Content provided by Kostya Etus, CLS Associate Portfolio Manager
At CLS, we have been focusing a lot on international investing recently. One reason is that we see a significant potential for outperformance within international equities when compared to the domestic U.S. market. This potential stems from many factors, including:
- Valuations are more attractive in international markets
- Foreign central banks are becoming more accommodative, while the U.S. Fed is in tightening mode
- More growth opportunities exist within developing economies
CLS’s emphasis on international investing makes sense to me, perhaps because I come from an international background. I was born in Novosibirsk, Russia and moved to the U.S. in the early ‘90s. That upbringing has given me a different perspective on how I view international markets. For example, I understand that there are some things that simply cannot be defined by statistical data; they have to be experienced. To be a successful international investor, and to feel comfortable wading into the global market, it’s important to understand the intangible factors that can explain a foreign culture and prepare you for the risks and rewards of global investing.
My childhood experiences in Russia serve well to illustrate some of the cultural gaps that can make international investing worrisome.
When I was a child in the old U.S.S.R., everyone made the same wages (from doctors to teachers to janitors), so life was not about how much money you made, but how well you saved. In the early ‘90s, Russia made several missteps in its monetary policy, destroying the currency and creating hyperinflation. Combine a country full of savers with a worthless currency and everyone becomes poor overnight. Can you imagine being able to buy a house with your savings on day one, only a car on day two, and nothing but a coat on day three?
Since everyone was paid the same wages, it was necessary to have multiple jobs. Many people tried to re-sell goods at the local market. But to do so, they had to make a few payments: rent for their table on the street (seems reasonable), police protection for that table (getting questionable), and finally pay-offs to the mafia to make sure nothing “bad” happened to them or their goods (no comment). The bottom line is, these types of activities did not simply apply to the local market, they were part of everyday business. There are countries today where it is common practice to pay off local officials in order to be able to do business in the area.
These examples are not meant to scare you away from international investing, but to help illustrate certain risks that cannot be quantified (such as corruption). It is important to understand all of the risks involved before investing in speculative markets, but the bottom line is that rewards from international investing often outweigh the risks over the long run.
To better explain the benefits of, and reasons for, investing internationally, I recently wrote a white paper titled “Why International: The Case for International Investing.” (The 23-page paper may seem a bit daunting but don’t worry, there are a lot of pictures. Further, I have also put together a one-page summary of the white paper that is less intimidating).
One of the main reasons to invest globally is the increasing growth of more developing countries as they catch up technologically. This creates significant opportunities for the global investor. But, aside from current market conditions, it is important to understand the simple notion of diversification and its benefits to long-term investing. Historically, globally diversified portfolios have earned superior risk-adjusted returns over the long run, compared to portfolios composed of only domestic (U.S.) equities and bonds. An analysis of portfolio volatility shows that diversification benefits get stronger as more international is added until the 30-40% range is reached. In fact, we recently bumped up the international equity holdings in our benchmarks at CLS from 20% to 40% to better reflect a fully diversified global asset allocation portfolio.
Other reasons are more social and political in nature. For example, there are trade restrictions around the world due to political issues. Another example is that there are countries where women are not freely able to work or even drive a car. Could you imagine if our workforce was reduced in half? “The times they are a changin” (Bob Dylan) and these political and social issues, as well as corruption, should subside as countries realize they have to adapt in order to grow in this ever changing global landscape.
Konstantin (Kostya) Etus is a portfolio manager on CLS’s international focused fund.
This material does not constitute any representation as to the suitability or appropriateness of any security, financial product or instrument. There is no guarantee that investment in any program or strategy discussed herein will be profitable or will not incur loss. This information is prepared for general information only. It does not have regard to the specific investment objectives, financial situation, and the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Investors should note that security values may fluctuate and that each security’s price or value may rise or fall. Accordingly, investors may receive back less than originally invested. Past performance is not a guide to future performance. Individual client accounts may vary. Investing in any security involves certain non-diversifiable risks including, but not limited to, market risk, interest-rate risk, inflation risk, and event risk. These risks are in addition to any specific, or diversifiable, risks associated with particular investment styles or strategies.
Valuation is the measurement of the current worth of an asset or company. There is no one single method to determine valuation. International investing is an investment strategy where investors chose global investment instruments. International investing can be accomplished utilizing a variety of investment vehicles including, but not limited to, ETFs, American Depository Receipts, or a direct investment in a foreign stock exchange. Diversifiable risks include, but are not limited to, political risk and currency risk.
The Equity Baseline Portfolio (EBP) is a benchmark used at CLS. Prior to November 2014, the EBP was a blended index comprised of 80% domestic equity (represented by the Russell 3000 Index) and 20% international equity (represented by the MSCI ACWI ex US Index), rebalanced daily. To better reflect CLS’s management, the EBP now is a blended index comprised of 60% domestic equity (represented by the Russell 3000 Index) and 40% international equity (represented by the MSCI ACWI ex US Index), rebalanced daily. The Russell 3000 Index is an unmanaged index considered representative of the U.S. stock market. The index is composed of the 3,000 largest U.S. stocks. The MSCI All-Countries World Index, excluding U.S. (ACWI ex US) is an index considered representative of stock markets of developed and emerging markets, excluding those of the US. An index is an unmanaged group of stocks considered to be representative of different segments of the stock market in general. You cannot invest directly in an index.