Should We Buy Foreign Index Trackers?

I believe that Islamic banks, such as some in Malaysia, by not dealing with interest-bearing instruments, avoided any tainting of their funds by sub-prime loans. That should give their economies a certain 'edge' over the western countries... Surely? Am I right? Anyone else have a view, pls?

So is the author suggesting a universal guideline to investing here that people from a certain country are better off tracking their own markets or is this article mainly for the UK investor? In other words if I am an Indian and I live in India, is it a good idea for me to track only the Indian stock market? Would the UK FTSE 100 be too exciting for me?

anshah, on your first point, I'd say the article is clearly aimed at the UK investor, and I'm sure the author would recommend UK index trackers as good investments for anyone. On your second point: that's a very good question.

Neil, before you begin your research, may I inform you that there is a burgeoning literature on what is one of the puzzles of macroeconomics called the home bias of investors:

http://www.investopedia.com/terms/h/homebias.asp

It is a mystery to members of the academic community why investors exhibit the bias toward domestic as opposed to foreign investments when portfolio risk can (obviously) be better diversified by investing in a greater variety and number of securities.

Other problems with your position:
You quote a wonderfully long UK stockmarket time series, and point out that 3/4 of the time I will do well when making a 5 year investment, 9/10ths for ten years, but surely, the oldest adage in finance is that past performance is not necessarily a guide to future performance or am I being foolish?

Moreover, when were the sequences of poor returns observed? What if thy were they one after the other ie serially correlated? In the worst case with a sample of 100 years, there are 96 rolling periods, we would have 96-3/4*96=96-72=24 that is 28 years of bad performance, now I am 32 now, so if this were the beginning of a sequence of poor rolling periods I would be 61 be the time I saw the result of a good rolling period.

Now I agree the above worst case scenario is unlikely, but you have assumed that bad performances are just as likely to show up in any given year. I don't have the data, but I bet that there was a significantly long sequence of poor performances in the 1930s let alone the 1940s when the war was on. If one had invested in both Germany and the US as well as the UK during the thirties and forties, I bet you would have done better than a UK only tracker as Germany thrived in the thirties and the US did even better in the 1940s.

What's more, in the early part of the last century, the US was considered an emerging market, in fact I expect that even in the 1950s there were people wondering whether the emergence of the dominant US economy was something one could rely upon, whereas the tried and tested European markets of Europe that had been around for three or four centuries were surely much more trustworthy.

Your position suggests that you are a passive investor (trackers) that is unwilling to take risk (invest in UK only), that's fine, but remember the quote by Mark Twain:

"It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so."

I think this quote goes to the heart of the matter when it comes to investments and in particular those who claim emerging markets are a foolish investment in comparison to the developed ones.

In essence I agree with the criticisms of anshah and I like the active thinking of martynemh - thanks for the tip.

In market lingo good active managers offer Alpha - that is returns that are uncorrelated with the market and is special to the selection of firms the manager is invested in.

An example of a good active manager is one that knows alot about small tech firms or other niche markets and they can make exceptional returns by using their superior (in comparison to rest of the market participants) knowledge of the sector.

If you know that your manager has knowledge that few others have then you're onto to something. The problem is that most people don't, and usually they are just listening to their "Independent" Financial Advisor.

By going for actively managed funds you are essentially saying well I don't know enough about stock markets but I do know alot about fund managers and so I therefore pick a good fund manager and let him deal with the stock market for me. If so then I would love to know the name of your fund managers if your not an expert on fund managers either then I recommend trackers or ETFs.

Good luck!

pathdocall, thanks very much for this. I don't know about fund managers, but I know someone who certainly seems to, execution-only stockbroker Hargreaves Lansdown, who also refund the initial charge and part of the recurring charge in most cases. In addition to the usual kinds of research, they actually meet with fund managers on a regular basis, and move funds in and out of the preferred group (the "Wealth 150") on the basis of their findings. (This might read like an advert but I'm not associated with them in any way other than as a satisfied customer.) However, I might very well put money into one or more trackers through them, though of course they can't offer discounts on trackers as they do on funds. The advantage of doing it all through them is simplified admin, such as one on-line portal and one tax statement covering all investments.

mbga8dmf, thanks, that's helpful.

mbga8dmf,
my confusion over ETFs is there for good reasons :o) see the Economist, March 1st-7th 2008: Special Report on Asset Management.

The point I was trying to make was that ETFs offer returns that may be uncorrelated with the market, or ETFs that replicate (in an automated way) the strategies of active managers. See the Economist for more on this.