Now is the time to diversify internationally

Dana R. Consler, BridgeTower Media Newswires

The benefits of investing internationally have not been readily apparent in recent years. U. S. stocks have outperformed foreign stocks since the end of the financial crisis in early 2009 through 2016. But through August this year, international equities have beaten the U. S. market by about 7%. Turning your back now on international stocks would be a mistake for a number of reasons.

First of all, investors should not ignore opportunities in the larger global marketplace. Today, 74% of all public companies’ stocks trade outside the U. S. and 75% of the world’s GDP is generated in foreign countries. Did you know that for the 10-year period ending Dec. 31, 2016, 76% of the 55 best-performing stocks in the world were non-U.S. companies (top five best performing stocks in the 10 industry sectors such as financials, energy, technology, etc.)?

Many foreign company stocks are better buys today than their U.S. counterparts. Stock markets in Europe, Canada, Asia and emerging markets, like China and India, are cheaper than the U. S. market and trade at valuations (P/E ratios) below their 20-year average.

Profit margins for domestic stocks are cyclically high today. Not so for non-U. S stocks whose margins are lower and have room to improve, which could drive stronger earnings for those companies.

The fourth reason for investing abroad has to do with diversification. Stock market performance regionally changes over time. Simply investing in the regions with the best past performance is the worst type of “rear view mirror” investing and leads to poor decisions.

Foreign stock diversification as a risk-reduction strategy works, because international stocks historically have had relatively low correlations of returns with the U.S. market. Owning investments that have low correlations with one another provides opportunities through better diversification, as volatility and risk are reduced.

It is a myth that investing in U. S. multinational stocks with large revenues or profits from overseas provides international diversification, because the performance of these stocks is very highly correlated with the U. S. stock market. In fact, many large-cap U. S. stocks have correlations exceeding 0.8, with perfect correlation being 1.0. Diversification benefits are limited when correlations are high. To benefit from diversifying outside the United States, you must be invested there.

How much of your stock portfolio should be invested internationally? We believe 30% to 40% is ideal, and studies confirm that this level of international diversification is necessary to obtain the twin long-term benefits of higher returns and less risk.

Lastly, are you better off using an active or passive strategy when investing internationally? A recent study by Fidelity looked at performance of large capitalization international equity mutual funds for the 23 years from 1992-2015.
Looking at average one-year excess returns versus their benchmark revealed that actively managed funds outperformed their benchmark by 0.86%, while passive index funds underperformed by 0.32%. The performance advantage from active management is obvious.

Long term investors need to have a healthy portion of their stock portfolios diversified internationally, using a well-diversified, active manager with a demonstrated track record of success. The benefits are clear, and the time to start is now. It’s the smart thing to do.

—————

Dana Consler is executive vice president of Karpus Investment Management, a local fee based, independent, registered investment advisor managing assets for individuals, retirement plans, corporations, non-profits and trustees. Offices are located at 183 Sully’s Trail, Pittsford, NY 14534, (585) 586-4680. He is a regular contributor to The Daily Record.