International markets can add flavor to the portfolio mix

E*TRADE Securities2

03/16/18

It’s easy to see why domestic portfolios often have a heavy bias toward the US. It’s the most comprehensive and diverse market the world has to offer. By some estimates, it alone accounts for more than half of the world’s total equity market capitalization.1

Still, that doesn’t mean investors should put all (or most) of their eggs in one red, white, and blue basket. Of course, that’s often easier said than done due to the pull of home-country bias. Quite simply, many tend to invest in what they know and stick to the creature comforts of home. According to one recent estimate, US investors invest a robust 79% of their holdings in domestic equities.2

Sometimes, though, finding a different vantage point can be eye opening, not to mention portfolio friendly.

International markets can add flavor to portfolio mix, 3/16/18

Source: FactSet

A big world outside the US

Looked at another way, the world excluding the US speaks for almost 50% of the total global market cap. For investors, that’s a large piece of a market pie that could offer any number of diverse investment opportunities. And after years of underperforming the US following the financial crisis, prospects for international equities look brighter amid relatively attractive fundamental valuations coupled with burgeoning economic growth.

Notably, emerging markets, helped by innovation and technology, represent more than 50% of global gross domestic product (GDP), but only about 10% of the world’s stock market capitalization. That suggests emerging markets may have an attractive runway to grow.3

A recent Morgan Stanley report offered perspective: The bank forecasts that Asia will become the world’s largest equity market within the next decade. It estimates Asia’s total stock market capitalization will almost double from $29 trillion to $56 trillion by 2027, outpacing the $42 trillion forecast for the US and Canada combined. China, including Hong Kong, and India, are expected to be the major players in Asia’s surge.4 Speaking of China, it looks poised to become the world’s largest economy based on GDP within the next decade.5

Reasons to invest internationally

Recent history and the current environment certainly argue in favor of adding at least a touch of international exposure: 

  • Solid returns aren’t limited to the US. Investors who had foreign equities in their portfolios last year know that as well as US stocks performed in 2017, the MSCI World ex USA Index outpaced the S&P 500® in 2017.
  • International equities can provide a layer of diversification. That is particularly true when US valuations look stretched. They can also help tamp down volatility risks in a portfolio, especially as correlations between global equities, or the degree to which they move in relation to each other, are at their lowest levels in more than a decade.1
  • Seeking exposure to markets that are not as mature as the US can give investors exposure to new opportunity sets amid growth cycles. Currently, for the first time in a long time, growth stories are evident across regions.

Reasons to stick with what you know

There are risks, of course. Many investors who have gone the international route can attest to often unstable geopolitics and unfamiliar policy. Other factors to consider include:

  • Exchange rate risk, or when currency depreciation reduces the value of a security denominated in that currency.
  • Liquidity risk, or not being able to convert a security or hard asset to cash (especially within emerging markets).
  • Higher transaction costs, including brokerage commissions, stamp duties, levies, taxes, clearing fees, and exchange fees.

Potential investment vehicles

The increasingly multinational nature of corporations likely means most US investors have degrees of international exposure already. But today it’s easier than ever to find more direct access. For one, the rise of exchange-traded funds (ETFs) has helped many investors ease their skittishness. ETFs offer increased exposure by region, country, market cap, sector, and even a hedge to foreign currency, all at minimal cost.

For investors who have shied away from international equities in the past, current dynamics may make it an idea worth exploring. Sometimes all it takes to find an investment opportunity is to look at the market profile from a slightly different angle.

 

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1. Guide to the Markets®, U.S. | 1Q 2018| As of December 31, 2017, page 43, JPMorgan Asset Management. https://am.jpmorgan.com/gi/getdoc/1383518167130

2. Miller, Lee J and Lu, Wei. “Advisers Battle U.S. Investors’ Home Bias as Valuations US,” Bloomberg, 26 Jul. 2017. https://www.bloomberg.com/news/articles/2017-07-26/advisers-battle-u-s-investors-home-bias-as-valuations-soar

3. Carlson, Ben. “Think Global to Avoid Shrinking U.S. Stock Market,” Bloomberg, 17 Mar. 2017. https://www.bloomberg.com/view/articles/2017-03-17/think-global-to-avoid-shrinking-u-s-stock-market

4. Sjolin, Sara. “Asia to become No. 1 stock market — and here’s an all-American way to play that, says, Morgan Stanley,” MarketWatch, 13 Mar. 2018. https://www.marketwatch.com/story/asia-to-become-no-1-stock-market-and-heres-an-all-american-way-to-play-that-says-morgan-stanley-2018-03-12

5. Scott, Malcolm and Sam, Cedric. “Here’s How Fast China’s Economy Is Catching Up to the U.S.,” Bloomberg, 6 Nov. 2017. https://www.bloomberg.com/graphics/2016-us-vs-china-economy/


Index definitions

The MSCI World ex USA Index captures large- and mid-cap representation across 22 of 23 Developed Markets countries, excluding the United States. The index covers approximately 85% of the free float-adjusted market capitalization in each country.

S&P 500 Index is a market capitalization-weighted index of 500 widely held stocks often used as a proxy for the US stock market. All components of the S&P 500 are assigned to at least one of eleven S&P Select Sector Indexes, which track major economic segments and are highly liquid benchmarks. Stock classifications are based on the Global Industry Classification Standard.