ACWI - VT And ACWI: How To Invest During Recession And Beyond

2023-04-28 06:31:30 ET

Summary

• Assuming that a recession is coming, relying on successfully selecting businesses shouldn't be the strategy for the vast majority of retail investors.
• There is a simple and unpopular method to stay invested, keep investing, and sleep well at night regardless of how global equities are trading.
• VT and ACWI offer investors exposure to a globally diversified portfolio of stocks, low expense ratio, low risk, and a solid and steady track record.
• An average retail investor makes a return of only around 2.9% a year, which barely covers inflation. These are individuals who are doing things opposite to the consistent acquisition of a global index fund.

Investment Thesis

The past one and a half years have been fraught with challenges for investors, as they've navigated pandemic-related disruptions, a war in Ukraine, and a greatly changing macroeconomic environment. With market areas showing signs of bubbles that are still far from being deflated, many investors are currently trying to position themselves in this dynamic environment. As portfolios are being adjusted and funds reallocated, diverse strategies are being promoted on how to invest ahead of a potential recession.

One common approach in the investing industry is the idea of a " stock picker's market ". However, it begs the question of whether it is possible, and if so, what are the chances of successfully navigating through a recession by picking stocks and having the stomach to possibly sit out a long period of poor performance of the chosen marketable securities?

Assuming that a recession is coming, relying on successfully selecting businesses shouldn't be the strategy for the vast majority of retail investors. It entails getting in and out of stocks, facing elevated volatility, tracking market developments, assessing their influence on industries or individual businesses, and ultimately making bets by putting hard-earned money at risk. Investors should ask themselves a question of whether this is how they want to utilize their time and if they are ready to watch their positions go down possibly by 50% or more.

Fortunately, there might be a way to avoid this hustle and incredible stress. There is a simple and unpopular method to stay invested, keep investing, and sleep well at night regardless of how global equities are trading. All it takes is to consistently acquire a piece of the whole market through the Vanguard Total World Stock ETF (VT) or iShares MSCI ACWI ETF (ACWI). This investment approach will result in ample returns in the future, although it's boring and unspectacular. However, it'll let an investor outperform most fund managers and retail investors by a high margin.

As market participants adjust their portfolios and reallocate their funds in this dynamic environment, this investment approach shall be considered for long-term-oriented individuals.

Active vs. Passive

Successful investing is all about common sense. As the Oracle has said, it is simple, but it is not easy. Simple arithmetic suggests, and history confirms, that the winning strategy is to own all of the nation's publicly held businesses at very low cost. By doing so you are guaranteed to capture almost the entire return that they generate in the form of dividends and earnings growth. The best way to implement this strategy is indeed simple: Buying a fund that holds this market portfolio, and holding it forever.

- Jack Boogle - Little Book of Common Sense Investing

This short quote provides most of the knowledge an investor should have to become successful by using the stock market as a vehicle to wealth. However, institutions and individuals have always been inclined toward high activity when it comes to investing which usually resulted in underperformance relative to the broad market.

Most of the readers of this article probably don't give their money to financial advisors or actively managed funds. Yet, there are quite a few individuals who invest through third parties or own financial products where they don't even realize that part of the premium goes to a fund that invests it in the markets. Thus, it's important for everybody to keep in mind how destructive are the fees charged by financial institutions to the returns.

To illustrate it, one may consider the Vanguard Total World Stock Index which has generated an average total return of 8.33% per year over the last 53 years, and an investor who starts investing at age 22 until age 65 and then continues for 20 or more years. Assuming the average mutual fund charges a cost of at least 2.5% per year, the net annual return for the average fund is just 5.83%.

Over 50 years, a $1,000 investment with monthly contributions of $500 would grow to $3,917,589.88, whereas in the average mutual fund, it would only grow to $ 1,663,618.15, resulting in a shortfall of over $2.25 million compared to the cumulative return earned in VT.

USA vs. World

Some of the greatest investors have often referred to the US Market when talking about the superiority of passive investments over actively managed funds or picking individual stocks. "I recommend the S&P 500 index fund," Buffett said, adding that most people are not wired to pick individual names and that buying and holding 500 of the largest companies in the U.S. will result in excellent returns.

Warren Buffett and those great American investors have lived and invested during the time of American dominance on the global stage. USA became the World leader after World War II and a new long-term debt cycle, which usually lasts 75 years, began. American stock market has made many people rich and betting on a basket of the biggest U.S companies has worked stunningly well. The question arises for an individual who has decades ahead is how sustainable it is to bet exclusively on America.

The United States is currently in a phase of tight monetary policy to combat inflation before an anticipated economic downturn, which may make the next few years challenging for the economy. Additionally, at the end of long-term debt cycles, where the world is now, the following major forces emerge:

• unsustainable levels of debt assets and liabilities,
• unsustainable levels of wealth inequality, values, and political polarization,
• shifts in power from older and more established countries to newer, more powerful ones.

These three forces combine to create meaningful seismic shifts in financial, political, and geopolitical orders around the world. These transitions typically involve a restructuring of domestic and/or world orders and are accompanied by broad economic, political, and geopolitical changes.

Although Buffett is naturally biased toward America while experiencing and participating in its outperformance, the international stage may be set for a major shift. Does it mean that an individual investor should avoid American stocks? No. However, being diversified across the world is less risky and may bring better returns.

Investing in the S&P 500 index through Vanguard Total Stock Market ETF ( VTI ) would have resulted in 9.65% annual returns over the last 30 years.

Investing in VT would have returned only 6.43% annually over the same period of time.

Applying these rates of return to the previous example the outperformance of VTI translates into a portfolio value of $939,696.08 against $518,321.33 after investing in VT.

Choosing between VTI and VT funds ultimately boils down to deciding whether to bet solely on the U.S. market or diversify globally. While the U.S. has historically dominated the global market, investing exclusively in VTI may not be the best strategy, as past returns are not an indicator of future returns. Investing solely in U.S. stocks means missing out on leading companies based outside the U.S., which could potentially offer better returns. No single country consistently outperforms others in the world, and any country that does outperform may become overvalued and eventually revert to the mean. With projections for lower returns for U.S. stocks in the near future and a PE multiple of 19.52, international stocks may be poised to take the lead. In fact, international stocks have outperformed U.S. stocks 96% of the time when U.S. stock returns were less than 6% and 100% of the time when U.S. stock returns were less than 4%. VT is also meaningfully cheaper on a PE basis with a multiple of 15.89.

VT vs. ACWI

Their function is to create and maintain financial market indices, which are used as benchmarks to track the performance of different segments of the market. They develop rules for selecting and weighing securities to be included in the index, and they also calculate and publish the index value at regular intervals. Index providers are typically independent third-party organizations that are trusted by investors and financial institutions to provide objective and accurate index data. Some of the most well-known index providers are:

• S&P Dow Jones Indices,
• MSCI,
• FTSE Russell.

These providers play a significant role in the financial markets by enabling investors to compare the performance of different investment strategies, and by facilitating the creation of financial products such as index funds and ETFs.

When it comes to index issuers, Vanguard and BlackRock are two of the largest in the world, with trillions of dollars in assets under management. Vanguard's VT and BlackRock's ACWI are both ETFs that offer investors exposure to a globally diversified portfolio of stocks. However, there are some key differences between the two funds.

VT is Vanguard's Total World Stock ETF, which tracks the FTSE Global All Cap Index. This index includes large, mid, and small-cap stocks from developed and emerging markets around the world, with over 9,000 holdings. VT's expense ratio is 0.07%, making it a very low-cost option for investors seeking global diversification.

ACWI, on the other hand, is BlackRock's iShares MSCI ACWI ETF, which tracks the MSCI All-Country World Index. This index covers large and mid-cap stocks from 23 developed markets and 24 emerging markets, with over 2,000 holdings. ACWI's expense ratio is slightly higher than VT's at 0.32%.

Comparison of Vanguard's VT and BlackRock's ACWI ETFs

The key difference between VT and ACWI is their approach to global equity investing. VT seeks to provide broad exposure to the global stock market by including small-cap and mid-cap companies, while ACWI focuses on large-cap companies.

ACWI may be a more appropriate option for investors looking to focus on large-cap companies, which tend to be more stable and well-established.

In terms of concentration, ACWI is more heavily weighted toward developed countries than VT. As of April 2023, the United States accounts for approximately 55% of the total assets in VT, while it accounts for around 58% of ACWI's assets. Besides that, the eight most owned counties in both funds are the same with slightly different weighing. Region breakdown is comparable though.

In terms of fund allocation, over 90% of the ACWI index composes of large-cap companies. Small-cap businesses are almost non-existent which makes VT more diversified when it comes to the companies' size. While large-cap stocks make up the majority of both funds, mid-cap, and small-cap stocks account for almost 19% of the VT fund which can be considered a meaningful portion.

Furthermore, both funds have a similar sector breakdown, with technology being the largest sector allocation followed by financials and healthcare.

Even though, there are some differences in terms of concentration, weighing, and geographies both ETFs performed similarly over the last 10 years with ACWI being slightly ahead. Total returns for VT and ACWI equal 72.11% and 75.39% respectively. This translates to compounded annual growth rates ((CAGR)) of 5.57% and 5.77%. Although these returns might not look staggering, they have been made with lower volatility and reduced risk compared to S&P 500.

Risks

ETFs may be the least risky when taking into account publicly traded securities. On the other hand, an exchange-traded fund can be comprised of unprofitable, share-diluting companies with poor fundamentals which makes it a dangerous bet rather than a low-risk investment. It's also worth remembering that past performance doesn't guarantee the future performance. A great example of all these threats is ARK Innovation Fund ( ARKK ) with the management that doesn't understand value investing and valuation. Evidence of it is ARKK's price target for Tesla ( TSLA ) and the fact that even though the fund made huge returns on the hype around the company, it's still the biggest position in its portfolio. A conservative valuation can be found in the following article .

Investing through ETFs in general involves certain risks, such as the temptation to trade frequently due to the ease of buying and selling shares from a mobile app. This can lead to emotional decisions based on short-term market fluctuations rather than a long-term investment strategy. Additionally, the simplicity and accessibility of ETFs may lead investors to overlook important details such as the underlying assets, fees, and tax implications.

If one could separate a group of the least risky ETFs, globally diversified funds being offered by reliable issuers such as Vanguard or BlackRock should be the way to go. Country, sector, management, or liquidity risks are mitigated and the only task for an individual investor is to set up a saving plan and stick to the strategy.

Conclusion

Investing in globally diversified ETFs, such as VT or ACWI, is much more advantageous for the vast majority of retail investors than buying individual stocks, actively trading, or investing in expensive mutual funds that charge high fees which erode the power of compounding.

These ETFs provide exposure to a broad range of companies across multiple regions and industries, reducing the risks associated with a concentration in individual companies or sectors. They also have low expense ratios, making them cost-effective. Moreover, they are passively managed, meaning they are not subject to the risk of underperformance due to poor fund manager decision-making. An average retail investor makes a return of only around 2.9% a year , which barely covers inflation. These are individuals who are doing things opposite to the consistent acquisition of a global index fund.

Saving through a globally diversified ETF gives an investor the important advantage of not being solely exposed to the USA, which has outperformed other countries in recent years. As mentioned, past performance does not guarantee future results, and it is impossible to predict which country or region will perform best in the future. Additionally, a globally diversified ETF allows investors to participate in the growth potential of a wide range of countries, even if some individual countries underperform in any given year.

The winning formula for success in investing is owning the entire stock market through an index fund, and then doing nothing. Just stay the course."

- John Bogle

Editor's Note: This article was submitted as part of Seeking Alpha's Best Investment Idea For A Potential Recession competition, which runs through April 28. This competition is open to all users and contributors; click here to find out more and submit your article today!

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