Why you should benchmark your portfolio against a global stock index

The strategy provides a measuring stick for gauging performance and tailoring your portfolio to underweight or overweight categories

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Real investing isn’t like collecting stamps, coins, art, or whatever. It is less about the pieces and more about how they work together towards a total return relative to risk.

Many investors simply gorge on hot companies garnering headline hype. Others focus on personally favoured regions, sectors or styles. Some just do something naive, like “low P/E” (price/earnings ratio).

My advice after five decades of running money professionally? Start by benchmarking – selecting a broad, global stock index to measure your portfolio against.

This not only provides a measuring stick for gauging performance, it also renders a blueprint for capturing the world’s full economic bounty. Let me show you how and why.

Otherwise, you will invite haphazard approaches – and stealthy risks.

How do you know if you own too much or too little of a sector? Or if your portfolio’s swings are benign wiggles or warnings of excessive risk?

How can you tell if you are positioned to capitalise on economic conditions you expect? Without a good comparative gauge the answers are guesses.

Enter benchmarking. A broad, global stock index like MSCI’s ACWI (All-Country World Index) reveals the global composition – letting you tailor your portfolio accordingly to underweight or overweight categories.

The ACWI includes stocks from 23 developed and 24 emerging markets, representing the vast majority of global stocks. Its sector, industry and country weightings are easily accessible through MSCI’s website and is updated monthly.

Crucially, the index is capitalisation-weighted – the greater a company’s market value, the greater weight its stock gets in the index – like the real world. Sensible!

Some indexes, including the oldest, the US Dow Jones Industrial Average, instead weighs holdings by share price. Same for Japan’s hallowed Nikkei 225.

Avoid them! Share price has no connection to true economic or market might, so price-weighted indexes often diverge sharply from the realities they supposedly represent.

Often, they exclude important but high-priced stocks because they would skew the index!

When we think of “The Market”, we envision a broad cap-weighted index like the S&P 500. I favour fully global ones.

Local indexes are subject to sector skew, particularly smaller markets. The world? ACWI market cap is just 16 per cent financials, 2 per cent real estate and 1 per cent telecom.

Even big regional markets are prone to serious skew. The eurozone tilts towards financials (18 per cent of market cap), industrials and consumer discretionary stocks (16 per cent each versus the world’s 10 per cent and 11 per cent, respectively).

Australia’s market is one-third financials and a quarter materials – five times the world’s.

Japan? Abundant industrials (23 per cent) and autos (11 per cent versus the world’s 3 per cent). Even the enormous US market is skewed – tech is 28 per cent of its market cap versus the rest of the world’s 11 per cent.

Using a global benchmark can mean you outperform narrower indexes, but won’t always.

Regional skew brings big booms … and busts. But, over the long haul, cap-weighted indexes’ returns should cluster narrowly.

Why? Good old supply and demand, which bars any one category from permanent leadership.

Consider: when a particular category gets hot, demand soars. Investment bankers stoke share supply to meet demand … but typically overshoot. Over years, supply outpaces demand, turning leaders into laggards. Rinse and repeat.

While bigger, broader, global benchmarks may not bring higher returns, their diversification smooths returns – and reduces risk – a big bonus. Less extreme returns mean less temptation to make emotional decisions.

After choosing a global benchmark, adjust your portfolio based on your visions.

First, do you envision a bull or bear market ahead? If you expect more of a bull market – like I do now – own slightly more of categories you expect to lead than your benchmark does … and less of projected laggards.

For me, that now means overweighting tech and big growth stocks and underweighting defensive categories – utilities, health care and staples.

Compare your performance with your benchmark’s to gauge your tilts as deft or daft.

Don’t deviate too far – you (and I) could always be wrong! Huge tilts lead to huge risk. Your benchmark is your guide to staying diversified.

Expecting a bear market? Then you might deviate drastically, decreasing equity exposure.

But beware – for investors requiring equity-like returns, ditching stocks is the riskiest move.

Do so only if seeing a huge approaching negative nearly everyone misses – not headline worries whose ubiquity assures they are already largely priced in the market.

Correctly identifying such sneaky shocks is hard – and rare.

Forget outsize, risky bets. Good investing hinges on small, tactical tilts that keep you exposed to a big, beautiful global market without ramping up risk. A good benchmark lights the way.

Ken Fisher is the founder, executive chairman and co-chief investment officer of Fisher Investments, a global investment adviser with $200 billion of assets under management.

Updated: October 03, 2023, 4:45 AM