In search of an everything bagel
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.