30 Jan Global Market Capitalisation: Using the wisdom of the crowd to your advantage
Have you ever played the game ‘guess how many sweets are in the jar’? Did you just come up with a wild guess or did you try to count as many sweets as you could see? Either way, you probably found out that your guess was nowhere near the correct answer! Strangely though, if you took the average of all the answers given by the other participants, you’re far more likely to have been closer to the correct answer. This is what’s known as the wisdom of the crowd!
We know it’s a good idea to spread our investments across different asset classes and countries; but what exactly is the best way to do this? Should you allocate more of your wealth to the UK or the US? And what about Emerging Markets?
At Tandem, we rely on robust academic evidence to make these kinds of decisions. Our approach is to allocate portfolios broadly based on global market capitalisation.
Global market capitalisation is the measure of the value of all shares held by investors globally. It is basically where shares are invested. This can be further divided into regions and countries. As of 30th December 2016, the global stock market was valued at £38.3 trillion! UK stock markets account for just £2.2 trillion (or 6%) of this.
Even though UK stock markets represent just six percent of the value of global equity markets, many UK investors allocate around a third of their equity assets to UK stocks. This is known as ‘home bias’. The result is that these investors miss out on much of the opportunities available globally.
The global market capitalisation is very useful for asset allocation purpose because it reflects the aggregate view of how investors across the world are allocating capital. Investors will allocate more to an asset class if they believe that asset class has an increased expected return and vice versa. While it’s impossible for us to know how each of the millions of investors across the world are allocating their capital, the global market capitalisation gives us a snapshot of the collective decision. And this collective allocation of capital among investment professionals across the globe is far more accurate than that of each individual investor.
Much like the ‘guess how many sweets are in the jar’ game, allocating assets based on the global market capitalisation enables us to benefit from the wisdom of the crowd. It provides a more accurate result than trying to out-smart the crowd.
This saves us from having to second-guess which countries’ equity markets will outperform year to year. We simply rely on the cumulative knowledge of seasoned investors across the world. Of course, the world is in motion — there’s no fixed relationship between markets, and their proportion can change over time, and this is why we have to reset our allocation regularly. Looking at the world of investing this way, helps clarify our asset allocation decisions and enables us to diversify in a way that isn’t possible otherwise.
Our 2018 TRAILS™ model portfolios have been updated to reflect the current global market capitalisation which has meant some slight tweaks to the percentages allocated into some of 11 funds of which they comprise.