Own the Financial Field With the Global Market Portfolio

Portfolio Talk

As we patiently wait for updated market data for the new year, it seems like an appropriate time to talk about “the market.” That simple term is tossed around daily in financial circles, but the true meaning is so often misunderstood that it can unfortunately perpetuate a warped viewpoint of asset allocation that leads well-intentioned people down a measurably risky path. So what is the market? And how might educated investors formulate a portfolio that tracks a true global benchmark rather than a small subset of fleetingly popular securities? The answers to those questions can be found in a straightforward but deceptively tricky to pin down asset allocation called the Global Market Portfolio.

In contrast to the many portfolios with specific asset percentages recommended by individual investing professionals, the Global Market Portfolio is the ultimate group effort. If you’ve ever bought or sold a stock, bond, home, or even just a product that helped a small business grow into a public company, you’ve played a small part in defining the asset allocation. That’s because this particular portfolio isn’t simply a collection of a few discrete assets packaged into a portfolio by a studious adviser. Think bigger. Much bigger!

Picture every possible investment around the world. That includes every stock, all types of bonds, real estate, commodities, private equity — pretty much everything you can imagine. Weight each of those investments by the total value of each asset and add it all up, and that’s the Global Market Portfolio. Simply put, you can think of it as the sum of all markets.

To express it as something a little more visual, look back at the title image to this post. Jack Bogle once famously wrote that “Don’t look for the needle in the haystack. Just buy the haystack!” While it’s true that an index fund is a well-diversified haystack, the global market is something else entirely. It’s the expansive field from which each haystack is harvested and neatly bundled. Timeless, stretching far beyond the visible horizon, and changing every moment in ways both large and small that no one set of eyes can ever appreciate.

Of course, something so vast and dynamic is also quite difficult to measure, which is perhaps why most fund providers choose to focus on smaller bite-sized markets that are easier to manage and profitably package. So it’s no wonder that even the most educated investors occasionally fall into the trap of referring to a broad US-based stock fund like VTI as the “total market” even when it’s not even close from a global perspective. To really understand the total investible market as a whole, you have to bypass easy answers and study the big picture.

While several people have written about the Global Market Portfolio, the underlying research almost invariably traces back to a set of academic papers by the trio of Ronald Doeswijk, Trevin Lam, and Laurens Swinkels who did the real legwork to gather the insane amount of data required to describe the true market as a whole. For detailed information, I recommend two of their papers here and here. They do an amazing job documenting a wide variety of global assets over time, spanning common things like equities and government bonds to trickier asset classes like private equity and emerging market debt. For example, here’s a chart from the first paper above that shows the composition of the global market at the end of 2012.

Global market portfolio at the end of 2012 (USD trillion and as %)
Figure 1 from The Global Multi-Asset Market Portfolio 1959-2012, Financial Analysts Journal

The first thing you may notice on that chart is that the total global stock market is way smaller than you probably expected from the amount of news coverage it gets. But another interesting fact is that the composition changes over time a lot more than you may realize. For example, here’s a chart I made of the high-level asset categories over time using data from the second linked study. Note that there are fewer options because they lumped similar assets together, such as including private equity in the equities allocation and grouping the different types of bonds under the same larger umbrella.

Chart by Portfolio Charts, using data from Historical Returns of the Market Portfolio, Asset Pricing Studies

While the proponents of the Global Market Portfolio often like it for the idea of simply buying assets in the current percentages and never rebalancing, if you stare at that chart long enough you may eventually notice a small problem with that plan. Most portfolio managers would probably agree that a portfolio with only one-third equities has a different risk profile than one with two-thirds equities, but the free-floating global market regularly swings between both extremes. That variability also presents a bit of a challenge in terms of backtesting, as looking at the risk and return of other fixed options next to a constantly moving target isn’t always a fair comparison. And it makes static portfolio breakdowns a bit deceptive for casual researchers as well, as if you look at the first pie chart and assume the Global Market Portfolio is far too conservative in terms of equities you may not know that the snapshot in 2012 was actually one of the lowest allocations to equities on record.

So in order to evaluate the concept in a larger historical context, I chose to look beyond the noise and study it in terms of the average global asset allocation since 1970 (the timeframe for my dataset). Think of it as averaging the 5 major categories provided by Doeswijk, Lam, and Swinkels in the previous chart into straight horizontal lines. On top of using their generalized categories for the different asset types, I also combined the data for corporate bonds under the government bond umbrella due to data availability. While it’s certainly not perfect, the 2:1 ratio of government to corporate bonds coupled with similar behavior of investment-grade corporate debt in my experience makes it a reasonable approximation for general study. And if you read the fine print of the “Market Portfolio” paper, you may be surprised to learn that the commodities they studied were dominated by 88% gold. So for both accuracy and simplicity, I allocated that entire portion to gold.

Combine it all together, and you get a surprisingly simple asset allocation that anyone can easily build to approximate the true total market.

Global Market Portfolio

  • 45% World Developed Stocks
  • 5% Emerging Market Stocks
  • 44% World Developed Intermediate Bonds
  • 4% REITs
  • 2% Gold

While not covering every possible asset one can buy, it gets you over 90% there with only 5 funds (4 if you use a World stock fund like VT that includes Emerging Markets). That’s a terrific tradeoff of coverage and simplicity in my opinion, and one that any investor can easily manage without having to resort to exotic funds for insignificantly small slices of the pie. And by using fixed long-term average percentages rather than a constantly moving percentage of stocks and bonds, it’s also really simple to keep the portfolio balanced over time even as the world waxes and wanes through larger economic cycles.

For those interested in building a Global Market Portfolio but who either don’t have access to good global stock and bond funds or want to work with the funds they already own, here are the historical average internal breakdowns based on my own research:

  • Of the 45% Developed stocks, 22% are in the USA, 10% are in Europe (including the UK), 7% are in Japan, and the remaining 6% cover other smaller countries.
  • Of the 44% World bonds, 18% are in the USA, 18% are in Europe (including the UK), and 8% are in Japan. Obviously there are more bonds in other countries, but those three regions combined make up the vast majority of the developed government bond market to the point where everything else could be considered noise.

For the US-based investors out there, take a moment to let those numbers sink in. You know how Bogle talked about buying the haystack and promoted broad US-based stock and bond index funds? Well that particular haystack is certainly pretty big but still only accounts for about 40% of the global field. There’s nothing wrong with focusing on one country if that’s what you prefer, but if you truly want to own the whole market you’re going to have to branch out!

One of the most interesting things about this particular asset allocation is that it’s truly universal across all countries rather than relying on standard domestic/international splits, so let’s look at how it performed around the world. Here’s what the Heat Map looks like for all twelve home countries I currently track.

The first thing that stands out to me is that the Global Market Portfolio has been reasonably consistent across all countries since 1980, including a few notoriously difficult markets like Japan and Italy. That’s a great sign for those looking for a portfolio not so susceptible to home country bias. That said, it also struggled pretty much across the board in the 1970s, although that isn’t too surprising considering the high percentage of stocks and bonds during a decade of stagnating stock markets, skyrocketing rates, and massive inflation. Lots of portfolios did poorly in that timeframe, and it generally takes a larger tilt towards real assets like real estate, gold, commodities to soften the blow in that economic scenario.

While the similarities are interesting, the other thing I find educational here is the differences. Lots of investors probably assume that holding the exact same funds should provide identical returns no matter where you live, but it actually doesn’t work like that. The Portfolio Charts numbers track the true purchasing power of your investments including the effects of variations in local currency and inflation, and the charts make it glaringly obvious that these oft-neglected factors make a huge difference in the investing experience. That’s why I go to so much effort to translate portfolios around the world and why I believe tools like these are so important. Common advice about important things like drawdowns and withdrawal rates written for the US market may not apply to you at all! So don’t just settle for the first portfolio that sounds nice. Put it through its paces and make sure it also works where you live rather than just looking appealing half a world away.

So long story short, to help with that portfolio exploration I’m excited to add the Global Market Portfolio to the Portfolios list and hope that the data will help people find an asset allocation they’re comfortable sticking with for the long haul. I think it’s an excellent option for investors attracted by the idea of efficient markets who are looking for a simple way to diversify their investments all around the globe without leaning too far towards any one asset or market.

The world is a big place! Take the time to understand the Global Market Portfolio, and no matter how you choose to allocate your money you’ll be a smarter and more well-rounded investor better prepared for anything that may come your way.

Help spread the word about truly global asset allocation.