Foreign Stocks: Where to Invest, and How Much?

There was an exceedingly pertinent and interesting article in the Wall Street Journal which came out two weeks ago that I wanted to give Emerginvest's take on: "Going Global: How Do You Get There from Here?" It was the headline/leading article of the personal investing section of the Wall Street Journal and is completely centered around foreign stock exposure and what role (and how much) international investments should play in a portfolio composition. I don't think it's possible for an article to be any more in line with Emerginvest's focus…

It begins with a seemingly innocuous statement: (there is also a video)

This month, Citigroup Inc. recommended investors put 55% of their stock portfolio in foreign stocks, in a series of new asset-allocation plans. That's a big boost from 30% in its current plans. With this move, Citigroup joins a growing camp of experts who believe that investors' portfolios should match the world's stock-market weightings to get the best risk-adjusted returns over the long run.

Even for someone who is as interested in international investing as I am, I was shocked that Citi recommends 55% of one's portfolio to be overseas! Just last month, Mohammed El-Erian, co-CEO of PIMCO suggested in a Newsweek article entitled: "El-Erian: Buy More Foreign Stocks" that the typical US investor should consider "holding a third of your equities… in emerging markets." At the time, that was a forceful statement to most retail investors, and Citi follows up by recommending over half. Jeffrey Applegate, Citi's chief investment officer, defends the 55% foreign-stock portfolio allocation by citing that the fact that "The primary engines of growth have shifted away from the United States."

I couldn't agree more. It seems like such a simple concept: developing countries are racing to catch up with the developed world, inexorably producing more growth as a whole than the largely saturated markets in developed countries. One of my last posts dealt with a report from Morgan Stanley's head researchers, concerning how many developing countries are going to be pouring billions of dollars over the next decade to improve their basic infrastructure (transportation, sanitation, etc.) and how that expenditure will fuel their continued growth over the next ten years.

For me, it seems like a logical choice to put a sizable portion of one's portfolio overseas and it looks like the Wall Street Journal agrees. The WSJ cites "Emerging-markets shares total 8.4% of the global index, roughly four times where they stood just four years ago," and states "American stocks represented 66% of the world's market value in 1970 and have been declining bumpily since then, primarily as a result of the growth in emerging markets…"

That being said, even I acknowledge the concerns about short-term turbulence in emerging markets. We have seen most emerging markets fall drastically in the last few months. Despite a large surge on Friday, many major world indices are down sharply this quarter alone: Shanghai index in China is down 26.7%, Japan's NIKKEI is down 16.5%, while others like India are only down 3.6%, according to Emerginvest.com. These sharp declines have helped give ammunition to opponents of the argument that emerging markets are mostly uncorrelated to the US and other developed markets. The article gives some fairly convincing evidence that emerging markets are no more volatile than developed, saying:

As for the idea that a foreign portfolio is riskier than a domestic one, "the numbers don't back that up over the long term," says Christopher Davis, a fund analyst at Morningstar Inc. The standard deviation — in the mutual-fund world, a measure of how much a fund's returns have bounced around its average return over time — of the total U.S. stock market was 15.4 for the past 10 years, compared with 15.5 for foreign stocks, including those of emerging markets.

I'm sure that mutual funds heavily weighted their stock holdings with large-cap - and that small cap can still be volatile (as in any economy or market). However that is a far cry from the long held-belief by some US investors that emerging markets are heavily volatile, aren't trustworthy, and that things like legal issues can rip apart investments. The evidence suggested by Christopher Davis from Morningstar above completely dissuades me that there is any more risk when investing in major foreign companies than when investing in major domestic companies (this past week with the U.S. investment bank crisis is proof enough of that). To hedge against the "small cap" issue I mentioned, the article cites an analyst who recommends: "'Don't try to figure out if the next big thing is Indian oil or cars or shoes,' he says. 'Just buy the whole stock market of India.'" Sounds like reasonable advice to me, although I'm sure I'll still put a small allocation into a few of my "undiscovered" international stock picks.

In short, I'm happy to see the Wall Street Journal acknowledging that value in international investments and hope to see many more of these articles in the future.

Disclosure Statement: Emerginvest is a international finance portal, helping investors find investments from around the world. Emerginvest attempts to provide non-partisan information about world stock markets, and does not have any holdings in foreign equities. The above article was originally posted at Emerginvest's Emerging Markets Blog, and should not be construed as financial advice, and is not liable for any investment decisions based off of it.