Content Provided by Case Eichenberger, CIMA – Senior Client Portfolio Manager
Today’s topic is the favorite subject of a lot of portfolio managers and the conundrum facing many U.S. investors: Is it worth it to invest overseas? We have discussed this numerous times (and will continue to do so), but I hope the additional thoughts below help in your daily conversations with investors. Enjoy.
The Equal-Country Portfolio
Two words: risk management. Not every management firm in the U.S. believes in risk management, let alone subsists on it day-to-day like we do. We often talk about what “risk” means. Sometimes it’s volatility (the ups and downs), sometimes it’s what prevents you from realizing your financial goals, other times it’s the complete loss — or near loss — of your investment.
Bridgewater Associates, LP, released a paper on global diversification recently, and a few charts and tables caught my eye.
The data on pages four and five of the Bridgewater paper is intriguing to CLS as a global wealth manager. Put the market-cap weighting of the easily investable globe on hold for a second, and consider the risk-management effect of an equal-country weight. I know, I know. Most U.S. investors cannot handle 40% of their stocks in foreign equities, so how could they handle this? Well, we believe it might be worth prodding them to do so.
Bridgewater’s research shows additional decades, but the data above brings home the point of price appreciation (in USD) of these markets. We believe equal-weighting may enhance returns and, more importantly, manage risk. I think I know what you may say next: This is interesting, but it doesn’t matter because it was not easy to invest in those markets back then.
You’re right. But now we can. Markets are becoming more connected; technology allows that. Technology also allows us to access these markets cost efficiently via ETFs.
CLS research analyst Michael Hadden and I reviewed the ETF landscape, including the funds that were live before 2000, to see if we could replicate the findings for the 2000s and 2010s.
The results look similar. Today, we can invest in close to 50 single-country ETFs. We believe using more of these ETFs going forward will improve the chance that equal weight will deliver strong returns and risk management. Note that a lot of firms do this already inside the S&P 500 Index by equal-weighting the stocks.
The table below, pulled from CLS’s Why International: The Case for International Investing white paper, helps illustrate this, too. We believe the stronger or higher the return dispersion, the better equal-weighting works.
Why Overseas Investors Performed Well
A quick glance at the returns of the 2010s shows that the U.S. (S&P 500 Index) is the clear winner. There is no other country better, right? But, actually, your friends living overseas performed better during this decade. How?
Investors located in Europe, Japan, Brazil, the U.K., and China beat U.S. investors by investing in our own beloved companies. Currency effects are the reason, and they’re often overlooked.
The data below, gathered by Bloomberg, shows how those local investors performed. They all did better than U.S. investors. And you thought we had it good! The gist of it is that the U.S. dollar appreciated against other currencies, boosting international investors’ returns more than ours.
Takeaway? Currency effects matter. They can help and hurt, but they do help diversify. Note: The S&P 500 Index is usually accessed via UCITS (Undertakings for the Collective Investment in Transferable Securities, which regulates the sale of mutual funds across Europe) by investors in other countries, such as those in Europe.
Now Show Japan
There is a popular saying in investment blogging: “Now show Japan.” Basically, it means that every investment argument can be undone by the Japanese bubble in the late 1980s. Here’s what happened (source: Bloomberg).
In the 1980s, the Japanese market straight crushed it. It almost doubled the U.S., and the consensus at the time was that Japan was taking over the investable world.
Then, it happened – a bubble that crashed the market, which has never recovered.
The table below shows returns for the next decade. The enthusiasm for Japanese stocks fell off a cliff, whereas the U.S. market did very well (before our own bubble popped in the early 2000s).
What’s the takeaway? It’s not that Japan is a terrible investment and investors should avoid it, it’s that having your wealth dependent on the market of a single country is a risky endeavor.
The chart on page six of the aforementioned Bridgewater paper illustrates this further, and it shows how diversifying to other countries will help in drawdowns. After all, the U.S. saw the fifth largest contraction ever in financial markets during the Great Depression.
In the end, we believe risk management (CLS’s Risk Budgeting) and diversifying to other countries is a prudent strategy. Now, more than ever, you can gain access to global markets in a single trade at little cost. This trend shows no sign of slowing.
CLS’s investors understand this and expect us to find opportunities all across the globe, which continues to become more connected.
Thanks for reading.
The S&P 500 Index is an unmanaged composite of 500-large capitalization companies. This index is widely used by professional investors as a performance benchmark for large-cap stocks. 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.