Why Should I Invest Globally?
We often hear the question, “Since US stocks are doing so well, why should anyone hold international stocks?” Given that US equities have greatly outperformed international stocks since the Great Recession (March 2009 being the low point), this question is understandable. Yet, it stems from two common investor biases: Home Country Bias (we tend to invest in things closer to us) and Recency Bias (we tend to overweight more recent information).
Here are at least six reasons to keep a global focus.
First, modern portfolio theory shows us that if we combine asset classes that are not perfectly correlated, we can create a portfolio with a better expected risk-adjusted return. Over the last 50 years, US annualized returns were 9.37% and international annualized returns were 8.48% with a correlation of 0.49. While correlations have increased, there is still value in the diversification. As you can see in Table 1, US and international markets do not move in lock step. A blended portfolio historically would have provided for a higher Sharpe Ratio – a greater return for risk taken.
Table 1: Equity market total returns by decade
Second, the US has had a tremendous decade, but there are many instances of once strong stock markets running into decades long headwinds. Look at Japan (Table 2), as an example: A strong market in 1980’s gave way to 20+ years of decline markets followed by a decade of strong returns.
Table 2: Japan's lost decades
Third, most investors construct portfolios for the long run. “Recency Bias” occurs when investors put disproportionate weight on recent market events rather than considering long-term evidence. We need to be cautious here as there have been many periods over the last five decades when international markets outperformed US markets. In fact, in the 70s and 80s, international markets crushed the US, and in more recent memory, in the 2000s. As illustrated in Table 3, US markets have not always outperformed international markets. In fact, since 1970 the US market has outperformed international markets 25 times, and the international markets have outperformed domestic markets 25 times.
Table 3: Years Outperforming Other
Fourth, what has worked for the last ten years may not work for the next ten. We get many long-term market forecasts. While we don’t necessary follow these, they do give a great sense of investor sentiment. Forecasts come from banks, institutional investment consultants, industry practitioners as well as others. We are in a period when almost all have outlooks that show asset classes with lower expected returns over the next 7-10 years than what we have experienced in the last 7-10 years. If they are right, then this is quite sobering. And for most, US Large cap outlook is particularly unexciting relative to international and emerging markets (which are not that exciting either, by the way, but better than US markets.)
Fifth, the industry mix. The US market does not reflect a true global market. A focus on the US will cause investors to overweight technology and health care and underweight financial, industrials and consumer staples. This introduces more risk and volatility to a portfolio. Below are the top five sectors for S&P 500 and MSCI EAFE Index as of October 17, 2019. It is easy to see that these two sector allocations are quite different.
Sixth, growth. The world’s population growth and subsequent economic growth will not be US centric. Pretty much all global population and GDP forecasts have the US shrinking as a percent of global economic and population footprint. Long-term investors are looking overseas for long-term returns.A PWC Global report entitled The World in 2050 suggests the US will drop from the largest economy to third behind China and India, from 16% of the world’s GDP in 2016 to 12%. In fact, all G7 economies lose ground to faster growing emerging markets.
While investors feel comfort staying closer to home, keeping a global allocation and focusing on data versus emotions, should provide better long-term results.
