Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
Also read:
- Q2/H1 Hedge Fund Letters - Letters, Conferences, Calls, And More
- Hedge Fund of funds Business Keeps Dying Every Year
- Emerging Hedge Funds: Can They Outperform?
- Baupost Letter Points To Concern Over Risk Parity, Systematic Strategies During Crisis
- AI Hedge Fund Robots Beating Their Human Masters
While the trend has reversed year-to-date, U.S. stocks have handily bested a composite of their overseas brethren for several years. An investment in the S&P 500 five years ago ending in April would have returned about 13.7% annualized, while an investment in the MSCI All Country World ex-USA index would have netted only about 5.6%, with less risk1.
The outperformance of U.S. stocks has had many investors asking whether global diversification is worth the trouble. But while it is tempting to view recent performance as evidence that U.S. stocks are all an investor needs, the loss of diversification associated with a US-only portfolio should give investors pause. U.S. stocks make up only about half of the market value of global equities2. Constraining your investment to this degree leaves out a huge pool of opportunity in the equity space.
Equity investments outside the United States can be broadly divided into two main groups: international-developed and emerging markets. The first features investments in developed economies, such as Japan, the United Kingdom, Canada, Australia, Germany and France. The second represents investments in developing economies. The so-called BRICs, Brazil, Russia, India and China, are well-known emerging-market economies. From time to time, index providers will reclassify a country based on economic improvement, or vice versa, but the labels have remained largely fixed.
International developed investments are generally considered to be safer, but also with lower expected return than their emerging counterparts. The MSCI World ex-USA index of international developed stocks returned about 5.4% from January 1988 through April 2017. The MSCI Emerging Markets index returned about 10.9% over the same period. But that outperformance came with considerable additional volatility, as the annualized standard deviation of the developed index was about 16.8% vs. about 22.9% for the emerging markets benchmark3.
You can opt for an investment that includes both international developed and emerging stocks, or one or the other. Investments labeled “global ex-US” will generally contain both, but it’s important to ask the question about what types of economies your assets may be exposed to in any given fund.
For American investors, investing internationally brings both benefits and risks. You diversify across different markets, factors, industries and specific stocks. This increases the number of baskets, so to speak, across which your eggs are spread. However, you do take on potential political risks associated with different countries and often there are additional costs, such as stamp duties or withholding taxes. Currency risk is another consideration. U.S. investors who invest internationally essentially experience two different returns on their investments. The first return is the local stock return of the actual holdings they purchase. The second return comes from the change in the value of the U.S. dollar relative to the currency in which the local stock is denominated. When a U.S. investor buys overseas, he is effectively translating his U.S. dollars to the local currency in order to purchase the stock. If the U.S. dollar gains in value relative to the local currency, the investor will lose on the currency portion of the deal because whatever earnings the stock achieved on local terms must be translated back to U.S. dollars. Of course, if the dollar depreciates relative to the other currencies, the opposite occurs.
By Dana D’Auria, read the full article here.
