Why is part of my portfolio invested outside the US?
The article below is shared from a recent Dimensional Funds newsletter. We found it particularly informative on providing global diversification. All portfolios at BPC Advisors hold a similar allocation between the US and global markets.
Many investors in the US may be wondering why part of their portfolio is invested outside of the US, especially given a global backdrop riddled with challenging circumstances recently. In fact, for the five-year period ending August 31, 2022, the S&P 500 Index had an annualized return of 11.69% vs. the 2.04% return of the MSCI World ex USA Index and the 1.02% return of the MSCI Emerging Markets Index.
While there may be many reasons a US-based investor may prefer to stick with what they’re familiar with, it is important to remember that non-US stocks provide valuable diversification benefits, and that past performance is not a reliable predictor of the future. We discuss both these points in detail below:
There’s a world of opportunities in global markets: As the title image of this article illustrates, nearly 40% of the investable stocks in global equity markets are outside of the US, and account for nearly 18,500 companies. Investing only in the US would not expose you to the performance of those markets or stocks.
The past is not a reliable predictor of the future: It is difficult to know which countries or even markets will outperform from year-to-year, in the same way it is difficult to know which stocks, sectors, or premiums will outperform. For example, for the period between 2000-2019, the average return of the best-performing developed market country was approximately 32%, while the average return of the worst-performing country was approximately -15%3. By diversifying, you are unlikely to have either the best or the worst outcome, but it also means you are likely to achieve a more consistent outcome and manage catastrophic losses that can accompany investing in a single country. By holding a globally diversified portfolio, investors are better positioned to capture returns wherever they occur.
Case Study – The Lost Decade: The period between 2000-2009 is often called the “lost decade” by US investors as the S&P 500 Index recorded one of its worst 10-year performances with a total cumulative return of -9.1%. Those who remained diversified, however, would have felt some of that loss offset by the favorable returns in non-US markets, particularly emerging markets. Given recent geopolitical events, some investors may wonder about the validity of investing in emerging markets, which are sometimes considered riskier markets to invest in. However, this case study shows that by holding a globally diversified portfolio, investors may be better poised to capture returns wherever and whenever they occur.
Exhibit 1: Global Index Returns (January 2000 – December 2009)
Past performance is no guarantee of future results.
Think about it from the standpoint of your own life. Some of your favorite goods and services may originate from companies that are not based in the US. Your coffee might originate in South America, your phone may be manufactured in Taiwan, your clothes could be woven from Egyptian fabrics, and your car might be German-made. While it may be the case that an investor prefers to have a home-country bias for tax-related reasons, in general, diversifying globally can ensure investors decrease concentration risk and increase their investment opportunity set.
In conclusion, while both US and non-US asset classes offer the potential to return positive expected returns over the long run, they may perform differently over shorter time periods. A long-term investment strategy focused on global diversification can position an investor’s portfolio to capture the returns from thousands of companies across the globe.