Kuta Beach

Kuta Beach

Saturday, 8 September 2007

The Problem with Australian Shares

I invest in Vanguard and have all my money in the Australian shares index fund that tracks the S&P/ASX 300. I am worried that I am underdiversified because the top Australian companies tend to be resource and finance companies.

Bogle says you should invest only in American firms, but that is tantamount to a religious person believing only his religion is right because he was born and bred that way. It's emotional reasoning based on instincts of trust and familiarity. I remember reading an article at DFA (Dimensional Funds Advisors) by Eugene Fama that claims that if indexers were serious about applying correct weights they would invest 60 per cent of their wealth overseas and 40 per cent in America, but most people irrationally invest in their own country. Investing in your own country can be rational if investing in a foreign country is more expensive, but more on average it is not and if it is the costs differences are negligible.

Vanguard Australia offers LifeStrategy Funds that invest in multiple areas. The High Growth Fund invests in about 40% Australian shares, 20% International Shares, 20% property trusts, 3% emerging markets, and so on. The fees are slightly higher if you are investing under $100,000 but over that the fees are no different to those funds that track only Australian shares. What I want to know is whether these LifeStrategy Funds are in the spirit of Bogleism. They are better diversified, but the 40% invested in Australian shares is arbitrary and selected by the experts at Vanguard. This then is similar to active investing. The whole point of indexing is to remove human judgment of stock selection and market timing and to establish rule of law instead. However, these LifeStrategy funds seem to encourage human judgment in how much to assign to different indexes, e.g. how much should you put into emerging markets? How is this any different to stock picking, which is active management? If indexing is to be taken to the logical extreme then wouldn't we have to index the whole world?

I have asked this question at Wisebread.

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