What is the “market portfolio?” When I first learned of the concept in business school it seemed so simple. You just combine all of the assets in the world and hold them in proportion to their market values. Why? Because academic theory says that’s the most efficient thing you can do, and trying to beat such a portfolio is an act of futility for most investors.
Moving on to the real world, I learned a few things:
1) Everyone has a different definition of “the market.”
2) Many try to beat it (regardless of what “it” is).
3) Even those that aren’t trying to beat it don’t own anything close to what fits the academic definition.
4) Buying all of the world’s assets, and doing so at a reasonable cost, is no easy task.
With the explosion of index ETF products and a sharp reduction in fees in recent years, the goal of approximating the market portfolio has become more attainable. But still, many questions remain:
Are stocks and bonds enough (most advisors say “yes”)? If not, how many other asset classes should be included?
Are U.S. assets enough (John Bogle says “yes”)? If not, how many other countries/regions should be included?
If a broad bond index doesn’t include certain types of bonds (ex: high yield, bank loans, TIPS, municipal bonds), should you add those other bonds separately?
If a broad equity index does not include certain stocks or countries, should you add those via other vehicles?
How should you treat private equity/debt?
What about MLPs, preferred stock, and convertible bonds?
How should you treat commodities? Ignore them because futures contracts net to zero or calculate their weights based on their physical value? If on physical value is buying an ETF that buys futures contracts an accurate representation?
Should Gold be treated as distinct from other commodities? How should one weight Gold, based on how much has been mined in all eternity or how much is currently held as an investment?
Should real estate be weighted by investable asset size (including private real estate) or just the value of REITs?
Does one simply ignore things like stamp collections, jewelry, fine art, expensive wine, vintage cars, and other collectibles?
What about the value of private companies, private loans, etc.?
Should the litmus test on whether to include an asset be whether it pays interest, a dividend, or has the potential to produce earnings/cash flow? If yes, how do you treat negative yielding bonds and commodities?
For international exposure, should the weighting be currency hedged or unhedged?
Is Bitcoin an asset?
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