I’m part of a group that tries to make financial advisors better by sharing insights with each other. The topic came up in regards to how other advisors view international equity exposure. Some advisors had a heavier international allocation, others had very little, and one advisor claimed that international investing was a “scam”.
PSA: Off topic, but reconsider financial advisors that get overly emotional about an investment style (thinking international investing is a scam) or bring politics into the investment decision.
I didn’t/couldn’t give advice in that forum, but I essentially let the advisor know there are a few things to consider from a long-term strategic standpoint or a shorter-term tactical standpoint:
Long-Term Strategic Considerations
Do you believe there are high quality, growing companies with investments (stocks/bonds) trading at attractive valuations outside of the U.S.? I personally believe that the U.S. is not the only country in the world that have solid companies to invest in. I’m a global investor, but that’s just me. Some of the strongest companies and brands exist outside of the U.S., including products that you utilize every day. Some of the weakest companies or most expensively valued companies exist in the U.S. that you may want to avoid.
Did you exhaust all of your investment options in the U.S.? The U.S. financial markets are the most liquid and most diverse in the world. I find it hard to believe that a long-term investor cannot find investment options to consider in the U.S. If you are only focused on large cap companies, then yes, maybe consider options outside of the U.S. If you open up your investment universe across market caps, sectors, industries, corporate credit, structured credit, private investments, etc. in the U.S., you may not need international exposure at all to get the return objectives you are looking for.
Are you willing to have performance that potentially looks very different than the U.S. markets? This is probably the biggest hurdle as it’s an emotional factor, not a fundamental factor. If you have 30% of your assets in international markets that are down in a year that the U.S. markets are positive, how will you handle it? What if it is multiple years of international market underperformance relative to the U.S., like we’ve had in the last several years? Will you capitulate and give up?
How much do you care about portfolio risk/return metrics and rebalancing opportunities? One reason for diversification outside of the U.S. is that different countries may have business/investment cycles different than that of the U.S. There may be periods where the U.S. does well and Europe does poorly economically, or Asia does well and both the U.S. and Europe do poorly. Or maybe emerging markets and higher potential economic growth becomes more attractive than the slowing developed world. Having different economic/geographic regions performing well at different times can actually help reduce overall investment portfolio volatility. If the returns are “forecasted” to be similar in each country’s home Investment index (i.e. S&P 500 in the U.S.) over a 10 year period, but they perform differently in different shorter-term time periods, you have the potential to buy low in the underperforming market, and sell high in the outperforming market.
Just this simple rebalancing strategy can add value over time. If you do not care about this rebalancing strategy or won’t actually execute it, and you believe U.S. markets will perform similarly to international markets anyway, then having international exposure may not add much benefit to you. If you believe you can correctly time when to allocate across U.S. and international markets on shorter-term tactical positioning, then it may make sense to have international markets as part of your opportunity set.
Shorter-Term Tactical Considerations
How as the U.S. dollar performed relative to other foreign currencies? Currency movements can be a big driver of international market performance. There are a number of reasons why the U.S. dollar can rally against other foreign currencies (higher U.S. interest rates, it tends to be a safe haven currency in turbulent times, there is a general desire for U.S. assets, etc.). These reasons can push the U.S. dollar to extreme levels to the upside. The opposite of those reasons an push the U.S. dollar lower against other foreign currencies as well.
Since currency can be a big driver of international market performance, if you want to try to put the odds more strongly in your favor, and if you want to be tactical to a U.S./international allocation, consider waiting for currency extremes to occur and make your tactical shifts at that time. In today’s market environment, simply look at a chart of the U.S. dollar and determine if we are at a potential extreme and act accordingly.
Check out Tradingview.com for a chart on the U.S. dollar over a several year timeframe: https://www.tradingview.com/symbols/TVC-DXY/
How has sentiment been for investors in international markets? Sentiment can also be a big factor when investing in international markets. In periods of high geopolitical uncertainty (Russian/Ukraine crisis, China COVID lockdowns), investors may feel like they should avoid international markets and hide out in the U.S. Often times the biggest returns come from periods of very negative sentiment to international markets to less negative sentiment. In these environments, investors may see better valuations in international markets in high quality assets that trade at material discounts to similar investments in the U.S. Money then starts to flow to foreign investments, foreign currencies rally against the U.S. dollar and international markets start to outperform.
What are the comparative valuations across investments in the U.S. relative to investments outside of the U.S? Valuations matter over the longer-term. If there is an auto company in the U.S. with similar growth/profitability as an auto company in Germany, but the U.S. company trades at a 40% premium to the company in Germany, which company should you rather invest in? Sometimes valuations in the U.S. are at a premium to similar investments outside of the U.S. due to the premium investors are willing to pay for highly regulated companies trading on highly regulated U.S. financial exchanges. The question is how much of a premium should investors pay? Look at historical valuation differences of similar investments in the U.S. and outside of the U.S. Look at the historical averages then compare those valuations to current valuations to help determine whether there is a market extreme to try to take advantage of. Remember, low valuations are not everything, you need to consider quality and growth as well as attractive valuations in order to try to put the odds in your favor for any investment.
Research publications from Yardeni (Yardeni.com) provide some good historical valuation charts at a glance. Just search for “Yardeni MSCI P/E” and you’ll find some good information to start.
Bottom Line
Only you know whether international market exposure is appropriate for you. If you believe that it is from a strategic long-term investment perspective, consider utilizing global active managers that can select investments across the U.S. and outside of the U.S. with additional tactical allocation management if you don’t want to try to figure out how much international exposure you are looking for. If you do not believe it is for you, make sure you don’t change your mind (make an emotional investment decision) when international markets outperform U.S. markets at some point.