The Vanguard Total World Stock ETF (VT) replaces the Vanguard FTSE Emerging Markets ETF (VWO) in the SmallTrades ETF Portfolio. The revised portfolio will be rebalanced as needed to correct a 28% error in asset allocation.
The investment performance of VWO is declining due to unfavorable conditions in the emerging markets. Political turmoil and fragile economies in several regions of the emerging markets account for declining global productivity (1,2,3). The impact on financial markets is shown by a slight downtrend in emerging markets stock indices compared to an upsurge in developed markets stock indices (chart 1, ref 4).
The investment strategy of VWO is to track the FTSE Emerging Markets index while VT seeks to track the FTSE All-World Markets index. Chart 2 (below) is similar to Chart 1 in showing that VWO’s market prices are gradually declining while VT’s prices are steadily climbing.
The replacement of VWO by VT in the SmallTrades ETF Portfolio will satisfy the risk-management strategy of diversification. The revised Portfolio might outperform the benchmark S&P 500 total return index under favorable market conditions in years to come. Here are several lines of supportive evidence:
1) A hybrid stocks index of U.S. large-capitalization stocks (75% weighting) and emerging market stocks (25% weighting) yielded an annualized return of 6.1% compared to an 5.7% annualized return from the benchmark U.S. large-capitalization stocks. The time period was 1997-2011.
2) A model portfolio of the hybrid stocks, U.S. bonds, U.S. REITs, and precious metals indices yielded an annualized return of 8.5% compared to the benchmark 5.7% return. Equal amounts were invested in every index at the beginning of the 1997-2011 holding period.
3) VT tracks the FTSE Global All-Cap index.
4) Charts 3 and 4 ( below) summarize the 5 year performance of the revised SmallTrades ETF Portfolio as determined by an updated ETFportfolioDESIGNER2. The best rebalancing strategy is to correct a 28% “rebalance signal”.
The SmallTrades ETF Portfolio is modified by substituting VT for VWO without changing the original allocation plan. Twenty five percent of the portfolio’s market value is allocated to four asset classes represented by VT, VNQ, AGG, and the combined GLD-SGOL holdings –[comment: GLD and SGOL are operationally equivalent except that they store gold bullion in different vaults located in London and Zurich. The split vaults help protect from physical damage and theft in one vault]–. The Portfolio will be rebalanced when any asset class deviates outside the 72-128% range of expected market values.
1. Emerging markets, Locus of extremity. Developing economies struggle to cope with a new world. The Economist. 2/1/2014
2. Paul Wiseman and Joshua Freed. Markets staggered by global concerns. Associated Press. 1/25/2014.
3. Emerging economies; When giants slow down. The Economist 7/27/2013.
4. FTSE Factsheet. 12/31/2013.