An Overview of Our Allocation Changes (March 2022)

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We are constantly reviewing our portfolios’ asset allocations in order to bring them more in line with our Investment Committee’s current best thinking.

Here is a summary of our recent changes.

Tilted U.S. Large Cap to Value

Recently, we elected to trim our Technology allocations back slightly and reallocate into Small Cap Value and Mid Cap Value.

This March, we also decided to change our preferred U.S. Large Cap Value fund from Vanguard S&P 500 ETF (VOO) to SPDR MSCI USA StrategicFactors ETF (QUS). With an expense ratio of 0.15%, QUS uses quality and value tilts to focus on high-quality and attractively valued firms.

This represents a further tilt toward U.S. Value and away from U.S. Growth.

Removed Hong Kong

Hong Kong has always been one of the freest countries even though it has also carried with it an expiration date of 2047. Alas, starting in 2019 and ramping up in 2020, China started the process of overtaking Hong Kong earlier than their contract said they should. In June 2020, during the uncertainty, we cut back our Hong Kong allocations slightly.

Then, in 2021, The Heritage Foundation removed Hong Kong as a ranked country entirely. As a result, we started our exit strategy from the fund. We reduced our allocations to Hong Kong and fixed our dynamic tilt so that the allocation to Hong Kong could only go down.

Now, in 2022, our Investment Committee decided to remove Hong Kong from our Freedom Investing allocations. For our hand-traded accounts, we will process this removal gradually over the course of the year, keeping in mind Capital Gains Management hurdles.

Added Austria, Sweden, and Norway

After switching to a new composite score from our analysis on the predictive power of individual subscores, we added three countries to our developed allocations: Austria, Sweden, and Norway.

In Austria , “Property rights and judicial effectiveness are strong, but government spending and tax burden score poorly.” Austria’s investable markets are composed of a balanced blend of the sectors with Financials, Utilities, Materials, Energy, and Industrials having the largest cap weights .

Sweden has a “vibrant and outwardly oriented manufacturing-based economy” with timber, hydropower, and iron ore as its main resource base. Its Industrial sector makes up approximately 36% of its investable market index . Sweden posted an impressive score this year of 98.4 in Property Rights. The Heritage Foundation explains that in 2022 Sweden saw, “increases in scores for rule of law and labor freedom overriding declining scores for business freedom and trade freedom.”

Norway saw an impressive 2.9-point overall gain since 2017. In 2022, it brags the very impressive scores of 99.6 in Property Rights, 96.6 in Fiscal Health, and 96.0 in Government Integrity. The Heritage Foundation explains, “Norway is one of the world’s most prosperous countries, and the production of oil and gas accounts for 20 percent of its economy. Other important sectors include hydropower, fish, forests, and minerals.”

These countries are represented by iShares MSCI Austria ETF (EWO) with an expense ratio of 0.50%, iShares MSCI Sweden ETF (EWD) with an expense ratio of 0.54%, and Global X MSCI Norway ETF (NORW) with an expense ratio of 0.50%.

Movement Toward an Equal Weight in Developed

Prior to 2022, we had used a size-weight, sector-weight, and freedom-weight to help determine our static country allocations. This meant that larger countries with a higher freedom score and more healthcare would receive a larger allocation.

The MSCI All Country World Index excluding the United States (MSCI ACWI ex-US) can be thought of as the default way to invest in foreign countries. It invests in all the foreign stocks of the world in exactly the proportions that they are valued in the world. Any decision to deviate from investing like this index is a choice.

In the past, we had included the size-weight (also called cap-weight) in our freedom allocations because the MSCI ACWI ex-US is cap-weighted.

However, this year, we reviewed whether a cap-weight or country-level equal weight might perform better. In a country-level equal weight, each individual country has the companies within it cap-weighted, but the allocations to each country start as an equal allocation.

To run this analysis, we used annual return data from Morningstar of the country-specific MSCI index for each country of the 22 developed countries for which we could find index return data. The equal weight portfolios were rebalanced annually.

In developed markets from January 1, 1987, MSCI EAFE saw a return of 7.54% with a COV of 2.74. Over the same time period, a country-level equal weight of the available countries saw a return of 10.70% with a lower COV of 2.16. Year over year, the average annual advantage of the country-level equal weight was +2.34%.

Because of these findings, we decided to remove the size-weight and sector-weight from our static calculations and move our allocations closer to an equal weight.

Meanwhile, we kept our freedom-weight. Our analysis of the predictive power of economic freedom suggested that higher freedom scores may poise a country for higher investment returns.

New Emerging Market Country

We are still in the process of revisiting our country-specific emerging market strategy, but even in the midst of that analysis, we decided to add South Korea to our allocations.

In the MSCI indexes, South Korea has been coded as an emerging market country. In the FTSE, South Korea has been coded as a developed country.

Because our preferred emerging market fund, Vanguard FTSE Emerging Markets ETF (VWO), tracks the FTSE Emerging Markets Index, this means that our emerging market allocations do not have South Korean exposure.

As a result, we added South Korea to our country-specific emerging market allocations.

Schwab Institutional Intelligent Portfolios (IIP)

In our algorithm-traded Schwab Institutional Intelligent Portfolios (IIP), where we are limited to only 20 exchange-traded funds (ETFs), we made several more fund changes.

Emerging Markets

In order to make room for new additions, we removed allocations to our specific Emerging Market countries of Taiwan and Chile and replaced them with an allocation to Alpha Architect Freedom 100 Emerging Markets ETF (FRDM). FRDM strives to be a freedom-weighted emerging markets equity strategy. Our target countries of Chile, Taiwan, and South Korea are among its top allocations.

For our hand-traded portfolios, we prefer the country specific funds. The expense ratio of FRDM is a higher 0.49% compared to a blend of FLKR (0.09%), FLTW (0.19%), and ECH (0.57%). However, because of the limitations of the IIP platform, FRDM provided more room for diversification.

Because the country exposure of FRDM and VWO overlap, we also reduced our allocation to VWO in order to mitigate this effect. This accidentally results in a tilt away from some of the more unfree countries of Emerging Markets such as China.

Developed Markets

In order to make room for all the new additions, we removed United Kingdom from our IIP allocations. United Kingdom is still part of our overall Freedom Investing strategy, but we ran out of room in the IIP program because of the fund limit.

In the room made by those changes, we added Sweden and Norway to the program. These countries are represented by iShares MSCI Sweden ETF (EWD) with an expense ratio of 0.54% and Global X MSCI Norway ETF (NORW) with an expense ratio of 0.50%.

Fund Changes

Finally during Schwab’s recent ETF review, they permitted the addition of Franklin funds to their IIP program. As a result, we were able to change the funds for Australia (EWA to FLAU), Canada (EWC to FLCA), and Switzerland (EWL to FLSW).

We were also able to implement our U.S. tilt to value by changing the fund for our U.S. Large Cap from VOO to QUS.

If anyone who is part of our IIP program is interested in what you could gain by switching to our hand-traded accounts, you can read about the advantages and disadvantages of each program here or email our DIY team directly to discuss.

Photo by DESIGNECOLOGIST on Unsplash

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Chief Operating Officer, CFP®, APMA®

Megan Russell has worked with Marotta Wealth Management most of her life. She loves to find ways to make the complexities of financial planning accessible to everyone. She is the author of over 800 financial articles and is known for her expertise on tax planning.