With international investing, countries matter

As published in the Minneapolis Star Tribune 5/19/2019.

As investment advisers and legal fiduciaries, we are always motivated to keep clients well-informed. At review meetings, that means shining a light on which aspects of their portfolio are performing best and which ones are not. Owning a diversified mix of investments means you are usually disappointed in something, and lately that “something” has been international equities.

As a category, non-U. S. stocks have significantly underperformed their American counterparts for the past decade.

As of April 30, the S&P 500 averaged 15.3% annually over the past 10 years. Compounded, that results in cumulative returns of 316%! Over the same 10-year period, a mix of 80% non-U. S. developed economies and 20% emerging markets gained only 7.8% per year on average with cumulative returns of 111%.

That’s roughly one-third the total return of U.S. large-cap stocks. It’s a gargantuan performance gap that has led many investors to wonder why they should bother owning international stocks at all. One reason is that exposure to foreign economies provides a measure of diversification.

There’s the usual disclaimer that past performance is no indication of future results. If you review the annual performance of various asset classes, you will see that emerging markets have been either the best performer or the worst performer nine times in the last 16 calendar years (5 times at the top, 4 times at the bottom).

In other words, especially bad years do not reduce the likelihood of especially profitable ones.

You may be less diversified than you think

Most importantly, however, we view this as an opportunity to hold a magnifying glass to the international slice of your portfolio to better understand what exactly you own and how you can improve. Your international investments are probably not as diversified as you may assume.

Most investors get their international exposure through a broad-based index or mutual fund. If you do, how much of your international exposure is to developed economies vs. emerging markets?

You might be surprised to learn that the single most popular international benchmark, the MSCI EAFE Index, has 24% of its holdings in Japan, 17% in the United Kingdom and 11% in France.

That’s more than half your international investments concentrated in only three countries. Suddenly, you have a reason to care about a possible Brexit.

The MSCI Emerging Markets Index is even more concentrated, with 33% of its holdings allocated to China. That’s nearly three times as much as the next two largest countries in the index: South Korea (13%) and Taiwan (11%).

Handicapping foreign economies

If you think tariffs or a prolonged trade war make Chinese companies unattractive, you may need to make some changes.

Investors need to be mindful of which countries they are betting on and which ones they are avoiding. Modern technology makes it easy to purchase country-specific funds (our recommended approach) at a relatively low cost. Deciding which ones offer the best risk/reward trade-off might be a decision best delegated to a professional, but there’s no denying that all foreign economies are not created equal.

Not including frontier markets, there are 44 countries represented in most international equity benchmarks. In 2018, their annual returns ranged from a 1.6% gain (Peru) to a 41% loss (Turkey). Countries matter to your investment performance.

As any prospectus will remind you, international investing comes with additional risks. For most Americans, returns will be affected by currency movements.

Equally important is the regulatory environment in countries around the globe. Public companies outside the U.S. may not be subject to the same regulations or disclosure requirements as those listed on U.S. stock exchanges. The rules of governance can differ greatly. Prioritizing countries that demand more transparency is a good way to reduce risk.

Depending on your goals, there are several international strategies worth considering. Perhaps you want exposure to smaller cap companies or prefer specific industries or sectors. International investing can be as targeted as you want, but the default approach should not be mistaken as “one-size-fits-all.”

First, gain a better understanding of what you really own. Then we can figure out whether or not your international investments are worth keeping.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

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