In search of an everything bagel

By Felix Salmon
May 13, 2010
worried that a set-it-and-forget-it buy-and-hold investment strategy of any description is prone to failure -- but at the same time it's fair to say that the track record of people trying to do anything more active is unimpressive. So, in a world where stocks look far too risky to invest in, what should people do with their money?

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This morning I worried that a set-it-and-forget-it buy-and-hold investment strategy of any description is prone to failure — but at the same time it’s fair to say that the track record of people trying to do anything more active is unimpressive. So, in a world where stocks look far too risky to invest in, what should people do with their money?

For any given asset class, there are good reasons to stay away. Emerging markets have a long history of disastrous sovereign crises, complete with markets going to zero. Stocks are volatile, and bonds don’t yield remotely enough to justify the risks of (a) rising interest rates; (b) default; and (c) inflation. Inflation-linked government bonds are often quite illiquid, and if you want to keep them in a constant-duration portfolio, that can damage you a lot, since you’re constantly buying and selling in order to keep the duration constant. Besides, they’re asymmetrical: the downside is always much greater than the upside, and in general debt is denial.

On the other hand, as Matt Ridley explains at length in his new book (which I review here), pretty much the entire history of humanity is a history of economic growth coming as ever-increasing numbers of people connect and trade with each other. Real Gross World Product is going to rise over the long term, especially now that the world’s population is more interconnected than ever before, and therefore it’s reasonable to assume that investments, in aggregate, globally, are likely to go up too.

A lot of people like investing in stocks because the stock market has, in the US, and over the past couple of generations, managed to outperform GDP growth. But that’s not sustainable over the long term. Stocks can grow to account for an ever-greater share of the economy, at the expense of privately-owned companies; and they can become increasingly leveraged. But both trends must come to an end, and indeed it looks as though we reached that point a while back. From there on in, the main way for stock-market growth to exceed GDP growth is if you have a bubble, and investing in bubbles is in general contraindicated.

Like most of the sensible people invested in index funds, I’d love to see a fund predicated on the idea that “I know that I don’t know”. I don’t want to be responsible for making asset-allocation decisions, because I’m not qualified to do so, and I’m likely to end up allocating assets to underperforming sectors of the global economy. So what I’m looking for is an everything bagel: an index fund or ETF which allocates its money to all the public asset classes in the world, apportioned according to market capitalization. It would include a lot of government bonds, of course, and a smattering of index-linked ones; it would have corporate debt and subordinated debt and convertibles; it would have MBSs and CDOs and securitized credit-card receivables; it would have local-currency bonds and stocks from BRICs and from frontier markets and from all the other emerging markets too; and of course it would have a large amount of money in developed-world equities too. Add the whole thing together, and you’ll have a single investment which is as diversified as you can get: a simple, unleveraged, all-in bet on the global economy.

Now the management fees on this kind of thing would probably be prohibitive if it tried to invest in hundreds of different jurisdictions and asset classes at the same time. And it would still be subject to expropriation risk as well: countries are more than capable of confiscating foreign investments, or defaulting selectively on their foreign debts. Just because you’re invested in a country, doesn’t mean your real returns will match that country’s GDP growth.

But maybe this is one of those cases where a bit of financial innovation might not go amiss: can someone invent a Gross World Product swap, a financial instrument which simply pays out (or reinvests back into itself) that year’s increase in global economic activity, as denominated in say SDRs? No one’s going to get rich investing in such things. But it would do a pretty a good job of preserving global purchasing power, and would surely serve as a useful benchmark for more active global fund managers. Although I fear to think how the people on the short side of the swap would delta-hedge their exposure.


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Emerging markets going to zero? I don’t know, maybe frontier markets.

I can agree with your position that stocks cannot outperform the economy over the very long run. However, over a period of a few decades it is possible.

“The following chart shows seasonally adjusted nominal GDP and the S&P 500 index on log scales over the entire sample period. The growth rates are both roughly exponential and of similar magnitude over the long run, with the stock market exhibiting the greater volatility.”

See Chart 1: cators/gdp-growth-and-stock-market-retur ns/

Posted by david3 | Report as abusive

You seem pretty confident that stocks can’t outperform GDP growth indefinitely, but it’s not clear (to me) why you think that.

Posted by Beer_numbers | Report as abusive

Stocks are a component of GDP, a signifier of growth in particular market segments…along with a whole host of other factors. Stocks can’t outperform GDP because to do so, every single other factor must then NOT outperform GDP. That’s not going to happen either. What’s happened so far is a big run of success, pulling the meter further and further in one specific direction…and now we’re starting to see the bounce back from other segments of the economy.

==Bob D.

Posted by REDruin | Report as abusive

You can pretty much do this with four funds. Vanguard has a low-cost US total market fund, an ex-US fund, and a total bond fund. PIMCO has the tolerable foreign bond fund. I can’t find it now but MSCI or S&P used to a have breakdown of global investable assets. You get about 95% of the way there with those four funds.

It’s true, economic growth and returns to investors aren’t the same things. Labor gets a share too: -cant-find-my-money.html

Posted by chrismealy | Report as abusive

Isn’t there a problem with using macro-economic trends (Real Gross World Product) for individual investors. Given the instability of individual working patterns over the past 30 years, increased educational costs (and extended professional training and apprenticeship) and out of reach real estate, the time horizon for investors today is usually than 40 years, and in many cases, less than 20.

Aren’t you really backing into an argument that public pensions are the best way to go?

Posted by Ninety9 | Report as abusive

I don’t see why there is any connection between what GDP growth is and what stocks can return over an indefinite horizon. Can someone explain it to me?

Posted by right | Report as abusive

Vanguard Total World Stock ETF ticker VT. also a mutual fund if you want to be less tax-efficient. close as you can get to the market portfolio in CAPM.

Posted by N.Mycroft | Report as abusive

And in the end you own a complex, opaque set of bank liabilities.

If you want the bond, buy the bond. If you want the stock, buy the stock. If you want the Gold, buy the Gold, hard and physical.

This unwillingness to bear sensible risk as an investor is irritating and a true sign of what is wrong at the core of investment decisions today.

Posted by Finster | Report as abusive

The purpose of investing is to create the ability to have a lifetime of acceptable income. Until about 25 years ago, that seemed to be the general focus with traders acting to provide liquidity. At some point in time, it switched so that the goal became to amass wealth without equating it with future income.

Unfortuantely, stocks have largely become diconnected from the concept that they have two fundamental roles:

1. Procvide capital to the issuing firm; and
2. Provide income/dividends growing at least the rate of inflation

I don’t think that this bubble and financial crisis will be over until stocks are primarily back to those fundamental purposes. That will probably require consistent dividend yields over 3%.

Posted by ErnieD | Report as abusive

Mycroft, thanks for the VT idea, I like it. Now to find a fixed-income equivalent, and we’re halfway there… I wonder, is it fair to say that a US investor should be underweight US equities, for much the same reason as Enron employees shouldn’t have invested their pension fund money in Enron stock?

Posted by FelixSalmon | Report as abusive

What about Siegel’s Constant? Didn’t he show that US markets have grown by 6% in real terms over the last 230 years? Isn’t that a long enough time to outlast bubblenomics?

It’s clear that stocks can grow faster than GDP because of operating (as opposed to financial) leverage that provides excess returns to the claimants on residual cash flow concomitant with the risk to that cash flow.

Real estate provides a claim on operating cash flow, debt provides a senior claim on operating profits, and equity provides a junior claim on net profits. Markets provide liquidity. If returns from real estate and debt are less than GDP, equity returns will be higher than GDP.

This is not that hard to figure out. But the investment returns from a global cap/issuance weighted ETF will diverge significantly from global GDP in the short-run, because of pricing inefficiencies.

Posted by Publius | Report as abusive

Felix, sorry to be blunt, but your 4th paragraph doesn’t really make any sense at all.

Stocks are not a component of GDP. At best, stock returns and GDP have some type of economic activity at their core, but they aren’t related and one doesn’t put a limit on the other.

What puts a limit on stock returns is the return of the underlying companies. Over the life of the firm, the equity investors will earn what the firm earns on its equity. Unless you think that firms are limited to earn sub-GDP growth rates on their capital (that’s an argument I couldn’t make with a straight face), there’s no reason to expect that stock returns are capped by GDP growth.

Bubbles happen when stock returns significantly outpace the returns of the underlying firms.

Posted by Beer_numbers | Report as abusive

Felix: If anything, you want to be a little bit overweight US securities (as opposed to the rest of the world), assuming you’re planning to live here the rest of your life. Your future liabilities will correlate more highly with dollar assets than with others.

Posted by dWj | Report as abusive

It’s called Global Tactical Asset Allocation, or All Assets. (see below)

Or pick a target-date retirement fund, for say, 2020-2030 – you can find some good ones with global equities, global bonds, commodities, metals, alternatives, absolute strategies.

I know you asked for a single vehicle with actual exposure to all of those non-traditional financial investments, but you really don’t need the actual exposure, you just need a close enough tracking to be comfortable, and one that doesn’t dislocate when stress is high. You can get a very good beta to your Global GDP index with three or four diverse global ETFs (low fees), and a large account at a big mutual fund house will let you make your own fund of funds, from a very broad selection. Not as easy as one, but if you can buy one fund online, you can buy 3-5.

That said, a World Allocation List:

PIMCO Global Multi-Asset Fund (PGMAX), managed by Mohamed El-Erian
- nds/profile/PMGM/portfolio_A.jsp

PIMCO All Asset Fund (PASAX), managed by Rob Arnott
- nds/profile/PMALA/portfolio_A.jsp

Barron’s: 52421827460577.html

CBS: icle/asset-allocation-funds-6-picks/3600 02/

Posted by SteveHamlin | Report as abusive

What to do with the money, as opposed to hiding precious metals under the bed? Taleb is thinking productive farmland. I’ll see him that and raise him the Amish. Invest in Amish farmers in the US, in Mexico, in Brazil, wherever they are to be found — and fund their expansion.

Shy away from investing where returns are predicated on cheap energy, and moral, labor, or regulatory arbitrage.

Posted by Sundog | Report as abusive

As Karl Marx understood well, wealth flows to those who own the productive assets. Meanwhile, promises such as bonds and more fanciful instruments can become very flaky if the issuer comes under duress. Nearly every entity, when its existence is threatened (and most entities are threatened severely from time to time), will choose preservation ahead of honoring promises.

Corporations, which can be owned via stocks, are claims on real tangible assets of productive value as well as all manner of knowledge and intellectual property. They are also actively run by people who can maneuver around all manner of taxes and regulations in the preservation of capital, while creatively seeking new opportunity at all times. Importantly, corporations can efficiently move capital across borders when it is threatened and keep capital as a diaspora for many years until it can safely return home.

Posted by DanHess | Report as abusive

It is called Global Asset Allocation, or All Assets. (see below)

Or, one could invest in a target retirement fund, say 2020-2030 – there are good ones that have global bonds, equity, commodities, metals, alternatives, absolute strategies.

While you are talking about taking actual exposure to all of these global financial alternatives, you don’t really need actual exposure to create a decent tracking portfolio against your idea. While you asked for single product ideas, a basket of three or four diversified global ETFs could get you a high beta vs. the Salmon World GDP index. You could also set up an account at a large mutual fund/ETF house and do a simple allocation among their numerous options, managing your own fund-of-funds (that defeats your ‘one product’ idea, although allocating to 5 funds within one account is not that much harder than one fund).

That said:

World Allocation fund list:

PIMCO Global Multi-Asset Fund (PGMAX), managed by Mohamed El-Erian
- nds/profile/PMGM/portfolio_A.jsp

PIMCO All Asset Fund (PASAX), managed by Robert Arnott
- nds/profile/PMALA/portfolio_A.jsp

Barron’s: 52421827460577.html

CBS: icle/asset-allocation-funds-6-picks/3600 02/

Permanent Portfolio: ldings

I agree with dWj – you don’t need to conserve global purchasing power unless you’re going to be significantly purchasing around the globe. Be more worried about preserving purchasing power in the markets you frequent – that’s a proper hedge. Going long the Thai Bhat when you don’t intend to retire there is speculating.

For a fully diversified portfolio using ETFs, I’ve been summarizing different popular investment managers approaches here: 0AitqrKgg5ChPcGZGZ2lDOVZrM0RHU1EzcVlWQ0U wSGc&hl=en#gid=10

Posted by SteveHamlin | Report as abusive

You can’t really invest in “the global market”. A huge amount of capital is tied up in productive assets whose value flows to local inhabitants, and you simply can’t buy a piece of it. (e.g., highways, public transit systems, museums, public buildings, etc.) Also, tax regimes and wage demands mean that a lot of economic output won’t flow to owners of capital in any case.

But in terms of tradeable assets, this paper ( abstract_id=1368689) claims you can do a pretty reasonable job with just a small number of positions – roughly 1/4 each in equities (MSCI All Countries) and real estate, 1/3 in bonds (gov’t, IG and HY) plus a bit of commodities (which you can now get with an ETF). The only tough one for investing is real estate. You could do a REIT index, but that only covers the US.

Posted by FosterBoondog | Report as abusive

Felix, are you INVESTING or TRADING?

If you are INVESTING, then find mature well-managed companies with a transparent and predictable revenue stream that will throw off cash for dividends, share repurchases, and strategic acquisitions for many years to come. Nor are these companies strictly tied to the stagnant GDP of the developed nations, as they are already expanding successfully into the emerging markets.

I doubt you’ll get blockbuster returns with this strategy, but you ought to be able to stay 4% to 6% ahead of inflation over the long run. And you can sleep tight knowing that these business continue to grow in both good times and bad.

Or you can gamble on the short-term mood swings of the market. If you have the stomach for that…

Posted by TFF | Report as abusive

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