INTRODUCTION. Written by: Timothy Moore, CFA Portfolio Manager

Transcription

1 INTERNATIONAL INVESTING: LONG-TERM BENEFITS OUTWEIGH SHORT-TERM NOISE Going Global Improves Both Opportunities and Diversification INTRODUCTION Written by: Timothy Moore, CFA Portfolio Manager Investing always carries some degree of risk for any potential reward. One cannot have a retirement plan, brokerage account or financial planning with riskless stocks or bonds. Arbitrage is fleeting (seconds or minutes) and unavailable to the regular investor. Trade, travel and the production of both goods and services have become significantly more global over the past decade. As such, stock markets globally do not always move in tandem, so there are diversification and other benefits from allocating some of a portfolio to international securities. Both the magnitude and the direction of one country s stock market return can be very different from its neighboring country in any given year or over a few consecutive years. International means outside your home country and can be broken into 2 categories by MSCI (Morgan Stanley Composite Index a leading provider of indices): 1. Foreign Developed (24 countries by MSCI like US, Canada, Japan, Western Europe) 2. Emerging Markets (21 countries by MSCI like China, Brazil, India, Russia, Mexico, South Africa, Taiwan, South Korea) Sixty-six percent of the world s stock value (by total market capitalization) comes from outside the United States! (Bloomberg 3/25/13). Japan is 7%, United Kingdom 6%, Mainland China 6% and Hong Kong 6%. By simply overlooking these 4 well-known international spots, you are ignoring 25% of the world stock market. Media overload and stereotypical distracters create sticky biases in people s minds. I have met a few clients who are adamant about never wanting to be invested in emerging markets due to fear or misunderstanding. However, Procter & Gamble, Coca-Cola, Colgate-Palmolive, IBM, Apple and most of the Top 100 biggest US-based companies have 10-20% of their total revenues exposed to emerging markets. So, you can be unknowingly invested there if you own any of those! Multinational companies are one way to play international investing, but we also utilize direct investments in companies headquartered outside the US. Cabot Money Management, Inc. Page 1

2 Over long-term horizons (more than 5 years), international allocations have been able to outperform a 100% US portfolio as shown below. Nothing is ever guaranteed, but there are strong reasons for this capability. BENEFITS AND ADVANTAGES Diversification: Never place all your eggs in one basket also holds true for a stock portfolio. Just as it is extremely risky to have all your money in only one or two stocks, the same is true for having it all in one country. Economic booms and busts occur in every region of the world at different time periods. Diversification is more easily achieved by investing a portion outside of the United States. Over the past 40 years, countries do not move in tandem more than 55% of annual trading days on average, with the exception of a global or financial crisis (like 2008). Hence, less interdependence between stock markets supports diversification benefits. Not all countries are created equally and some move more like the US on a daily basis (United Kingdom is 85% similar to S&P 500 Capital Appreciation the past decade in their respective own currencies). Increased Opportunities: Over the past two decades, globalization has vastly improved its reach to emerging markets. Overseas countries have become the beneficiaries of improved regulatory environments and governments more supportive of capital markets and corporations. Technologies, financial systems, urbanization, population growth and capital to fund new companies all contribute to this attractiveness abroad. Foreign Developed Markets Importance: Sony, Samsung, Toyota, Honda, BMW, Mercedes-Benz, Nokia, Louis Vuitton, Gucci, SAP and Canon are just a few companies that come to mind and started overseas. Trade and Comparative Advantage: cross-border trading is the most active it has been in decades. Countries began specializing in specific areas such as luxury autos and machinery goods from Germany; autos and consumer electronics from Japan; soybeans, oil and iron ore from Brazil; software, medical equipment and transportation equipment from the United States. All countries trade in order to improve their economy. Accounting practices in Western European countries (IFRS) are more transparent than US accounting practices (GAAP). Dividend yields are 1-2% higher in foreign developed than in US markets. Proximity to the world s growth engine (China) is easier for trade and logistics in many non-us countries. Lastly, great foreign businesses with still high sales growth and profitability are overlooked by investors. I prefer to buy a great management team with twice as much sales and earnings growth, large addressable market, higher dividend yield and much cheaper valuation in Europe than its US peer. None of the best performing stock market countries in each of the last 17 Cabot Money Management, Inc. Page 2

3 years has been the US (Morningstar). Australia is one of the top 3 best annual total return of the last 110 years (Credit Suisse). Emerging Markets Importance: Economic Growth is 3-4 times as much in emerging markets (defined by Real GDP growth) compared to developed markets (US, Canada, Western Europe, Japan, etc), such as +6% growth versus +2%. More specifically, the United States is growing just one-third as fast as the emerging markets economies! 35% of global private consumption comes from emerging markets. This is fueled by urbanization (younger generations moving from farms or rural areas into cities) and the rise of the middle class (better wages and lifestyle affordability). 60% of global capital expenditures by corporations go to emerging markets 45% of world GDP comes from emerging markets, but only 20% of world stock market value Halo Effect: growth fuels other growth with expanding sale streams, building more plants and offices, hiring, acquiring resources or distribution. Improved productivity and trade among bordering nations OUTPERFORMANCE HISTORY While the last 5 years have been much better for the US stock market (S&P 500 as index) than either foreign or emerging markets, that only gives the myopic recent picture. This is one of the few 5-year periods in the past 25 years where the US has outperformed emerging markets. Emerging markets have generated 100% more total return over the past 13 years than the S&P 500 (Bloomberg 99-12). Emerging markets have demonstrated superior risk-adjusted returns versus US markets in two-thirds of the time periods going back nearly 20 years. 3 Years 5 Years 6 Years 10 Years 13 Years Cumulative Total Return (incl Reinvested Dividends) US Market (S&P 500 Index) 35.9% 8.6% 14.5% 97.3% 23.4% Emerging Markets (MSCI Emerging Markets Index) 15.2% -2.7% 35.4% 352.6% 122.5% Europe (Stoxx 600 Index in US Dollars) 12.7% -15.3% -3.5% 146.0% 48.6% Source: Bloomberg RISKS AND DISADVANTAGES No free lunch metaphor applies to investing too! Any upside comes paired with some disadvantages and risks: Foreign Currency Exposure: a top risk from unpredictable currency rate fluctuations that could help or hurt a stock by 5-10% in a single year (even Cabot Money Management, Inc. Page 3

4 by 20-30% in extremely rare cases). However, if you have diversified exposure to enough countries in different regions of the world, you tend to mostly mitigate this risk as other currencies rise and fall versus the US dollar. Government Intervention and Political Risks: laws and regulation evolve differently in emerging markets. There can be a swift flood of economic stimulus or interest rates control one year, but then tightening controls the next year or government-owned entities creating unfair competition. It can also be just for 1-2 specific industries and not the entire country. However, in foreign developed markets, the regulation and political arena is similar to the US. Notable defaults and restructurings of currencies and debt over the past 20 years have been in Argentina, Russia, Greece and Iceland. But these are rare and not overnight actions. Slightly Higher Trading Costs: are often incurred with individual companies outside the US. Besides higher commissions, there can be stamp duties, levies and other transaction fees. American Depository Receipts (ADRs) can be available instead of buying the foreign holding in their local exchanges, but not for most smaller and mid-sized companies. Liquidity Risk: occasionally arises when your buy or sell order cannot be completely filled in the same day due to not enough demand or supply. Liquidity has improved dramatically in the past decade and there are many ways to easily and safely evaluate it before entering any trade order. Underperformance Shortfall versus US Stock Markets: tends to occur when there is some global crisis or flight to safety as investors go into the fetal position or capitulation, like late 2008 through early 2009 and again in late In those infrequent circumstances, the S&P 500 did outperform emerging and foreign developed markets by 4-15%. Usually this is due to risk appetite, but the emerging markets also rally faster too when negative sentiment and concerns reach a trough. Commodities can also be another cause of higher near-term volatility than the US, with China and Brazil as examples of export-dependent nations (although China is nearly selfsufficient domestically nowadays). But most nations are becoming less dependent on exports as they build up their services and domestic natural resources capabilities. WHEN AND HOW TO GET INVOLVED? Any advice or suggestions are provided for informational purposes only and is not a solicitation to purchase any investments or services described herein. Please consult your advisor to determine if an investment strategy is appropriate for you. Past performance of either the domestic or international markets or any specific investments is not predictive of future results nor will diversification alone protect from loss. Age-old guidelines back in the 1990s were to have only 5-10% of your total stock portfolio invested outside the United States. But fast forward twenty years, after industrialization, rising middle class growth and the launch of thousands of companies overseas since then. Nowadays you find many global investors with 15-25% abroad including a minor portion of that in foreign and emerging market bonds exposure (which we also participate in at Cabot). Easing in over two years, like average costing in with a few percent every six months into Exchange Traded Funds (ETFs), or right after a stock market Cabot Money Management, Inc. Page 4

5 correction, are two ways to get involved. Another way is through our company-specific selection of structurally advantaged companies we analyze at Cabot. As always, one should never be myopic when investing in stocks and should have a holding horizon of more than a year before deciding to invest. Worth keeping in mind is that just because the entire European or emerging market underperformed the US in one year, it does not mean that we cannot pick 3-4 great companies out of thousands to outperform their region or the US. Cabot Money Management, Inc. is a wealth management firm based in Salem, MA, with additional office space in Boston. As a firm with nearly 30 years of experience, Cabot has a national clientele and is a frequent contributor to CNBC, Bloomberg, The Wall Street Journal, The New York Times, and other local, national and international media. Cabot provides highly customized global investment management services coupled with tax, estate and financial advice for individuals and their families. Contact us at (978) or send your to info@ecabot.com if you have any questions regarding this white paper. Cabot Money Management, Inc. Page 5