Rules-Based Strategy Summary: Global Value Investing
Global value investing is a strategy that involves buying index funds that track the cheapest global stock markets in the world. Adapted from Meb Faber’s book, “Global Value: How to Spot Bubbles, Avoid Market Crashes, and Earn Big Returns in the Stock Market“, this strategy builds a portfolio of ten ETFs of cheaply valued single-country markets.
In other words, buying the stock markets of countries that are cheaper than their historical norms can show huge growth potential over subsequent years.
The CAPE Ratio
The primary method that Meb uses to determine relative valuation is the CAPE ratio. The CAPE ratio was invented by Robert Schiller and is defined as:
- The cyclically adjusted price-to-earnings ratio
- A ratio used to gauge whether a stock [or other asset or groups of assets] is undervalued or overvalued by comparing its current market price to its inflation adjusted historical earnings record.
- A ratio using the average earnings over the last decade helps to smooth out the impact of business cycles and other events and gives a better picture of a company’s sustainable earning power.
The best way to understand how the CAPE ratio works is to use a table that shows the average returns of both a higher and lower CAPE ratio. This table from Meb’s research demonstrates the CAPE ratio’s benefit in providing a proxy for potentially higher or lower returns over the next 10 year period:
As you can see, when the CAPE ratio had a lower historical value (average of 10.92), the average 10-year return was 16.1%. Alternatively, when the CAPE ratio was high (23.31), then the average 10-year return was -3.3%. That is a massive difference and highlights the selling point for this rule-based investing strategy.
More Data on CAPE Ratio and Returns
Here is more data from the same paper. In this table, the U.S. stock market average returns for various CAPE levels is shown:
Pretty clear to see that the higher the 10-year CAPE ratio is, the lower the subsequent returns are over all periods of forward returns.
Let’s now look at how to build a portfolio using a Global Value Investing strategy, including where to get the data.
Rules-Based Portfolio Construction & Management
The challenge with using the CAPE ratio is obtaining CAPE ratios for each individual country. One way is to subscribe to Meb Faber’s Idea Farm. On a quarterly basis he provides the calculated CAPE ratios for investable countries.
Instead of that method, I personally use the data and tools at Research Affiliates. On their site, under the Tools menu, they have an Asset Allocation tool and available download that provides the visitor with a listing of the Expected Returns for various assets around the world. This includes expected returns for individual countries.
On the bottom of the screen there is a link to download an Excel file with all of the data to build this strategy. My personal approach is to use Research Affiliates’ expected returns values rather than just the CAPE ratio. I feel this is a more robust approach, as it takes into account more than one valuation metric to determine if the country is really that cheap.
I use the “Expected.Returns.All” tab in the downloaded spreadsheet, sort it by “Expected Return (Nominal)“, and buy the ten countries with the highest expected returns. Hence, by doing this I am buying the countries with the cheapest valuation right now.
These ten ETFs are held for a year, and the analysis is done again. Countries that have moved out of the top ten are sold and the new countries are bought.
Here is what the list of cheapest countries – highest expected returns – looks like for the data as of June 2018:
Some could argue that a holding period of 1-year is not enough. That is fair, and a longer rebalance period can be used if you want. The key is to remain consistent and let the low valuations do its work for at least a year.
The Global Value investing strategy is a long term commitment and therefore requires patience. You need to let the low valuations do their work. It may take years for the results to show, but when they do they are typically substantial.
I like the above method as Research Affiliates blends valuation metrics to come up with the expected returns. They do not rely only on the CAPE ratio. I feel this provides a more balanced approach; the results available on this site over the years will tell us if it is working or not!
- Trades country specific ETFs. See the section title “Assets Traded” below for a list of the these ETFs and where to find them.
- When ready to build a Global Value Investing, go to the Research Affiliates website and enter the Asset Allocation tool under the Tools menu.
- Click the Download link at the bottom of the page. Open the Excel file when it is done downloading.
- Navigate to the “Expected.Returns.All” sheet, and sort the list by the “Expected Return (Nominal)” column. I set up data filters on the heading row, and the sort highest to lowest.
- Buy Rules: Buy the ETFs for the 10 individual countries with the highest expected returns. Buy each ETF using an equal weighting.
- Sell Rules: One year following the set-up of the portfolio, download a new version of the above spreadsheet and sort by expected returns as above. If any countries have fallen out of the top 10, sell that country specific ETF.
- Rebalance: Replace any sold countries with the new countries that are now in the top 10. You should always have ten ETFs in your global value investing portfolio.
Research & Backtest Results
For more information and detailed research on the Global Value investing strategy, here are some key links to review. Keep in mind, the approach above differs slightly from these in terms of data use:
The backtest results of the Global Value investing strategy are from Faber’s research paper and book (linked above). What is presented below is only a subset of the detailed analysis done by Faber for the paper. For a full explanation of the results, I suggest you read the paper and book. If you are going to invest in this rules-based system, read these.
Here is a summary of the performance from Faber’s research paper:
I track real-world implementation of this version of the Global Value investing system. To see how the portfolio performs in real-time and the real world, check out all the blog posts tagged with Global Value Investing category (see sidebar).
The ETFs the strategy on this site uses are from BlackRock. They have an ETF dedicated to most investable countries around the world. You can easily search for the ETFs that match the cheap countries you need to purchase.
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