Asset Allocation: GDP vs. Market Cap Weight

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Includes: EFA, EFO
by: Secular Investor

Below are the top 10 weights by market cap of the MSCI EAFE as of May 28, 2010. The question when it comes to GDP vs Market Cap Weight becomes obvious when one considers these market cap weightings, particularly considering such a large allocation to Japan. Unless you are very bullish on Japan and the UK one has to consider an alternative method to weight an allocation to EAFE countries.

Country

Weight

Japan

23.4%

United Kingdom

21.3%

France

9.9%

Australia

8.2%

Germany

7.8%

Switzerland

7.6%

Spain

3.4%

Italy

2.9%

Sweden

2.8%

Netherlands

2.6%

Why not consider a GDP weight? In fact, if you compare the annual returns of an EAFE GDP weighted portfolio against the MSCI EAFE index you’ll find the GDP approach outperforms.

02 - '09

Avg Annualized

EAFE GDP Wgt

11.15

MSCI EAFE Index

10.39

Variance

0.76

Better yet, why not consider a forward looking GDP approach using 2011 IMF forecasts of GDP. One example includes just the largest countries of EAFE, plus Canada, and includes the BRIC (Brazil, Russia, India, China) countries to gain exposure to some of the fastest growing economies in the world. Below is an example of a GDP weight portfolio using a target multiple based on one’s qualitative views to the various countries, ie a neutral weight to Canada, a 50% overweight to China, and a 75% underweight to Japan.

Country

2011

GDP %

GDP % Int'l

Target Multiple

Target

Australia

1,234.29

2.85%

4.42%

1.75

7.74%

Brazil

2,035.04

4.70%

7.29%

1.75

12.76%

Canada

1,641.90

3.79%

5.88%

1

5.88%

China

5,987.55

13.82%

21.45%

1.5

32.18%

France

2,723.49

6.29%

9.76%

0.75

7.32%

Germany

3,384.92

7.82%

12.13%

0.75

9.10%

India

1,496.51

3.46%

5.36%

1.5

8.04%

Japan

5,377.43

12.42%

19.27%

0.25

4.82%

Russia

1,733.88

4.00%

6.21%

1

6.21%

United Kingdom

2,297.45

5.30%

8.23%

0.75

6.17%

Disclosure: 65% short S&P 500, 35% cash

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