Retail Investors Refuse to Globalize

Retail investors’ behavior is not reflective of the current global landscape. According to Hewitt Associates’ 401k data for 2007, retail investors were only allocating 14% of their equity portfolios to international investments. This contrasts starkly with the current US portion of global market cap and global GDP. Unlike retail investors, institutional investment activity clearly reflects awareness of the rapid expansion occurring outside the US.

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I heard Paul Wolfowitz, former head of the World Bank, lecture on this topic several years ago. At the time, Mr. Wolfowitz pointed out that in 25 years the US portion of global market cap would shrink from roughly 50% to 25%. He also outlined that this trend began to accelerate in the 1970s (at that time US markets made up 66% of global market cap). What troubles me is that institutional investors like Harvard and CalPERS have increasingly moved their equity allocations in line with this global market cap shift. Unfortunately, individual investors who are increasingly more responsible for their own investment decisions (as DC plans overtake DB plans) are showing no signs of adjusting to this trend. This could prove to be a costly mistake.

According to the MSCI Blue Book, in 1970 the US public equity markets made up of 66% of global market cap. We recently ran a simulation using S&P 500 (SPY), MSCI EAFE (EFA) and MSCI EM (EEM) Indexes to test how investors would fair if they had kept pace with globalization. We began the simulation in 1970 with 60% invested in the S&P 500 and 40% in the MSCI EAFA index. In 1988 we shifted the portfolio to be 40% the S&P 500, 40% MSCI EAFA and 20% the MSCI EM index to reflect the shrinking global landscape. Rebalancing annually, this global portfolio averaged a return of 11.71% vs. 10.50% for the S&P 500 over the same period.

The case for retail investors to move to a global portfolio is a case for improving their returns. Since 1970 the rate of real GDP growth has slowed in the US. This is also reflected by a US public equity market that has seen its growth rate slow post-1970. This is exactly why institutions are increasingly moving toward global equity mandates. The risk to US retail investors is that they may see investment returns significantly below previous generations. This does not bode well for those investing for retirement today.

Two new ETFs help retail investors easily allocate globally: Vanguard FTSE All World Index ETF (VT) and the iShares MSCI ACWI All Country World Index ETF (ACWI). Both of these investment options provide retail investors with an equity allocation reflective of globalization at a very low cost.

Disclosure: The author’s firm has positions in SPY, EFA, and EEM.

Comments

[Cashman:]

The economy is in a frenzy of buying foreign produced goods. We as producers should stand up and say enough is enough! Buy equally or your stocks are worthless in this exchange!

2008 Aug 27 08:30 AM

[Cashman:]

Global investing could be more lucrative if the world economy wasn't so volatile. We instituted NAFTA and it seems that every nation has got it's far shake with the exception of this Nation's(USA). Buy Buy Buy! Made in ______________. Fill in the Country. Exportation of goods should be on the new President's agenda. I.E. Fair trade. This investor refuses to buy foreign stocks until the scales balance.

2008 Aug 27 08:40 AM

[Tony Daltorio:]

This article is spot on! I make sure my clients have a good portion of their assets in foreign stocks or they're not my clients. Over the past 4 years, they have averaged a total return of nearly 200%. Personally, I have 95% of my portfolio in foreign stocks and commodities.

2008 Aug 27 10:25 AM

[Just Askin:]

VT sounds great in theory, but it looks rather illiquid (32,000 av. vol).

2008 Aug 27 10:34 AM

[2houndz:]

Cashman - Let's have the next President enforce a rule that says we won't buy anything from a country that doesn't buy the same amount from us. That sounds like a great policy, and woud shut our economy down in about six minutes. Sharp thinking.

2008 Aug 29 06:12 PM