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The Case for International Diversification

Posted by Gabriel Burczyk | CEO
February 14, 2017

diversify-and-reduce-risk-with-international-stock-investingIf it feels like the United States has been delivering good (but not gangbusters) economic growth and solid stock market returns since 2009, it’s because it has been – at least relative to some other parts of the world. Europe has continued to struggle with GDP growth and cannot seem to fully shake its sovereign debt issues; Japan has experienced weak growth and lackluster inflation for years; Britain is taking the significant and potentially risky step of leaving the European Union; and Emerging Markets growth has slowed. In a world of political and economic uncertainty, the United States often feels like the best house on the investing block.

For those reasons – and because the US is arguably the largest and most diverse economy in the world – many investors prefer to keep their money close to home. In many ways it makes sense, and for the last few years it has likely been a beneficial strategy. But as Russ Koesterich of Blackrock (the largest money manager in the world1) smartly points out, “the tendency to invest close to home is understandable, [but] it may not be optimal,” adding that “US outperformance isn’t pre-ordained.”

The Best Performers Change from Year to Year

Koesterich has a valid point. Just looking at Emerging Markets as an example, you can see below that from 2003 – 2009 there was a streak of outperformance relative to other categories. Those strong years were enough to make Emerging Markets the 2nd best performing category from 2002 – 2016 (annualized), and aren’t long-term returns what matter the most?

JPMorgan-2017-asset-class-returns-chartClick here for larger image.

Using International Diversification as a Tool to Reduce Risk

Performance is not the only reason it could make sense for investors to diversify portfolios internationally. There is also the potential benefit of reducing the overall risk in your portfolio by investing in non-correlated assets. Blackrock underscores this idea as well, in stating that “owning a portfolio solely focused on the United States may lead to sub-optimal risk-adjusted returns. In other words, investors may be taking on risk that could otherwise be managed with diversification.” While diversification does not guarantee profit or protect against loss in declining markets, international investing can be an important component of a well-diversified portfolio.

JPMorgan-2017-global-equity-market-correlationsClick here for larger image.

As you can see below, a more-diversified portfolio delivered better returns with similar risk than a less-diversified portfolio:

JPMorgan-2017-diversified-portfolio-chartClick here for larger image.

Valuations Suggest that Stocks May be Cheaper Abroad

With US stocks on a strong run over the last few years, valuations have risen above 25-year averages. This does not necessarily mean that stocks are currently overvalued or too expensive. What it does mean, however, is that foreign stocks are cheaper historically than their US counterparts. Could this mean more opportunity for foreign ahead?

JPMorgan-2017-global-valuations-chartClick here for larger image.

Ask a Wealth Manager about International Investment Strategies

If you’re unsure of whether your portfolio is allocated abroad or if investing internationally is even right for you, just call one of our Wealth Managers today. We can analyze your portfolio holdings to show you what international exposure you have currently, and what we might do differently to make your portfolio more diversified. Call us now at 1-800-541-7774 or start a conversation over email at wealth@wrapmanager.com.

 

Source:

1. Based on $5.1 trillion in AUM as of 12/31/16

 

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