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Maximizing returns while minimizing risks is a hallmark of good investing. Even in a bull market like this one, where domestic stocks are outperforming global assets, many financial experts say a well-diversified portfolio should include international investments.
That diversity doesn’t just minimize risk. It also offers investors an opportunity to capture higher returns from foreign markets that may thrive when U.S. stocks founder. Foreign “assets have their own economic and political risks separate from the United States,” says Marc Lowlicht, CEO of Opes Private Wealth Management in East Hampton, New York.While incorporating another set of risks might sound, well, risky, historically, international assets have only added to a portfolio’s returns, with little to no negative effects, Lowlicht says.
Every dog has its day. That can seem counterintuitive now, given the long rally and steady climb of the Standard & Poor’s 500 index toward 3,000. The S&P 500 is up nearly 10 percent so far this year, so why mess with a good thing?
The reason is that every asset class takes its turn at the top, says Nicole Peterkin, CEO of Peterkin Financial, a fee-based financial planning practice in Braintree, Massachusetts. Sooner or later, international stocks will have a chance to shine, and when they do, they can beef up a portfolio’s return, says Andrew Denney, founder and CEO of Prosperity Financial Group in Springfield, Missouri. A 10 to 20 percent sleeve in international assets, an allocation he recommends, can add another 1 to 2 percent to a portfolio’s total return, Denney says.
In three of the last 10 years (2007, 2009 and 2012) the MSCI EAFE Index, which includes Europe, Australasia and the Far East, outperformed the Russell 1000, an index of the largest 1,000 U.S. companies, Peterkin says. In 2007, the MSCI EAFE Index grossed 11.17 percent compared to the Russell 1000 Index’s 5.77 percent, she says.
As of Aug. 21, the MSCI World Index, a common global fund benchmark that includes large- and mid-cap equities in 23 developed market countries, was up 15.18 percent, and the MSCI Emerging Market Index was up 25.78 percent, making it the strongest index for 2017. “If this trend continues, and I believe it will, it will make for an excellent year in the international markets,” Denney says.
A home country bias is OK. While international stocks make up about 50 percent of the global market cap, a domestic bias for U.S. investors makes sense, says Tim Holland, senior vice president and global investment strategist at Brinker Capital in Berwyn, Pennsylvania. He prefers a stock portfolio that invests 70 percent in the U.S. and 30 percent abroad, with slightly more than a third of international stocks in emerging markets to take advantage of their younger demographics, more robust economic growth and better valuations.
One reason to overweight the U.S. is that foreign stocks tend to have higher volatility than domestic stocks due to the variable of their currency, he says. “There’s a saying, when the U.S. catches a cold, the world catches the flu,” Denney says. As a result, international stocks can sometimes be hit even harder than their U.S. counterparts, with emerging markets especially volatile.
In many cases, overseas markets, both developed and emerging, aren’t as efficient as the U.S., Holland says, and that provides greater opportunities to buy undervalued foreign stocks. Emerging markets, for instance, lagged developed and U.S. markets for many years, Holland says.
When considering specific stocks, look for companies that have a strategic advantage over their competitors, Denney says. “For example, even though Japan is in an economic malaise, we love Toyota Motor Corp. (ticker: TM) because it’s a well-run company,” he says.
The pharmaceutical company Novo Nordisk (NVO) is another example. “It has a monopoly on the world’s insulin supply,” Denney says. “Every 15 hours a KFC is being built in China, and now obesity and diabetes are on the rise. This should bode well for Novo Nordisk.”
He also likes investing in India. Its young population favors a strong labor force and a growing economy in the future. He recommends investing in India through an exchange-traded fund, such as the iShares MSCI India ETF (INDA), which has returned 24.7 percent this year.
Know the pitfalls. Like all investments, over-concentration in any single asset class or too much exposure to a specific market or country can lead to trouble.
“There have been countries’ stock markets that have literally collapsed overnight,” Denney says. He cites examples such as when China was on the brink of recession in 2016 or when Europe was struggling with the solvency of the European Union and Greece going bankrupt.
You should also have some idea of the company and country politics and what they might mean for corporate governance and shareholder rights.”Not all companies and countries treat foreign capital and investors fairly,” Holland says.
International investments may come with higher transaction costs and, in the case of mutual funds, steeper expense ratios, as well as the potential for foreign taxes.
As for performance, make sure you’re comparing apples with apples. “If you want a true indicator of how your investment is performing, it must be compared to its respective index,” Lowlicht says, such as the MSCI EAFE Index for comparing Europe’s developed markets.”Selling a global fund because it underperformed the S&P 500 defeats the purpose of diversifying through non-correlated assets.”