Is It Worth Investing In Cheaper Markets?
- dthenry5
- Aug 14
- 3 min read
What it is, its attributes and disadvantages. And how although the approach is currently working in most of the world’s markets, it isn’t in the US. Which is annoyingly the biggest slice of the global equity market pie.
This being the case, the obvious follow up question I think is whether we can “add value” to a globally diversified portfolio by making it less globally diversified. By tilting towards, or even excluding, certain countries’ markets.
The idea of actively moving geographical positioning toward or away from certain markets has gained a bit more traction since the turn of the year, as the rest of the world has outperformed the US for the first time in what seems like forever.
One swallow doesn’t make a summer of course, but this sort of thing makes people sit up and take notice.
Not least because the US market was, and remains, more highly valued than pretty much every other major market in the world.
If factor investors believe that cheap stocks outperform more expensive ones, then surely the same applies at a country level, right? And if we strip out the US and tilt towards cheaper markets, we might expect more bang for our buck. Right?
Not necessarily unfortunately.
Audrey Dong, Mia Huang, Mamdouh Medha at Dimensional produced a paper in 2023 looking at this question, and what they found was that there is no compelling and practical case for tactical allocation at the country level.
There is a lot going on here so let me walk you through it.
At a country level, only the Momentum and Profitability factors seem to add value reliably.
The markets of countries that hold more profitable stocks in aggregate outperformed less profitable countries’ - but only in Developed Markets. And screening for the markets of countries within Developed Markets which had momentum, which were “winning” seemed to add value - but the same was not true within Emerging Markets.
When the authors of this paper also considered whether these screens added value to a portfolio which was already factor tilted at the individual stock level, they found that only the Profitability factor within Developed Markets added material value over and above what one could expect to receive from a regular factor-tilted portfolio. And even then, it was only because of the exclusion of one country from the “highly profitable” portfolio during the sampled time - Japan.
The other downside of pursuing an approach of applying factors at a geographical level was that in order for some of these strategies to “work”, historically would have required an immense amount of “turnover" within the portfolio.
Apart from the practical considerations of successfully running a high turnover approach - trading costs money, and the need for high turnover will often kill an academic idea from becoming an investment product.
So there we go. While it might seem compelling to make bold asset allocation calls at a geographical level within your portfolio because “the US is expensive” or “the UK is cheap” or “I like Greek food” - the data would suggest that any positive results you would get from this kind of approach would be down to dumb luck, rather than attributable to any kind of investing science.
And we can see this in the classic “patchwork quilt” chart of the top stock market performers each year geographically. Pretty (totally) random.
Pretty heavy stuff this week, thanks for sticking with it.
Past performance is not indicative of future returns. None of the above is intended to represent advice to any specific individual. If you have queries regarding your individual situation, please consult a regulated financial adviser.