Investing internationally increases diversification and enables investors to take advantage of growth opportunities in foreign markets.
But how to gain this international exposure often gets little more than a passing thought. Often, international allocations are index funds that track broad-based indexes, such as the FTSE Developed Market ex-U.S. Index, a market-capitalization-weighted index of companies in developed foreign markets. Some investors may add a secondary allocation to an emerging market index such as the FTSE Emerging Index.
The problem with passive approaches to international investing is that countries don’t move in lockstep with one another. Some nations may thrive in a given environment while others lag.
For this reason, Dina Ting, head of global index portfolio management at Franklin Templeton, argues for “disaggregating” international exposures by allocating to single countries rather than broad-based international indexes.
We spoke with Ting to learn more about how and why this process is effective for financial advisors. She also shares which foreign countries she believes present the best investment opportunities. Here are edited excerpts from that interview.
Why should financial advisors and investors hone their international exposure by allocating to single countries rather than broad-based international indexes?
International indexes weigh each country based on its respective market capitalization. Hence, three countries — China, Taiwan and India — make up 70% of the FTSE Emerging Index. The top three countries of the FTSE Developed ex-U.S. Index — Japan, the United Kingdom, France — account for 42% of its market value despite there being 24 countries in the index.
This can obscure the large dispersion of single-country returns. For example, in 2020, the FTSE Emerging Index returned 15.5%. If you look at the individual country performance within that index, Taiwan returned the most at 39.2% versus bottom-performing Brazil, which lost 19.4%. This extreme dispersion of returns as well as fluctuation in each country’s foreign currency provide additional opportunity sets for advisors who target specific countries.
Disaggregation allows advisors to allocate higher weights to countries where they have higher convictions and change the potential risk and return characteristics of their portfolio relative to a broad market international exposure.
How can financial advisors and investors evaluate single-country allocation opportunities?
There are three lenses that financial advisors and investors can consider. The first is country fundamentals and characteristics. These include its capital markets makeup, sector breakdown, competitive advantages, gross domestic product growth, employment rate, interest rate, currency policies, governance and political conditions.
Second are the outside factors affecting the country. For example, they may include the response to major global events such as the pandemic, commodity prices, international trade relationships and other geopolitical risks.
Lastly are emerging long-term structural changes that would enable investors to take advantage of being at the forefront of change. These include changes in consumer behaviors, such as more online shopping and shifts in spending allocation, and changes in business models, such as subscriptions, cloud data centers and streaming.
There are also changes in resource allocation policies to consider and the country’s capacity to innovate. How quickly can the country adapt and mobilize its resources to solve emerging problems? Those challenges include a country’s exposure to climate change risk, such as water supply, transport infrastructure and food sources.
How should advisors include single-country investments in a client’s portfolio?
There are two ways investors can use single-country investments in a portfolio. First, they can build a fully customized international equity portfolio from the bottom up, assigning larger weights to countries that are expected to outperform and smaller or no weight to countries where the potential upside is limited.
The second approach is to create an overlay to broad market investing with a tilt toward selected countries with higher expected return potential. This approach does not require investors to assess the merits of each country and assign a specific weight, but still delivers the ability to overweight select countries.
Which countries are most primed for investment opportunity right now?
Three countries come to mind. Taiwan is notable for its dominant position in semiconductor chip manufacturing and sector makeup that enable it to reap the benefits of post-pandemic recovery spending. Semiconductor chips are used in everything from cars to computers and appliances. The semiconductor manufacturing industry is complex and concentrated with a high barrier to entry, thus it will take several years for other countries to compete effectively.
Japan is attractive because it is a major exporter to large Asian neighbors and its economy is predominantly made up of cyclical sectors that tend to do well in expansionary periods: industrials, consumer discretionary, materials and financials.
Canada benefits from strong commodity prices with demand outstripping supply and significant exposure in financials, energy, materials, industrial and consumer discretionary sectors.
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