Don't Sleep on International Stocks

We take it for granted now that the world is becoming more globalized every year.  This can be seen in the production of goods – NPR’s Planet Money  produced a series in 2013 following the production of a simple T-shirt, showing how cotton makes its way from the US to Asia or South America for production and back again to the US for sale.  Globalization is also plainly visible in sports marketing – if you watch European football (or soccer, if you will), you can see Chinese ads on the sidelines and American corporate logos on the jerseys.

Clearly, money flows between nations more freely than it used to.  As a result, investments in foreign companies have become more mainstream.  Plus, they offer diversification benefits in a portfolio that is heavy in US investments.

And yet, as Hilltop believes, many investors may fail to allocate enough of their portfolios to international investments.  Termed a “domestic bias” or “home country bias”, this tendency is understandable.  But it may cause many to miss out on potentially significant growth opportunities.

Foreign stocks make up almost half of the world’s market capitalization1 (that is, the total value of stocks traded in the global market).  So, the US still hosts a slim majority of equity investments, but it is only one portion of the available pool of investments.

When you go to the grocery store to prepare a week’s meals, you don’t just visit one section of the store.  You know that a complete meal needs produce, dairy, grains and meat (unless you’re a vegetarian).  Your investment portfolio is the same way – if US equities are the steak (or the vegetarian equivalent) you may still need side courses of international investments to bring out the steak’s best flavor.

Key Benefits:

  1. Many international markets are less mature than the US market, and therefore may have more potential for growth than US equities.2
  2. Because foreign stocks are generally not covered by as many investment analysts, a diligent fund manager may be more likely to identify opportunities not already recognized by the broader market.
  3. Decades of portfolio theory research shows combining US and international investments reduces overall portfolio volatility. 

Key Risks:

  1. Foreign stocks can be more volatile than those for comparable US companies, because many international economies are less mature and less transparent than the US.  And not surprisingly, investments can be negatively affected by the greater political instability experienced in certain countries.
  2. Currency exchange rates can negatively impact your returns.  For instance, if you hold a Chinese stock during a period when the US dollar gains strength versus the yuan, then your investment would return less than a US stock with the same nominal performance.

The first benefit above is worth highlighting. We at Hilltop believe the fastest growing economies over the next several decades will likely be within emerging economies.   And we believe we are likely to find some of the best opportunities in companies that have a home-field advantage in those economies.

As with so many things in life, investing is about balance.  It is difficult for us at Hilltop to see a scenario where we would recommend investing solely in either US or international equities.  There are clearly benefits and risks unique to investments at home and abroad.  Just make sure you’re not missing out on opportunities because of a domestic bias.  We encourage you to discuss the benefits and risks of international investing with your investment advisor before making any changes in your portfolio.

 

DISCLOSURES

1 - https://data.worldbank.org/indicator/CM.MKT.TRAD.CD?end=2016&start=1975&view=chart

2 - https://origin-www.bloombergview.com/articles/2016-01-28/economics-might-be-all-wrong-about-growth