“Why should we own ANY international investments,” asked one of my clients while discussing their portfolio recently? Then he followed up, "With globalization, don't we get the benefits of investing internationally by just sticking with the largest US companies that do business worldwide?"
For the past several years, strong performance in the domestic stock markets has led to more of these types of questions being asked. It’s not surprising really, since domestic stocks have significantly outperformed international stock markets since 2010.
That recent outperformance can lead investors to underweight, or completely avoid, many investments that are headquartered in other countries. Too much “Home Bias”, however, can mean lost opportunities to share in the success of thousands of companies representing about half of the world's investment dollars, as seen in Exhibit 1. Many of those companies do a lot of business in the USA. Companies such as Nestle, Shell, Toyota, Anheuser-Busch InBev, Michelin, Honda, and Bayer, are just a few examples of household names that would be excluded from a portfolio comprised solely of US stocks.
Exhibit 1
For some, the question may be more about the current political and/or economic atmosphere than anything else. Keep in mind that just as trying to time the ups and downs of local stock markets is virtually impossible, determining beforehand when domestic stocks will outperform international is a guessing game, at best. As seen in Exhibits 2 and 3, there are few (if any) patterns to the performance of developed or emerging stock markets over the past 20 years.
Exhibit 2
Exhibit 3
The recent outperformance of domestic markets may also be leading to memory loss for some of us that invested during “The Lost Decade” of 2000-2009. As a reminder, that was the S&P 500®’s worst 10 year period ever, losing an average of .95% per year. World markets outside the US did considerably better. For example, the MSCI World ex USA Index averaged 1.62%, and the MSCI Emerging Markets Index had a 9.78% annualized return over that same period.
Being diversified doesn't insure against losses. It actually does guarantee that we don’t have a large percentage of our portfolios in whatever stock, industry, or country that is the big winner, or loser, in a given year. But it can lead to better outcomes overall than trying to guess those winners or losers in advance.
Looking back to 1970, the S&P 500® outperformed a globally diversified portfolio in 18 years, while underperforming 29 times. That’s not to say that we'll see a repeat of that pattern, but by investing in a globally diversified portfolio (domestic + international) such as the Dimensional Equity Balanced Strategy[1] , you may smooth out performance and avoid the extremes of attempting to pick the winner or loser.
Exhibit 4
In fact, over that same timeframe, investing in a global portfolio would have beaten the domestic portfolio over 85% of the time.
Exhibit 5
As markets gyrate, it can be tempting to try and guess what foot will be next to rise or fall. But recent events such as Brexit and the US Presidential Election have shown us that markets can, and often do, act contrary to what the conventional wisdom seems to suggest. Keep that in mind if recent news items or random opinions have you second guessing why diversification matters.
Maybe Dartmouth College’s Ken French put it best, “Diversification is about the closest thing to a free lunch in capital markets, so you may as well get a huge helping of it.”
If you’re concerned about your level of diversification, get in touch for free portfolio review. I'll even throw in lunch.
[1] Rebalanced monthly. The Dimensional Equity Balanced Strategy Index is comprised of commercial and Dimensional indices, 70% US equity indices, and 30% non-US indices. US: S&P 500, large cap value, small cap, small cap value, Dow Jones REIT; non-US: international value, international small cap and small cap value, emerging markets, and emerging markets value and small cap. Additional index information is available upon request.
