U.S. stocks have significantly outperformed international stocks in recent years. Further, U.S.-based multinationals are major players in the world economy. Here at Claris, we have had clients ask whether they should stick with their international investments. We have even heard reports of other advisors recommending their clients abandon an investment philosophy that includes international investing. So, in light of recent underperformance, has international investing become unnecessary?
Time-tested principles of portfolio management and all available evidence say no. Let’s take a look at the three main reasons investors should stick with international investments in their portfolio.
Changing Market Leadership
The rationale for international investing is clear. International stocks represent roughly 45% of the global stock market, a figure far too large to ignore. By owning international investments, one is able to diversify their portfolio and take advantage of opportunities provided by companies in emerging and other developed stock markets. U.S. and international stocks frequently swap positions as performance leaders. It wasn’t that long ago that international stocks led the way over domestic stocks. While the last decade has seen U.S.-based stocks outperform, according to Dimensional Fund Advisors, the decades of the 70s, 80s, and 00s were characterized by international stocks outperforming domestic ones.
Positive International Outlook
How long will continued domestic outperformance continue? No one can say with any level of certainty. Will it continue forever? Again, no one can see the future, but every shred of evidence screams no. When U.S. and international performance leaders change again, like they always have, principles of portfolio management dictate that we have exposure to this asset class. We have all heard the warning that “past performance does not predict future results.” This disclaimer accompanies every offering for a financial product because the evidence shows that outperformance of one asset class never continues ad infinitum. In fact, a recent joint study by Vanguard, Morningstar, and Thomson Reuters expects international equity investments to outperform domestic ones by an average of 3.3% per year over the next decade. While the future is impossible to predict, positioning a portfolio to capture the returns offered by ALL markets is a bedrock principle of responsible wealth management.
A long-accepted rule of portfolio construction is that adding different asset classes, even those riskier ones, actually reduces the volatility of a portfolio. It’s true that correlations between U.S. and international markets have increased, but they still do not move in lock-step. The benefits of volatility reduction cannot be overstated. To put it simply, all else being equal, a less volatile portfolio will provide its owner with a greater growth in wealth than a similar portfolio with greater price fluctuation. It is important to understand that growth in wealth is what matters MOST to investors. Vanguard recently found that constructing the equity portion of a portfolio with a 35% allocation to international markets reduced volatility by a little over 5%. This is what’s known as the “free lunch” of diversification.
We continue to recommend exposure to international equities for the three reasons cited above, among others. Investing is not a short-term proposition. Serious, long-term investors would be well suited to tune out the short-term noise and focus on their long-term plan. To learn how you can diversify your portfolio with international investment options, contact a Claris Advisor.