Seamless, Non-Overlapping Global Portfolio Options

We were asked how a U.S domiciled investor can cover the world on a country basis with no-load, low expense ratio, index funds without creating gaps or unintended overlapping country holdings. That is probably something a lot of people would like to know. This article provides the options.

We added the requirement that the index funds be open to retail investors and not require more than $100,000 initial purchase.

DEMOGRAPHIC BACKGROUND:

The CIA Factbook identifies 237 nations on earth. MSCI identifies 48 of them as “investable” through public stock markets. We’ll leave the definition of “investable” for another time.

Within the range of China (#1 in the world by population) and Ireland, the smallest investable country in the world (#127 by population), there are 48 investable and 79 non-investable countries.

Smaller than Ireland, there are another 200 countries that are non-investable, ending with the Pitcairn Islands, population less than 50.

INDEX BACKGROUND:

We have selected MSCI indices for this excercise. MSCI is arguably the world’s leading international index provider. These are the 48 MSCI all-world countries:

Argentina, Australia, Austria, Belgium, Brazil, Canada, Chile, China, Colombia, Czech Republic, Denmark, Egypt, Finland, France, Germany, Greece, Hong Kong, Hungary, India, Indonesia, Ireland, Israel, Italy, Japan, Jordan, Korea, Malaysia, Mexico, Morocco, Netherlands, New Zealand, Norway, Pakistan, Peru, Philippines, Poland, Portugal, Russia, Singapore Free, South Africa, Spain, Sweden, Switzerland, Taiwan, Thailand, Turkey, the United Kingdom, and the United States.

The MSCI method is to market weight the countries based on “free-float”. That means, for example, that China which has a very large total stock market capitalization, has only a small weighting in the index, because most of the shares are not in the free-float.

Free-float represents those shares of a public company that are readily available for trading at any time. It excludes closely held shares, restricted shares and government held shares, for example.

There is, of course, the question of allocation weights, but that is the subject of another article.

INDEX FUND COMBINATIONS:

One Fund:

No solution

We are not aware of any no-load, low expense ratio, passive index fund that invests in all 48 MSCI investable countries.

Two Funds:

FTSE All-World ex U.S. [VFWIX or (VEU)]

Total U.S. [VTSMX or (IWV)]

The FTSE All World ex U.S. index is substantially the same as the MSCI All Country ex U.S. index with these differences: FTSE includes Luxembourg, but MSCI does not. MSCI includes Jordan, Morocco and Pakistan, but FTSE appears not to include them. It doesn’t really matter, because none of the emerging market funds invest in Jordan, Morocco or Pakistan. Those three countries may be investable in the eyes of MSCI, but apparently not in the eyes of the emerging market funds. Missing those countries would not be of concern to most investors.

Three Funds:

Total US

Total International (ex Canada) [VGTSX]

Canada (EWC)

Four Funds:

Total U.S.

Canada

EAFE (Developed Europe, Australasia, Far East) [(EFA) or VDMIX]

Emerging Markets [(EEM) or (VWO) or VEIEX]

Five Funds:

Total U.S.

Canada

Europe Developed [VEURX or (VGK)]

Asia Pacific Developed [VPACX or (VPL)]

Emerging Markets

Six Funds:

Total U.S.

Canada

Europe Developed

Asia Pacific Developed ex Japan (EPP)

Japan (EWJ)

Emerging Markets

The reason one might wish to break out Japan from EAFE and Asia Pacific is the very high weightings it has in those indices (75.6% of Asia Pacific and 23% of EAFE). Breaking out Japan allows for different weighting (up or down) and for a more granular rebalancing effort, if desired.

Seven Funds:

No solution

Eight Funds:

Total U.S.

Canada

European Monetary Union (EZU)

United Kingdom (EWU)

Switzerland (EWL)

Sweden (EWD)

Asia Pacific Developed

Emerging

This eight fund solution designed to separate the United Kingdom from the rest of Europe, requires several extra funds. The European Monetary Union does not include the UK, Switzerland, Sweden and Denmark, all of which are in the Europe index. This is an imperfect solution because there is no Denmark solution, but because Denmark is only 1.2% of the Europe index and because the UK is a full 33% of the Europe index, it may be worth the hole created by Denmark in order to manage the UK separately.

Nine Funds:

Total U.S.

Canada

European Monetary Union

United Kingdom

Switzerland

Sweden

Asia Pacific Developed ex Japan

Japan

Emerging Markets

There is no current way to break up emerging markets or developed markets more finely and still get full coverage of all 48 countries without creating overlaps.

If full but non-overlapping coverage of the investable country indices through passive management and low cost is your goal, these are your effective options.

Disclosure: Author owns some of the index funds identified.