Professional Documents
Culture Documents
1.4
1.5
1.6
1.7
Vanguard........................................................................................................................................ 9
WisdomTree ................................................................................................................................. 10
iShares Europe Domicile ............................................................................................................. 10
Further Reading ........................................................................................................................... 10
1.
The index of world stock returns (capital gain plus dividends) generate over long term a real total
return of about 6 % a year, long-term world government bond indices about 2.5 % a year1
Although stocks are riskier than bonds over short term, diversified stock funds are usually less risky
than government bond funds if holding periods are longer than 15 years (if risk is definded as the
worst historical real 15-year return of US stock and bond markets). Long-term investors should
mostly invest in stocks and bonds. Bonds should be government bonds in your local currency (see
the book by Jeremy Siegel and The four pillars of investing by William Bernstein).
The best estimate for the future 10 year real return of a stock index is the current Shiller PriceEarning ratio (also CAPE or PE10). You can find the current Shiller PE values for many stock indices
by searching Google for Images. As of December 2014, the expected real long-term returns are
about 6.5 % for European and Emerging Market stock indices and only 0 % (zero percent!) for US
stock indices.
Your optimal allocation between stocks and bonds depends on your time horizon, your additional
sources of income, the expected returns2, and your stress tolerance. Imagin your stock portfolio lost
70%. If this would induce you to sell stocks, your stock allocation is too large. See here for a
questionnaire to determine your stock-bond mix.
Value stock indices, and particulary small-cap value stocks indices, give a better real return over
long-term than the total stock market index. Value ETFs have similar risk as the total stock market.
Small-cap value stocks indices have larger risk than the total stock market for short periods but
similar risk for periods of 10 years and longer.
To minimize risk, a US or Euroland investor should own about 30% foreign stocks and 70% stocks in
his own currency in his stock portfolio. An investor in a country with only few stocks in his local
currency should invest about 50% in foreign countries. In addition to this strategic stock allocation
you should fine tune your tactical stock allocation using the Shiller Price-Earning ratio. (see also
Asset Allocation over 1 and 10 Years on https://sites.google.com/site/drsuriconsulting/publications;
to try out asset allocations on historical data of various asset classes get Simbas spreadsheet from
bogleheads; for asset allocation see also the book The Four Pillars of Investing by Bernstein)
Dont ever sell stocks when they lost a lot of value. In a market downturn, if all the news look awful
and the papers are full of ghastly news, dont sell stocks, but instead buy stocks if you can (look at
historical real stock returns of stock indices in the book Stocks for the long run, by Jeremy Siegel).
Dont try to predict the ups and downs of the stock market. Neither your banker nor your newspaper
can tell you anything about future stock market prices. The funds with the best management are the
endowment funds of US universities and the Norwegen State fund. They have a crew of the worlds
best economists, and they dont try to time the market. If they dont know to predict in which direction
1 I took the average of two data sets about the geometric mean of world stock returns. One, the geometric mean 19502012 according Figure 1 in Credit Suisse Global Investment Returns Yearbook 2013; and two, the mean 1900 - 2009
Chart 4 Credit Suisse Global Investment Returns Sourcebook 2010.
2 The best return estimate for government bonds (for save countries) is the bond yield. The best estimate of their real
returns is the bond yield minus inflation.
the market moves, why do you think you know? (If you still think you know a winning strategy, run it
on historical data first)
Dont try to select the best fund management. The fund performance over recent months or years
depends mostly on chance and does not tell you anything about the future performance of the fund.
Managed funds have on average the same performance as index funds, minus the management
fees (see the book by Bogle On Mutual Funds).
Dont rely on a banker, broker or consultant to buy and sell stock, bonds or ETFs for you. Buy and
sell yourself using an online broker. As Bankers make their money by selling expensive products to
you, you cannot expect from bankers insights for asset allocation, estimates of investment risks3, or
even correct information on the fund expenses (TER) that you pay. Brokers make their money with
your transaction fees. Your long-term performance is of minor importance to bankers and brokers. If
you prefer talking to a consultant, you should pay him or her on an hourly basis and try to make sure
the consultant receives no hidden kickbacks or favors for the financial products he recommends.
Never sell investments on bad news, but only because you are going to enjoy spending the money.
I would not buy a mutual fund or ETF that is managed by a traditional bank that is also involved in
investment banking for its own accounts. Since such banks also deal with stocks for their own books,
such banks have every incentive to sell bad stocks into the fund at an inflated price. There are many
tricks to do this and some may even be legal (such as frontrunning). A bank may also use their stock
analysis first for trading on its own books and only afterwards for trading by the fund.
The management fee (TER) of ETFs or mutual funds is usually rather similar to the loss of the fund
versus the corresponding index. It should be below about 0.5% a year or less. The officially stated
TER does not include all costs and may not always be true. (The Swiss Raiffeisen Index Fonds
Pension Growth officially publishes a TER of 0.45% (Jan 2015), which appears to be grossly
understated. It is actually a Fund of Funds. The TER should include also the fees of the subfunds
according to FINMA regulations. The Raiffeisen bank did not answer my questions. The FINMA
answered that they have no mandate for punishing anybody.)
If you buy single stocks, the largest single stock position in your portfolio should be less than 2% of
the total portfolio to avoid unnecessary risks. In other words, if you invest equal amounts in each of
50 randomly-chosen stock positions, your risk is similar to buying an index ETF of the whole stock
market.
Dont buy stock ETFs of countries with large expected growth. Contrary to gut feeling, banker
recommendations and newspaper articles, historical stock maket performance of such countries was
clearly very poor. Rapid economic growth is usually not sustainable as it is often caused by asset
price bubbles or increasing debts. Furthermore, such stocks are typically overpriced.
3 UBS recommended in May 2007 to Swatch Group investing in their absolute return fund, a diversified fund of funds.
The UBS banker said that it was as save as a money market fund. However, Swatch lost half of the investment. The
fund contained investments in the US housing market. (Such investments UBS coincidelly had in its own books and had
to sell them quickly, as they lost a lot value. I am not aware of any Swiss laws that would forbid the investment fund
buying securities that got sold by the bank.) The highest court in Switzerland decided that the contract entitled
Vermgensverwaltungsvertrag had never been a Vermgensverwaltungsvertrag, as Swatch executed the trades.
Furthermore, UBS did not have to reimburse Swatch for the loss (Tagesanzeiger).
increased their stock return mostly by investments leading to increased book value. Value stocks increased
their stock value return mostly because their P/B values improved. However, according to the book Stocks
for the Long Run by Jeremy Siegel, selecting stocks by book value did not achieve overperformance in more
recent years.
In another paper entitled International Evidence.. Fama and French calculate for 1975 1995 a value
advantage of 7.6 % a year versus growth. For similar 30 years in the US they get 4% a year fr Value versus
Growth.
For MSCI EAFE 1973 2014 4% per year, for EAFE value versus EAFE Core (see web site of MSCI Barra).
For 1974 2007 I calculated for the MSCI EAFE a value advantage versus the core (core=value+growth) of
2.0 % a year (ValueEAFEGross.xls). MSCI divides in two halfs of the stock market capitalization. There was
a dip of value versus growth caused by the subprime crises.
Kwag and Lee (J. Financial Planing, Value Investing and the Business Cycle) show superior risk adjusted
returns for value investing on data ranging from 1950-2002. They found similar results for the Sharp and the
Treynor (relative to market beta) ratios of risk. P/B, P/C, P/E and P/D definitions performed much better than
the market in periods of economic contraction and expansion. P/B, P/C, and P/E definitions of value perform
slightly better than the P/D definition, in particular during economic expansions.
According the book Stocks for the Long Run by Jeremy Siegel, the highest dividend quintile gives 4 %
better performance than the SP500 over about 50 years with similar risk relative SP500 and also similar risk
in terms of standard deviation. The same is true for stocks with low price to earning ratio (the highest earning
quintile). Since currently Wisdom Europe total dividend index pays 4.5% dividend, which is about the
average of the highest 10%, Wisdomtree weighting of DEFA and Europe Dividend indices should provide
about 3.5% more return than the index, or 2.5 % after tracking errors of the ETF.
According to What works on wall street, 2012, the decile with the highest dividend yield performs only 1 %
better than the average stock market (1931-2009). Wisdomtree ETFs loose about 1% to the index. Hight
dividend stocks performed well during the inflation of the 70s and in the first 9 years of new milleneum. He
removed the tiniest and most erratic stocks, which may explain this performance. The return of combined
value strategies as in the iShares EAFE value should be 4% per year higher than that of a comparable
dividend ETF (with slightly higher risk). A combined value ETF should have about the same risk as the
market.
Small Value has much higher return than the total market or large value (see studies by Fama and French).
Small Value is over 1 year (or less) more risky than the total market. Conversely, for investors with a 10 year
time horizon (or longer), small value has similar risk than the total stock market (see my study at
https://sites.google.com/site/drsuriconsulting/publications or look at the total real return indices since the
great depression).
1.3.1 Spread
The difference in evaluation ratios of value and growth stocks is also called the spread. Publications
disagree on the usefulness of the spread for market timing. Brush (2003) finds that the spread was only a
useful predictive variable for the stock market crash of 2000-2003, but not for the decades before. Before
this crash, the spread defined by price per cash flow became huge and indeed value outperformed.
However, Cohen (Journal of Finance ca. 2002) comes to the conclusion that also before this crash the
spread was a useful predictor of the value premium. He uses the Fama and French long-term data and
defines the spread in terms of book value. The average spread in book value for some Swiss stocks can be
Figure MSCI Definitions starting March 2003. Before this date they used only book value for distinguishing value
from growth.
1.6 Growth
I dont recommend buying growth stocks. Growth is difficult to predict. Growth stocks historically peformed
worse than value stocks. The earnings of a company are basically used for paying dividends and for new
company investments. These new investments should over long term approximately equal the growth of the
stock value. So, the historical average price to earning ratio is 15. Thus the expected real return is 6.6 % a
year (100/15). If the dividend is 3%, the expected growth of the stock value should be 3.3%. If a growth stock
has a price to earning ratio of 24, it can only pay 2% in dividents and invest 2% for growth.
Newspapers often recommend to buy stocks in country with rapid growth. This advice is wrong. Studies of
historical data show that if a country has rapid GDP growth stock indices perform poorly on average. Even if
one assumes that growth was predictable, the stock return is poor. This is because the stocks of countries
with rapid growth are usually expensive in terms of price to earnings.
Trend following strategies are a type of bet on growth. They appear to work sometimes. There are several
problems:
The the set of rules is not simple, such that the historical data may be overfitted. In the future, the
rules may not work anymore.
Since we dont know why a set of rules worked in the past, we dont know what factors should lead
They require usually too much selling and buying of stocks, which causes too much fees. This
turnover may cause a substantial loss such an ETF with respect to a trend following index.
1.7.1
Plain (blend)
I mostly recommend broad index ETFs with small management fees, such as ETFs of Vanguard (VGK, or
VTRIX as a mutual fund) or iShares MSCI EAFE. They loose about 0.2% per year to the Net Return Index
1.7.2 Value
iShares offers good ETFs for value stocks that follow indices by MSCI. The selection by the rules of MSCI for
value stocks lead to historically better performance than selecting only by using the dividend (in studies
looking of the US stock market). I looked mostly at MSCI EAFE value (EFV) and iShares MSCI Emerging
markets value (EVAL). iShares value ETFs loose about 0.2-0.5% per Jahr to the Net Return Index. From
historical studies, value should win about 2.5% to the plain index (according to studies of French und Fama)
and should be equally or somewhat less risky than the plain index (see Excel sheet of Simca on
Boogleheads website).
2.
Stock and bond ETFs face some remote risks caused by the companies that create these ETFs. One would
naively expect that an index ETF somehow holds the stocks that are in the index. Unfortunately, this is
usually not the case. Instead, these companies created some tricks to generate additional income. Since
according to standard economic theory (see CAPM) this income cannot be generated without risks, the
owner of the ETF risks to loose some of his investment, if these tricks should fail one day. Although I think
such an event has never taken place, the IMF has explicitely warned about the risks of ETFs.
There are two types of ETFs, but neither of both types is without risks. ETFs domiciled in Europe are often
synthetic, ETFs in US are usually replication. Synthetic means that the stocks underlying an index are not
bought, but instead, a financial partner guarantees to pay the money corresponding to changes in the index.
Physical replication means that stocks are really bought as one would naively expect. Unfortunately, the ETF
providers usually generate some additional income by lending stocks to other companies.
Synthetic with Europe domicile is saver than synthetic with US domicile as they follow in Europe a rule that
less than 10 % of the ETF capital can be at risk (10% UCITS limit).
In the following sections I describe some of the practices of Vanguard, iShares, and WisdomTree with
respect to stock ETFs replication in European and Emerging Market indices. I am not an accountant, but
Vanguard appears to be the safest ETF provider among these three.
2.1 Vanguard
Taken together, Vanguard uses full replication strategy, not synthetic, securities lending around 5% of capital
and is fully collateralized. Here are some comments from Vanguard:
Our securities lending practices are fully disclosed in our funds annual reports, said Linda Wolohan, a
spokeswoman for Vanguard. Among those disclosures are the fact that Vanguard holds collateral from its
counterparty that is worth 102% to 105% of the securities lent out and that the borrowed securities are
valued on a daily basis. The collateral is also invested in a diversified portfolio of money-market instruments.
The Investment Company Act of 1940 provides restrictions on fund lending. According to these provisions, a
fund may lend up to 33 1/3% of its total assets. However, Vanguard funds typically lend less than five
percent of the fund?s net assets. The amount of securities on loan along with the revenue generated from
securities lending is available in the shareholder?s semiannual and annual reports. For the Vanguard
European Stock Index Fund, including all share classes, the total value of securities on loan was
$432,508,000 as of April 30, 2011, the most recent semiannual report.
A number of policies and procedures exist to mitigate risks typically associated with securities lending
process. 1. Open loans are fully collateralized with cash (102% for domestic securities and 105% for
international securities). 2. Collateral levels are measured on a daily basis to ensure that those levels
continue to meet or exceed collateral requirements. 3. Cash accepted as collateral is then invested in
Vanguard's Market Liquidity Cash Managed Trust, a pool of high quality short term money market
instruments managed by Vanguard's Fixed Income Group. 4. All loans are executed on an open basis, which
allows Vanguard to recall a security on loan at any time.
The funds are permitted to invest a maximum of 20% of its assets in derivatives. In practice, this percentage
tends to be much lower. Based upon data as of 3/31/2011, the last date such data was available, the
international funds that you owned held the following percentage of assets in derivatives: European Stock
Index Fund Admiral Shares and Vanguard MSCI Europe ETF 1.20% Total, 0.60% Futures, 0.59% Forward
Foreign Currency Contracts Vanguard Pacific Stock Index Fund Investor Shares 1.80% Total, 1.21%
Futures, 0.60% Forward Foreign Currency Contracts Vanguard Emerging Markets Stock Index Fund Admiral
Shares 0.2% Total, 0.20% Futures Total International Stock Index Fund Admiral Shares 0.0% Total
International Value Fund 9.70% Total, 3.15% Futures, 6.55% Forward Foreign Currency Contracts
2.2 WisdomTree
Taken together, WisdomTree ETFs are not synthetic, but physical replication, securities lending is up to 30%
and fully collateralized. Here are some comments from Wisdomtree:
The WisdomTree ETF's referenced in your email are long-only equity funds. Although they reserve the right
to invest in derivatives they currently do not intend to make such investments. None of these funds holds
forward contracts, swap transactions or any other instrument that would generally be considered a
derivative. As such, these Funds are not exposed to counterparty risk from derivative transactions.
Each Fund may lend its portfolio securities to approved, credit-worthy counterparties (i.e., large banks and
other financial institutions that pass the Fund's credit-review process) pursuant to written agreement. Each
Fund may loan up to 1/3 of the value of its investment portfolio. All such loans are secured by collateral
maintained in segregated accounts at the Funds' custodian. The collateral typically is equal to 102% - 105%
or more of the value of the loan. While there is some credit exposure on these loans, it is minimized by the
credit review process and the use of these segregated collateral accounts.
3.
Investors pay the taxes to the country they live in and some taxes to the domicile of the stock or ETF they
own. The following sections only deal with taxes you pay to other countries. These taxes are usually
withholding taxes on dividends of stocks or ETFs. You see these withholding taxes on the yearly tax report,
which your get from your broker.
I will try to explain the most usual cases for investing in foreign stocks (and foreign stock ETFs) in simple
words. For a more competent review, see also the-international-investor.
This is a difficult issue, there are many special cases. I only know the Swiss perspective and I am not an
expert. You should consult with an expert, if you find an affordable one, or check things out with a minor
investment.
4.
Do not click on links in E-Mails or on Websites that are supposed to lead to the login page of your
broker. This is a very common attack called phishing.
Use current antivirus software if you do banking. There is free antivirus software for Windows from
Microsoft.
Do not use your banking computer in internet cafes or on public wireless networks
Never access your bank account from internet cafs or public wireless networks
If you install programs from the internet, get them from a trusted source, such as the site of a good
computer magazine, and do some research (google the name of the software and malware)
Some attacks install key loggers on your computer that catch your passwords when you login. More
sophisticated attacks use a man-in-the-middle, which means they when you log in with your one-time
password (TAN) the screen you see and your instructions to your bank are getting manipulated. After logging
in you may see a faked maintenance screen, but in fact your money is being stolen. As such man-in-themiddle attacks can only be successful on unencrypted data, they often happen in the browser. To avoid such
such attacks you need an additional layer of security that is independent of your computer. The European
Union Agency for Network and Information Security thus recommends to use a second form of
communication to approve transactions, such text messages (SMS) on a cell phone (a smart phone needs
antivirus software too). If you are a careful person, you may thus also consider some of the following safety
precautions:
Request an independent layer of security from your broker in order to verify transactions. This can
be a code sent to a safe phone (preferably not a smart phone) or calling your broker with a special
phone password, which is not written down in your brokerage account settings.
Buy a cheap computer and use it for online banking only. This is recommended by Kaspersky, a
leading provider of antivirus software, on his German website.
Use an operating system that is safer than MS Windows or Android. Apple or Linux are safer than
Windows or Android, but attacks have happened too. There are safer options:
The Chromebook from Google seems to be the safest operating system (if you trust
Google). Google pays millions for hacking a brand new Chromebook in hacking
competitions. Google never had to pay the full amount. The Chromebook operating system
is based on Linux and there are regular automated updates of all software. The capabilities
of the operating systems are limited and are very similar to those of the Chrome browser.
A similarly safe alternative is to boot (start) your computer from a read-only CD or readonly USB-stick with a variant of Linux, such as Knoppix. You then go immediately to your
brokers website, such that you cannot catch malware. Since the boot CD is read-only, any
traces on your computer are lost once your computer is shut down. Such live-CDs can be
downloaded for free or you may get them with a computer magazine. It needs some
computer skills, though.
Your banking account is usually linked to an email address. It has happened that the email got
spammed by a hacker, such that the owner of the bank account did not notice the emails from his
bank. To avoid this and other attacks using your email, get a secret email address for your online
banking. Google gives free email accounts with options for TANs (one-time passwords) or SMS
access verification. On vacation you may access your email from a cybercaf using TANs.
Dont call your bank using your computer (with skype) or a smart phone without antivirus. Never give
your online password on the phone (but only answer to your security questions, date of birth, social
security number and similar information).
Ensure that your wireless network at home uses a new password, which has to be long and with
special characters. Since most wireless networks carelessly broadcast their name, the password has
to be long enough to avoid brute force attacks (which try our all possible passwords).
You may suspect that your e-mail and/or computer got hacked if any of the following happens:
You get pop-ups with commercials on websites that should be without such advertisement
You fully login to your account or email, but only get to see a suspicious maintenance page
4.3 Brokers
4.3.1 Risk of Broker Default
Most people know that money in bank accounts is insured up to a certain amount according to the
regulations of the country. There is a similar insurance for brokerage accounts in a case a brokerage firm
stole money from their customers. Such insurances usually pay till a maximum amount per bank customer
and till a maximum over all customers. If a county is close to bankcuptcy it can legally charge taxes in any
amount on capital assets.
Brokerage companies can run out of money and default. Usually, another company will take over the
customers and the customers will not note much. If the default is more chaotic, the documents about which
customers own what stocks may be difficult to find, and it may take some time till the customers receive their
money back. If things are even much worse, some criminals in the brokerage firm actually stole the stocks or
cash and spent the money (sorry for the simplistic languare, but I believe it is correct in its essence). In this
case, the customers can get only their investments back if the broker was insured. Different countries have
different regulations about such insurances:
US: It will usually be insured by SIPC. In this case, the investor is insured up to a portfolio (ETFs
plus mutual funds at the same company) of about 500000 USD if the total losses caused by the
brokers default are less than some billions. Vanguard has an additional insurance for larger
portfolios.
Europe: The insurance depends on the country and the portfolio is usually only insured to a maximal
Switzerland, no insurance
Singapoore, max 50000 but only if the stocks have been bought on the Singapoore exchange.
In any case, you should make sure your broker is insured by contacting the official investor protection
agency of the brokers domicile (there are fake web sites for these agencies). The investor protection
agencies also give information about many illegal tricks that you should be aware of.
There was a long discussion about brokerage fees, exchange fees and 3a Konto fees in Switzerland on
MRmoneymustache. The contributors are not as experienced as on the-international-investor.
If you trade with a Swiss broker on the Swiss exchange you also have to pay a small stamp duty
(Stempelsteuer).
4.3.6 Brokers in US
Vanguard Brokerage charges no yearly fee and only about 10 USD for a trade with 10000 USD. They offer
only accounts in USD and no trading on non-US exchanges. They probably do not take foreign customers.
Vanguard is the only broker I now who correctly recommends to minimize trading (although they make their
income partially with your trading). Their Swiss office requires minimal investments of 100000 and the yearly
fees of the mutual funds are with 0.4% much higher than for the American funds.
InteractiveBrokers.com is almost equally inexpensive, but offers access to world-wide stock exchanges (see
above).
A disadvantage of a US broker is that your heirs may have to pay US taxes if you die. All owners of stocks in
US companies, US Funds, or US bonds are subject to US estate tax if they die (Economic Growth and Tax
Relief Reconciliation Act of 2001). This tax also applies to foreigners inheriting to foreigners! This does not
apply to smaller assets: According to H.R.436 Certain Estate Tax Relief Act of 2009, there is no tax on
assets of less than 60000 USD.
For a Swiss inheriting to non-US person, this estate tax only applies if the world wide assets of the Swiss are
above 3,5 Mio. USD (Art. III DBA Nachlass-Erbanfallsteuer CH-USA).
For residents of other countries, there are similar treaties (Figure below).