For the past decade, U.S. large-cap stocks have been the place to be — outperforming nearly all other sectors and markets.
Now, some market analysts and strategists say that after a good, long run, it may be time for investors to start looking further afield and to add some foreign stocks to their portfolios.
The best way for retail investors in the U.S. to buy international investments is through mutual funds and exchange-traded funds since it’s difficult to buy international stocks outright.
These strategists say that adding international holdings helps to diversify a portfolio as most U.S. investors are home biased — meaning their automatic default is to U.S.-domiciled holdings. International stocks are cheap after a decade of underperformance versus U.S. stocks, but experts caution that investors still need to look carefully at which international markets they want to add and why. Keep these points in mind:
— Diversification helps with performance.
— International market valuations are better.
— Some markets are smarter bets than others.
Diversification Helps With Performance
Over the long run, building a diversified portfolio gives investors better performance with less risk — and that includes adding foreign mutual funds and ETFs.
“Having a global approach is probably the most prudent, just given the diversification benefit,” says Dunkin Allison, portfolio manager with Delegate Advisors.
He says most investors have a home-country bias because it’s what they understand, but this is not unlike “having all your eggs in any one basket.”
Instead, he says, by taking a global approach, the diversification benefit investors receive over long periods has the opportunity to produce greater gains with fewer losses because investors spread out their risk and are already invested if a market sector is suddenly on the upswing.
Randy Farina, senior portfolio manager at Exencial Wealth Advisors, concurs. He points out that over the long term, international investing has produced higher returns, especially when including emerging markets, even though that hasn’t been in the case in the past few years.
International Market Valuations Are Better
Farina says some key metrics show international market valuations are cheaper — such as going by the price-to-earnings ratio. The S&P 500 is trading about 20 times earnings, while international developed markets are trading at 16 times earnings and emerging markets at 13 times earnings.
But he also points out that the quality of U.S. companies when using a return on earnings is higher than international developed and emerging markets, which may explain the valuation premium. Looking at gross domestic product as a proxy for corporate growth, Farina says the U.S. is growing faster than developed foreign markets but lags emerging markets. While overall valuations look more attractive for international markets than domestic, he’s not sure that’s going to be the sole reason international markets start rising. That said, he believes investors should have broad exposure to foreign markets in place for whenever markets revert to their historical mean.
Nate Fischer, chief investment strategist at Strategic Wealth Partners, says he always has a diversified portfolio for clients, including pockets of developed international and emerging markets. As an active manager, when he adjusts portfolios for more or less exposure to markets and sectors, it’s on a risk-adjusted return basis — that is, calculating profit on the risk he takes compared with a risk-free investment.
Because of past underperformance, he has kept allocations to foreign markets small. Right now he’s taking a wait-and-see approach before increasing the allocation. While valuations are inexpensive in foreign markets, Fischer says that’s because of slow growth. “(International markets) have had a nice run in the last six months, but so has everything else,” he says.
Some Markets Are Smarter Bets Than Others
Some market watchers think now is different for international markets.
Nick Niziolek, head of international and global strategies at Calamos Investments, says foreign stocks have been cheap for a while, and the pandemic may be the catalyst to lead to foreign market outperformance.
The U.S. isn’t recovering as well as Asia and Europe from the economic effects of the virus, and a weaker dollar is helping with that. It’s also a synchronized recovery, with Asia leading, he says.
Santiago Ulloa, founder and managing partner at WE Family Offices, says the outlook for Europe is positive, especially after the historically important news last month that the European Union agreed to create a recovery fund to help the countries worst affected by the pandemic. Previously, monetary policy was decided at the country level, but this new bond is backed by the EU for countries to draw from.
“This was a turning point. There was a lot of noise, especially after Brexit, whether the EU could hold on, but this bond says they’re not going to let the European Union fall,” Ulloa says, referring to the United Kingdom’s vote to leave the EU.
Niziolek agrees that this move may be the first step in creating a fiscal union in the EU and it shouldn’t be ignored. “I wouldn’t underestimate how significant of a development that is (post-pandemic),” he says. “This can help support growth in southern Europe, and then you’ll see more fiscal spending out of Europe, which should be pro-growth.”
They both say China is also seeing a strong rebound after the pandemic, which should bode well for the country.
Ulloa says right now he would hold off on investing in Latin American regions in part because those economies continue to be devastated by the virus. Those markets might be doubly hit because the global recession has dented demand for commodities, the basis for most emerging-market economies.
Niziolek says that region has been hurt worse than the U.S. when it comes to the virus, but he also says “that market has been very beaten up.”
According to him, it’s not an area that his firm is avoiding since it has strong ties to China and could see a recovery with the Asian nation, “but I think there are better ways to play it.”
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Is It Time to Add International Exposure to Your Portfolio? originally appeared on usnews.com