24 Feb 2014, 12:53pm
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  • Vanguard Lifestrategy has a lot going for it. Shame you have to buy it all at once

    One of the places the lazy index investor gets pointed to is Vanguard’s Lifestrategy – a sort of all-in index fund that tracks the whole world and rebalances automatically, without all the stress of doing it yourself. Buy regularly every month, sit back and forget for 20 years. I was looking at this for Mrs Ermine’s ISA.

    Trouble is, at the moment 30% of LS is made of highly priced stuff  like the US , that is on exceptionally high valuations at the moment and unpleasantly high by CAPE, and along with another 30% composed of the UK which looks like this

    As Clint would say, do you feel lucky, punk? Well, do you?

    As Clint would say, do you feel lucky, punk? Well, do you? Remember that money was worth more in 2000 so its’ not quite as good as it looks, but one would clearly be buying high

    The UK and the US together  makes up over a two thirds of Lifestrategy so it would be a nasty headwind to buy into now. On the other hand, a portfolio roughly diversified like Lifestrategy is where I’d like to be in about 8 years time. An evil thought comes to mind – what about buying the cheaper parts first 😉 Let’s lift the lid and look at what’s in there.

    Vanguard Lifestrategy isn’t the MSCI World

    I’d always assumed this is a worldwide index from the way people talked about it, but it turns out this is not the case. The US flavour of this is quite different from the UK version – if you take a butcher’s hook at the geographical spread of the latter

    Vanguard UK Lifestrategy 100% Eq geographical allocation

    Vanguard UK Lifestrategy 100% Eq geographical allocation

    There’s a long tail but I’ve caught about 90% of the allocation. And it’s not what I expected, which would be more something like the MSCI world index.

    MSCI World composition

    MSCI World composition

    To be fair, MCSI World is still about 80% developed world at least. The very heavy UK weighting of VGLS100% – presumably comes from the view UK investors will typically show a home bias. As shown in my portfolio – I’m easy with that. I am surprised that the UK is as much as 9% of the MCSI investable universe, whereas the US being more than half doesn’t really surprise me that much. Lifestrategy has the advantage of being a recipe for a diversified portfolio which comes along with a handy benchmark. There are lots of other ways of thinking about diversifying, but taking Lifestrategy to bits is a lazy win.

    Let’s take a look at what it’s made of (straight filched from Trustnet)

    Note: I had the bad luck to post this just as Vanguard made notable changes to Lifestrategy, so the exact values are incorrect. Take a look at the comments for the latest lowdown – thanks for the heads up!

    21.9% VANGUARD US EQUITY INDEX ACC
    21.6% VANGUARD FTSE DEVELOPED WORLD EX UK EQUITY INDEX ACC
    16.7% VANGUARD FTSE UK EQUITY INDEX ACC
    11.6% VANGUARD FTSE DEVELOPED EUROPE EX UK EQUITY INDEX ACC
    11.1% VANGUARD FTSE U.K. ALL SHARE INDEX
    8% VANGUARD EMERGING MARKETS STOCK INDEX ACC GBP
    5.8% VANGUARD JAPAN STOCK INDEX ACC GBP
    3.3% VANGUARD PACIFIC EX JAPAN STOCK INDEX ACC GBP

    Total 100.00%

    Lifestrategy 100 – diversification roughly where I want to be in ~ 8-10 years’ time

    So this is the sort of balanced asset allocation where I want to be in 8-10 year’s time. That’s when I will have stopped contributing to my ISA. Obviously it’s a moving target. The world of 10 years from now may have a larger EM allocation, because, well, some of those markets may have emerged and therefore be that much bigger. I’ve ranked these components into high-level categories and roughly summarised the balance of VGLS from it’s components. There are inconsistencies – Developed world ex UK is polluted with a lot of US. However, since some of my aim is to steer the long term balance towards something like VGLS using some of those Vanguard funds that make up VGLS that data error doesn’t matter so much.

    So where am I now (uk l is UK large, FTSE100 big fish, UK m s is medium small UK shares). FWIW I didn’t design it to be this unbalanced. Some of those big UK fish just grew. They’ll probably shrink in years to come, looking at the current valuations…

    where I am now. I'm skewed somewhat by The Firm that I can only sell off in sub CGT lumps

    where I am now. I’m skewed somewhat by The Firm that I can only sell off in sub CGT lumps, but I’m also skewed by the HYP that also holds UK big fish

    It’s easy enough to add up ten years worth of ISA savings and estimate what the target value is (added to what I have already, which will be the foundation).

    Where do I want to be (this is my estimate of Lifestrategy’s composition)

    an esitmate of the current Vanguard Lifestrategy allocations

    an estimate of the current Vanguard Lifestrategy allocations

    And the standard index investing mantra is go like a good little indexer and buy VGLS100A every month, and hold. But I haven’t got where I’m now by indexing, I’ve got there by buying what people hated. Two thirds of the composition of VGLS100 it is on or near all-time highs! Not only that, I’d have to sell off my HYP. I don’t want to buy high, I want to buy low. At the moment, f’rinstance, that EM index is a lot cheaper than the US index fund

    EM versus US index fund prices

    EM versus US index fund prices

    Kinda makes sense to go buy that wodge of EM first, since it appears to be on sale at the moment, whereas buying the US index at the moment seems to be like going to Harrods? I’m going to aim for what’s cheap – well, to about 3/4 of the ISA allocation. And I’ll dial back on buying the VUSEIDA for the moment – sometime in the coming years there’ll be a market swoon in the US, and that will be the time to go for that. That will probably be at the same time as a general developed world market rout. So loading up on EM isn’t a bad, and the Pacific ex Japan VAPEJPA:ID has also shown lacklustre performance of late. I don’t currently have anything in that space, either

    Strategic Diversification over several years – buy what people hate 🙂

    It’s often said that the FTSE100 gets most of its earnings from abroad, so it is more geographically diversified than non-UK indices 1 which I’ve relied upon to feel easier about such a shockingly heavy home bias. I also don’t suffer the sectoral swings I’d take from the FTSE100’s varying composition because I choose the HYP shares, and I have tried to sector diversify these

    The aim is to end up with roughly the same asset allocation as Lifestrategy once I’ve reached steady state – I will have enough income to live on but not enough to invest fully into the ISA after I’ve shifted my pension AVC fund into it over quite a few years. To actually achieve Lifestrategy’s asset allocation I’d have to sell off some of my HYP. I’m not going to do that, so I will always be more UK-heavy than Lifestrategy. But I will try and build a more balanced  Lifestrategy-like portfolio, buying the assets I don’t currently have when they are cheap. I am lucky in that I bought the current UK stuff when it was cheap, I wouldn’t want to try and do that right now. Taking a look at the performance of the individual  components that make up VGLS

    The Lifestrategy constituents.

    The Lifestrategy constituents.

    In this comparison it’s clear that you can buy VIEMKT 2 for the same price as a couple of years ago. Now obviously it may still tank, but reversion to the mean indicates it’s less likely to do that than something that has been riding high. If I want to own a certain amount of this in a few years time I may as well buy it when it is on sale 🙂 The Japan fund also looks a bit sick, I guess Abenomics isn’t quite as good as the FT makes out here. If there’s ever an asset that deeply scares me, it’s anything to do with Japan, it’s been in a permanent tailspin throughout my working life. It’s the investing equivalent of Montgomery’s

    Rule 1, on page 1 of the book of war, is: “Do not march on Moscow”. Various people have tried it, […] and it is no good. That is the first rule.

    Field Marshal Bernard Law Montgomery

    And correspondingly, throughout my working life, you could say

    Rule 1, on page 1 of the book of investing, is: “Never invest in Japan”. Fortunes have been lost in the quicksands there

    Fortunately the calculated Lifestrategy weighted equivalent of what I want on this index isn’t too bad. If I can find a way to drip-feed that I can live with the expected loss. I don’t expect this to do other than go down the pan, but that’s one of the conundrums of diversification and trying to buy low. You have to buy stuff that looks bad at times, just like those income trusts did in 2009/10. Even stuff that looks bad and has always looked bad for my economically active lifetime – I suspect Japan is diworsification.

    Nothing shows you quite like this the opportunities you might get to buy things when they’re on sale if you take a few years about it.

    Callan's Periodic Table of Investment returns - see how EM has gone from hero to zero to hero to zero

    Callan’s Periodic Table of Investment returns – see how EM has gone from hero (2009,2010) to zero (2011) to hero (2012) to zero (2013). This is US biased, but 2013 was the year of the developed world

    Now the thesis of Lifestrategy indexing is you buy a vertical slice, weighted appropriately. Repeatedly, over many years. I want to buy a horizontal slice over about 8 years. From the lower half of the Table 🙂 If you look at Lifestrategy, a good two-thirds of the weighting in US and UK, throw in dev xuk and you’re running at three-quarters developed world. All that is riding high at the moment. So if you buy Lifestrategy now you’re buying a lot of stuff that’s at high CAPE valuations. I don’t need to do that.

    That high valuation doesn’t matter terribly much if it’s one year out of 40 – you’re only buying 1/40th of your total capital savings at a high valuation. One of the other years could have been 2008, when everything was down the toilet, and you’d have got a great deal 😉 The next time within the next 10 years when the developed world is in the pits again you’ll get good value too. Indexing is great if you invest the money as you earn it, over decades. Which most people do.

    But I’ve only got another eight years of contributory investment life ahead of me, because I have absolutely no human capital left, so I am not generating income myself and investing that. I don’t want to  buy Lifestrategy now, because it means buying 60-75% of dear assets and highly correlated with what I have already. It isn’t right for me, and general index investing isn’t right for me either because of my short contributory time horizon and existing asset spread. However, selective indexing I haven’t got an objection to, I’m not going to go stock-picking in non UK markets. VGLS100 is a pretty good model of a diversified portfolio with free benchmark. I just don’t want to buy all the bits at the same time.

    I don’t buy the US at the moment because I focused on winning income from a UK HYP. As a comparison of the Vanguard US and UK components shows there is notable correlation between the two, at least over the last five years.

    Vanguard US and UK, rebased to GBP

    Vanguard US and UK, rebased to GBP

    I’m not going to buy the UK index either (because my HYP is plenty enough) and it looks like my UK bias has been standing acceptable proxy for the US market because of this dev world correlation. It’s a pleasant surprise – remember the dark days of 2009 when the developed world economy had been destroyed and emerging markets were going to charge over the parapet and eat all our lunch 3? The trouble is that people tend to overestimate what will happen in the short term and underestimate what will happen in the long term. Popularised by Bill Gates

    We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten. Don’t let yourself be lulled into inaction.

    It made him rich, though I do recall the Internet caught Bill napping. Anyway, I suspect the developed world’s lunch is still being coveted. And I wouldn’t like to be lulled into inaction, and kick myself five, ten years off for having failed to buy some EM exposure when it was going for a song. Obviously if I’d started in July 2009 then I’d have got it 40% cheaper

    40% cheaper in 2009...

    VFEM still 40% cheaper in 2009, though we had over 10% inflation since then

    I’m not going to buy it all in one go, but I will  spread myself out across the year. VFEM is an ETF in this space, and TEMIT seems to be on a 6% discount at the moment. Emerging markets seem to have a history of currency crises and market train wrecks, though that’s kinda rich given the near-death experience the First World went through recently.

    I favour actively passive. Not passively active 😉

    Notes:

    1. according to that study revenues for the French CAC and German DAX are similarly overseas-derived
    2. or some equivalent, like the ETF VFEM. I can’t see VIEMKT on TD Direct, though their Vanguard fund choice is weak. Interactive Investor seems to offer it for sale
    3. I’m not asserting second sight here; I felt that way too!
     
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