ETF portfolio: finding value in the world’s cheapest stockmarkets

Our new portfolio will pursue profit in undervalued markets worldwide.

Value is one of the few consistent predictors of investment returns, and when it comes to attempting to profit from value investing, there are plenty of ways to skin the proverbial cat.

Our new global value portfolio seeks to profit from the eight most undervalued single-country markets in the world, out of the 40 that are investable and accessible using ETFs.

Value investing: how to become a bargain-hunter investor

Spotting value

To determine value, we have used a variant of the price-to-earnings ratio (p/e) called the cyclically adjusted price-to-earnings ratio (Cape), developed by the economist Robert Shiller.

The p/e ratio is the share price of a company divided by the company’s annual earnings per share. The p/e of a market index as a whole is the weighted average of the p/e ratios of all the shares in the index. We are using the Cape because it gives a longer-term perspective on price-to-earnings ratios by averaging company earnings over the past 10 years.

To find the best-value markets, we use data published by private equity firm Star Capital Partners. In total, 40 single-country markets are counted as investable. We have chosen the eight with the lowest Cape ratios (the bottom 20%). This should provide a decent level of diversification as long as these markets are not all cheap for all the same reasons. Certain markets may have to be excluded from our portfolio because no ETFs track them.

The markets that qualify, in order of their ‘cheapness’, are those in Greece, Russia, Turkey, Poland, South Korea, Spain, Singapore and China. Valuations in these markets vary a fair amount: the market in Greece sits on a negative Cape while those in China and Singapore have Capes of more than 14 times.

Note that ETFs for Greece and Singapore are not listed in the UK, so returns are initially paid in dollars and converted into sterling by a broker.

The portfolio will be rebalanced every year, at which point any market no longer among the cheapest 20% will be jettisoned and replaced with a new entrant. All ETFs in the portfolio will be rebalanced to the equal weighting that we have started with.

Automatic rebalancing allows us to keep the portfolio oriented towards value, as it provides an opportunity to access markets that have become cheap since the previous rebalancing and discard those that have since become more expensive. It also allows us to bank gains from markets that have recovered.

At the same time, rebalancing should ease the temptation to make subjective macro or market calls – something investors have proved themselves to be generally poor at. There will be no need to deliberate about the future direction of the Turkish stockmarket or potential risks brewing in Russian equities. When we rebalance in the October 2020 edition of Money Observer, trading costs of £10 per trade will be applied.

Novel strategy

The strategy behind the portfolio comes from investment manager and writer Mebane Faber, who touches on it in his book Global Value: How to Spot Bubbles, Avoid Market Crashes and Earn Big Returns in the Stock Market. Faber opts for the cheapest 25% of markets, while we have gone for the bottom 20%.

It seems the strategy is untested, as no one has yet adopted it, but Faber has done some back-testing. According to his research, putting your money in the cheapest 25% of markets between 1993 and 2015 would have earned you an annualised return of 14.5%. Of course, past performance does not guarantee future returns.

We have opted to stick with the cheapest 20% of ETFs for ease. The practicalities of applying the strategy means markets not covered by ETFs (such as those in Portugal and Hungary) but deemed cheap are not included in our portfolio. That could have a bearing on returns, but let’s strap in and see where the ride takes us.

Portfolio based on best-value single-country markets

Country Fund Ticker Cape ratio Starting value (£) Units purchased Unit price(£) Weight (%)
Greece Global X FTSE Greece 20 ETF GREK -3.4 1,004.81 133 7.55 12.5
Russia HSBC Russia Capped ETF HRUB 7.3 996.03 102 9.75 12.4
Turkey iShares MSCI Turkey ITKY 8.3 996.45 78 12.73 12.4
Poland iShares MSCI Poland SPOL 11.8 1,005.55 65 15.43 12.5
South Korea iShares MSCI Korea IKOR 11.9 1,016.00 34 29.87 12.7
Spain Amundi ETF MSCI Spain UCITS ETF CS1 13.7 999.96 6 167.94 12.6
Singapore iShares MSCI Singapore Capped ETF EWS 14.2 1,000.64 53 18.78 12.4
China iShares MSCI China A UCITS ETF IASH 14.9 999.30 300 3.33 12.4
Total       8,018.74      

Source: ETF data, SharePad; Cape ratio, Star Capital Partners, as at 2 September 2019.

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Dividend Reinvestment

Nice idea, a similar idea to the "Dogs of the Footsie" in Money Observer on a global scale.
The article doesn't appear to spell out when and how dividends will be reinvested?

Interesting Concept, but

EWS and GREK are not available to UK investors as US ETF providers don’t produce the KID & KIID documents required under MiFiD 2, unless you can persuade your broker to designate you a professional (Interactive Brokers will allow this subject to certain requirements). Also, if you can trade the Hungarian and Portuguese markets, 3 stocks in each make up 85% of the total capitalisation of the entire market and would be a pretty good proxy

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