International vs. Domestic

February 6th, 2008 at 09:37am Brent Brodeski

  Brent R. Brodeski, MBA, CPA, CFP®, CFA, AIFA® 

Below is an interesting read borrowed from Weston Wellington’s blog on the Dimensional Fund Advisor’s website.  It references the fact that just 10 years ago; convincing people to invest overseas was an uphill battle.  I can personally attest to this.  I recall many tough conversations convincing clients that it made sense to invest globally.  While it was a hard sell, it has since paid off in spades. 

Ten year’s later the message is much the same.  Invest Globally.  And while it is no longer difficult to convince people to invest overseas, people are now actually beginning to question the wisdom of investing in the good ‘ole USA.  I mean, why invest in America when China doubles every 12 months? 

Why?  Because diversification still makes as much sense as ever.  Furthermore, the typical American still spends over 80% of their money with domestics companies using U.S. dollars.  And just as domestic investing has been kind of a bummer in recent years, foreign stocks will certainly stub their toe at some point.  So having domestic stocks will help mitigate the risk of a downturn in overseas markets and/or a strong U.S. dollar.   

So as you read Weston’s entry, keep in mind that is it very likely that 10 years from now we might instead have the opportunity to poke fun at those pundits who are currently advocating abandoning US stocks to invest exclusively overseas. 

Excerpted from the Dimensional Fund Advisors Website: 

December 19, 2007

Global Investing “Bunk”

Weston J. Wellington, Vice President, Dimensional Fund Advisors

Ten years ago today an opinion piece appearing in the Wall Street Journal by a prominent financial writer claimed that the notion of broad-based international diversification of equity investments for US investors had been convincingly revealed to be little more than faddish “nonwisdom.” He described a strategy of accepting market rates of return across a broad universe of countries as being little more than gambling since “speculators in 86 foreign markets apportion my funds.” He had resisted suggestions from financial professionals to diversify globally, he said, smugly confiding that he had “no money in the former Yugoslavia, none in the present Argentina, none in the future Republic of Antarctica, none in Zambia,
Belgium or Kazakstan.” (Even if he had, it might be hard to tell. The aggregate weight of these countries would have represented about 1% of a globally diversified capitalization-weighted portfolio.)

At the time, the case for international diversification appeared questionable based on recent performance. For the period ending November 1997, the S&P 500® Index had outperformed benchmarks of developed country and emerging country stock markets by a wide margin over one, three, five, and seven-year periods. For the three-year period, annualized return was 31.05% for the S&P 500® Index compared to 6.19% for the MSCI EAFE Index (net dividends) and -7.24% for the MSCI Emerging Markets Index (gross dividends). Why bother investing in L’Oreal, Heineken, or Samsung when General Electric and Microsoft are showering shareholders with such impressive returns? In the author’s view, “the notion that the
US offers insufficient opportunity to diversify is absurd.” A prominent mutual fund executive made a similar observation the following year, comparing investment opportunities in the US market to a prospector standing in “acres of diamonds.

“The article went on to cite a prominent fee-only financial advisor who applied a globally diversified passive strategy for his clients, poking fun at his allocation strategy that “a robot could figure.” The thinly veiled suggestion was that investors were ill-served by such advice.

The author cited poor disclosure, risky currencies, and weak legal protection of shareholders as reasons why US residents “can lead a happy investment life without leaving home.” Perhaps so, but he was silent on the merits of this advice for citizens of other countries. Should Dutch grandmothers or
Hong Kong physicians boycott their local securities markets and limit their holdings to US securities? If they did so, would their decision cause prices to fall in non-US equity markets, raising the cost of capital for local firms and hence investment returns for the remaining shareholders? It sure seems plausible to us.

Since the article appeared in December 1997, global markets have had their share of ups and downs, but results suggest that excluding non-US securities from consideration may have unappealing consequences. For the ten-year period ending November 2007, annualized return for the S&P 500® was 6.16% compared to 9.00% for the MSCI EAFE Index and 14.76% for the MSCI Emerging Markets Index. Among nineteen major markets (EAFE constituents plus Canada), only one (Japan) has underperformed the S&P 500® in US dollar terms over the last ten years. And while US investors are currently fretting over losses related to the mortgage market fiasco, markets such as India roll on to record highs (the Bombay Sensex hit 20,290.89 on December 11, up from 3329.14 ten years earlier) and some observers are explaining the continued strong performance of emerging markets as a “flight to quality.“

Can any of us predict with confidence what the next ten years will hold?

Roger Lowenstein, “‘97 Moral: Drop Global-Investing Bunk,” Intrinsic Value, Wall Street Journal, December 18, 1997.
John Waggoner, “Send Your Savings Abroad? Conventional Wisdom Says Yes, Many Experts Say No,”
USA Today, July 6, 1998.
The S&P data are provided by Standard & Poor’s Index Services Group.
MSCI data copyright MSCI 2007, all rights reserved.

Entry Filed under: Investments