Chris discusses the case for international investing through a core-satellite approach with specific countries.
Given the strong performance of U.S. stocks in recent years, it is no surprise that investors have some skepticism when it comes to international investing. In fact, behavioral economists refer to the fact that investors often focus on domestic stocks in their equity portfolios and limit international stocks as "home country bias." Nonetheless, it is important to remember international investing offers two major benefits:
Benefits of international investing
December's volatility in the U.S. brought home the importance of having some exposure to stocks outside the U.S. when emerging markets outperformed the U.S. Indeed, historically, U.S. and international stocks have gone through periods where one region outperforms the others. Combining assets that don't move in lockstep can lead to a reduction in volatility in the portfolio for the long run.
2. Access to growth.
International economies - particularly emerging countries - may offer faster rates of economic growth than the United States (Source: IMF World Economic Outlook, January 2019). For example, in emerging markets, a growing middle class and developing infrastructure can help generate wealth and dynamic companies with significant growth potential. And developed countries are already home to many world-class companies that U.S.-only investors could be missing in their portfolios.
To be sure, investing in international stocks brings risk, including currency exposures and geopolitical risks. The good news is that there are ways to potentially mitigate (but obviously never eliminate) those risks using a "core-satellite" strategy. This refers to a portfolio with a broad exposure (core) to an asset class while enabling the flexibility to adjust to current market conditions with country investing (satellite). Many investors do that in their portfolios with sectors.
A country core-satellite approach can be approached in a number of ways:
Managing strategic core exposures.
A non-U.S. allocation in a broad benchmark typically has significant concentration in just a few countries such as Japan, the U.K., and China. Allocation changes to these countries, typically as a result of views on macroeconomic events, regime changes or other trends, can have a significant impact on risk and return.
Managing currency exposures.
The currency risk in international investing can be significant. For U.S. investors, a currency's strength or weakness versus the dollar can either amplify or dampen returns from that country. Currency-hedged products can help mitigate that risk, but investors should be cautious, because currency exposure can actually add diversification properties in a portfolio in some instances.
Implementing macro themes.
With a core-satellite approach, tactical macroeconomic or relative value views are typically expressed in the satellite allocation. These can include commodity cycles, U.S. dollar cycles, and regional growth dynamics; understanding how they affect individual countries is key. For example, a tilt towards commodity producing countries can potentially boost returns when commodity prices are high (or vice versa).
Managing political event risk.
Geopolitical events are another area where investors can manage risks or exploit potential opportunities in countries. For example, elections are frequently a focal point for emerging market investors as policy swings, economic reforms, and changing sentiment play an outsized role compared to developed markets. Such patterns create risks, but also opportunities by tactical tilts, hedging the FX exposure, or some combination thereof.
For many investors, a broad, index exposure for non-U.S. regions may be appropriate, but it does come with drawbacks, specifically a large allocation to a few large countries, which can increase risk. But investors have a range of ways to invest internationally and tailor their approaches to meet their goals and with their own tolerance for risk in mind. In this effort, country exchange-traded funds (ETFs) can be a powerful tool. The precision exposure offered by country ETFs enables a tremendous flexibility in the range of applications and level of sophistication.
This post originally appeared on BlackRock Blog.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.