The Concept of the World Portfolio
💡 Take Away
The world portfolio is based on various financial theories, such as the Efficient Market Hypothesis and the Capital Asset Pricing Model (CAPM).
For private investors, globally diversified index funds are suitable. These aim to represent the global economy while minimizing risk through broad diversification.
Financial professionals develop different implementations of the world portfolio, such as the ARERO World Fund and Multi-Factor Investing.
Theoretical Background
By combining some of the financial theories, the foundation is created for the rationale behind investing in a world portfolio.
Markets Are Efficient
Efficient Market Hypothesis (EMH): efficient markets reflect all available information in their prices
- If we assume that markets are efficient, then a stock has a value of X because it accurately reflects all relevant information.
- As a result, it is impossible for an individual investor to consistently outperform the market in the long run.
- This means that market forecasts published by analysts are ultimately irrelevant.
Capital Asset Pricing Model (CAPM)
This model focuses on pricing in financial markets, specifically the relationship between expected return and expected risk.
The higher the risk, the higher the return.
It has proven useful for private investors, which is why it serves as a theoretical foundation for investing in a world portfolio.
Why a World Portfolio?
To minimize risk, there is one key tool: diversification.
- The maximum level of diversification is achieved by investing in everything available (which is why the term “world” is used in “world portfolio.”)
- While no world index can truly capture everything, it provides broad exposure at low costs.
Diversifying
- avoid individual company risk, which is inherent in stock picking (selecting individual stocks)
- minimize regional risk, helps eliminate the so-called “home bias”—a psychological tendency where investors prefer to invest in companies from their home country.
With a buy-and-hold strategy, you avoid the gambling-like nature of market timing. Successfully predicting the best times to enter and exit the market is extremely difficult. By holding your investments for the long term, you eliminate the reliance on luck.
How Is the World Portfolio Implemented?
Different people implement the world portfolio concept in different ways.
ARERO World Fund
- ARERO: “Aktien – Renten – Rohstoffe” (stocks – bonds – commodities)
- The fund allocates 60% to global stocks, 25% to European bonds, and 15% to commodities.
Gerd Kommer's Approach
- Combines global investing with multi-factor investing
- Aims to integrate multiple return-enhancing factors, such as small-cap stocks and value stocks
DIY World Portfolio with ETFs
- An MSCI ACWI-based ETF covers a large portion of the global economy.
- A 70/30 portfolio splits investments between a global index and an emerging markets index.