The Global Market Portfolio (GMP)

The global market portfolio is a theoretical representation of the aggregation of every investable asset with respective weights held constant. While there may be an ETF somewhere that attempts to mimic this, it is safe to say that the global market portfolio is an idea and does not exist in the real world. The idea of the market portfolio brings discipline to the investment process and serves as a benchmark against which to analyze portfolios.

The GMP can be the status quo asset allocation without all other information. The idea behind this is that it already reflects the supply and demand forces of the investment world and could likely be suitable for an average investor. The GMP would undoubtedly represent an improvement over a simplistic allocation such as half equity, half risk-free asset. It would benefit diversification as all prior investors have sought it out worldwide.

To begin to deviate away from the GMP, an analyst would need an articulate argument as to why it was justified in the specific case at hand.

Another advantage of using the GMP as the starting point in asset allocation selection is its intuitive usefulness in mitigating the effects of home-country bias.

Despite its use as a foundation, there are a few issues to be aware of in real-world applications of the GMP. They include:

• Non-public assets make it hard to estimate the size of markets and segments.
• Residential real estate can be challenging to simulate without a physical purchase.
• Certain investments, such as commercial real estate, can be too significant to be replicated alongside smaller asset classes in one investor portfolio.

Question

Which of the following is most likely a reason the application of the Global Market Portfolio could be subject to error?

1. Investor biases.
2. Lack of information about specific assets.
3. Sample size neglect.

Solution

The correct answer is B:

Non-public assets make estimating the size of specific markets and segments hard. For example, private investment in farms in the United States or Europe could be substantial, but as these investments are not required to be publicized as in NASDAQ or FTSE-traded stocks, knowing the exact size of the market is subject to some estimation, not an exact science.

A is incorrect. Investor biases (including sample-size neglect) are better described as reasons or using the global market portfolio rather than a reason for potential error in its use.

C is incorrect. Sample size neglect involves failing to understand that smaller samples tend to have much higher measures of dispersion, all else equal.

Reading 4: Overview of Asset Allocation

Los 4 (h) Describe the use of the global market portfolio as a baseline portfolio in asset allocation