Why I choose to diversify with an all-world index

AS A young investor (and the writer of a young-investor column), I frequently receive investment advice from well-meaning colleagues, seasoned market professionals and financial planners.

Everyone has his or her own vehicle of choice: investment-linked plans, robo-advisers, meme stocks, the list goes on. Often, what they recommend is something they have had success with.

One piece of advice I was recently given was the importance of putting at least some of my money into the Singapore stock market.

Investors are often warned of the dangers of home bias, but this person suggested to me that my exposure of a grand S$500 in the Straits Times Index (STI) put me in danger of ignoring a low-risk way to diversify my portfolio.

Is this true? Should more young investors consider dollar-cost averaging into the STI on a regular basis? I’m inclined to believe there is a better option.

In the last 10 years, the STI has significantly underperformed one of the most popular investment options: the S&P 500 index.

Between August 2014 and August 2024, the S&P 500 yielded 13.2 per cent in annualised total returns. The STI yielded just 3.3 per cent over the same period.

Such returns explain why an S&P 500 exchange-traded fund is a popular investment. Because it consists of 500 stocks, it also offers some diversification.

Of course, investors should not stop there.

In recent years, the S&P 500’s returns have been delivered by a very small number of technology-linked stocks. Also, there is every chance that the dominance of the US economy and US stocks will not continue for decades into the future.

The addition of an investment into the STI is one way for new investors to diversify their portfolios.

It has the benefit of being easy to invest in because no currency conversion is necessary. Investors also avoid taking on currency risk.

Unfortunately, the STI’s performance in the recent past does not inspire a great deal of confidence as a means of diversification.

Consider how it performs against a much more staid index: the MSCI World, which covers 1,429 large and mid-cap counters across 23 developed markets.

Over the same period under review, the MSCI World delivered an annualised total return of 10 per cent – not as stellar as the S&P 500, but still much better than the STI.

Risk versus return

Some might say the point of the investment into the STI is not to deliver outsized returns, but to act as a low-risk stabiliser in times of uncertainty.

This argument is unconvincing, in my opinion. Data from website ValueInvesting.io shows that in the last 10 years, the maximum drawdown of the STI was 27.5 per cent.

That is slightly higher than the 25.5 per cent for the MSCI World and 24 per cent for the S&P 500.

The maximum drawdown is a measurement from peak to trough, and is a commonly used indicator of downside risk.

It is not the only indicator, of course. In its worst year, the STI suffered only a modest fall of 10.8 per cent. The S&P 500, in comparison, fell 18.2 per cent; the MSCI World fell 18 per cent.

In practice, this means that the average investor would have felt far more anxiety over an investment in the latter two indices. On this measure, the STI scores well.

Finally, we turn to the Sharpe ratio. It divides a portfolio’s excess returns by the standard deviation of returns over the same period of time. Excess returns are calculated by deducting the risk-free rate from total returns.

The higher the Sharpe ratio, the better the risk-adjusted performance. Unfortunately, the STI has a negative Sharpe ratio.

I have to acknowledge here that the above numbers reflect snapshots in time. It is possible that the STI would perform better if I used a longer time span, or if I used different time periods.

At the same time, the nature of the Singapore market has changed in recent years. It does not have the pull it once did, and a backward-looking analysis incorporating a long-ago period might not be reflective of the future.

Admittedly, the same is true for any analysis of the S&P 500 and the MSCI World. These are, however, older indices with longer track records.

Their long-term outperformance has been studied many times over. Although past performance is no guarantee of future returns, it does help with peace of mind and with attracting continued inflows.

Home bias versus local knowledge

One reason investors are often warned against home bias is that it is easier to gain an edge in one’s home market. By that logic, an investor seeking diversification and Singapore currency exposure might be better off cherry-picking a few good stocks than buying the STI.

The three local banks, with a combined weightage of half the STI, have outperformed the index. Over the same 10-year period, a portfolio equally split among the three banks delivered 10.2 per cent in total annual returns – roughly on a par with the MSCI World.

The bank portfolio’s maximum drawdown was slightly high, at 31.9 per cent; but it did not do too badly in its worst year, falling 15.1 per cent. This portfolio also has a far better Sharpe ratio than the STI, at 0.37 per cent.

Banks are generally cyclical, though. Their main business is lending money, which means they will do worse in recessions. These are not safe havens.

As diversifiers, they may also be out of reach for young investors. On the Singapore Exchange, the standard board lot size is 100 shares. A single lot of DBS will cost upwards of S$3,600.

UOB shares are not too far off, although OCBC shares are cheaper. Neither, however, can compare with the low absolute spend of buying one lot of the iShares MSCI World Index ETF for about US$150 or the FTSE All-World ETF for less than US$140.

From the perspective of a young investor, the MSCI World is hard to beat in its attractiveness. Buying the index offers a cheap way of gaining exposure to many more different stocks while achieving a potentially similar rate of return.

A bonus: Singapore is on the list of the 23 countries in the index.