the emerging markets.


On Mar 11 10:31 AM vidro3 wrote:

> how are EEM and VWO different? I would think there is a good amount
> of overlap between the two, no?

Mar 11 01:19 PM

[Dividend Tree:]

donzelion/vidro3:
In this post, I provided the shortlist for two markets. I am working on next post analyzing which one is good of my objective. So stay tuned!

Thanks for your comments/observations!

Mar 11 01:47 PM

[tinscale:]

Both track the MSCI Index but EEM does it with 342 holdings and VWO with 784 holdings. General Question: If all else is equal, given 2 ETFs covering the same sector (energy, utilities, healthcare, etc.), is there any advantage or reason to consider the number of holdings when deciding? I haven't found any discussion of that.


On Mar 11 01:19 PM donzelion wrote:

> There is massive overlap between VWO and EEM, and the correlation
> between them so tight that there's no point in picking both. Last
> I checked, VWO had lower fees, a much broader actual diversification,
> and a higher yield than EEM. However, EEM is older, bigger, and
> more broadly traded.
>
> If you only want one or the other, pick the one with lower fees (try
> etfconnect.com for current fees). For me, I like DEM because I don't
> trust market cap weighted indexes in the emerging markets.

Mar 11 02:21 PM

[donzelion:]

"Given 2 ETFs covering the same sector , is there any advantage or reason to consider the number of holdings when deciding?"

The jury will probably be out on that point for some time to come. Seems that broad diversification "smooths" out jaggies, but doesn't translate into better performance once you get past 15-20 equities or 90% of the market cap in the sector. Fees and bid/ask spreads should make a bigger difference in most sectors.

HOWEVER, emerging markets are different. Where Enrons/Madoffs are uncommon in developed markets, you'll find at least 1-2 of them within the ranks of the top 10 companies in every emerging market, and you'll find them there all the time. Thus, broader diversification is one viable tactic for limiting impact (but a better option in my book remains dividends). (By the way, I'm speaking from experience of a different sort in some of the trickiest of the emerging markets...can't divulge details, but suffice it to say, the real money out here comes from accessing them by means other than equities, ADRs, etc.)

Mar 11 03:47 PM