April 6, 2022

Why Invest in International?

Since 2007 international stocks have lagged the returns of U.S. stocks. So, are global stocks worth investing in if they have not generated superior returns to U.S. stocks in recent years? After all, by investing in international U.S. stocks, wouldn't I get enough exposure to global economies? To answer these questions, we must discuss the potential gains from diversification. The gains from diversification depend on the correlation of returns for international and U.S. stocks. In their 1991 paper titled Investor Diversification and International Equity Markets, economists Kenneth French and James Poterba observe that "risk reduction is available from cross-border holdings." [1]  Meaning that a U.S. investor has the potential to reduce the risk of their portfolio as measured by the correlation of returns by adding international holdings. Because the returns of investments can vary by country in the short term, investors may have a conviction to tilt their investments towards one country (typically their home country). This conviction is often called home country bias. However, global exposure could be a practical approach for potentially higher risk-adjusted returns if you can recognize this bias.

Additionally, we can visualize the periods of under or over performance of U.S. stocks compared to international stocks in the chart below. [2] From this chart, we can see that we have seen an unusually long underperformance of international stocks in recent years. It is impossible to predict the future relationship between international and U.S. equities but incorporating global stocks in a portfolio has historically lowered long-term risk. However, history could suggest that this relationship might switch its ties at some point in the future.

I know you may be wondering how that data stacks up to the international environment this year. With the ongoing conflict between Russia and Ukraine, we must think about what that means for investing internationally today. We can look at the wartime stock market performance around major international conflicts. Looking at the select geopolitical events in the table below, we can see that the market returned positively by the following year in all but three instances. After these conflicts, the average twelve-month return of the S&P 500 was 8.6%.[3]

The bottom line is that although geopolitical conflicts can increase uncertainty in the markets in the short-term, historically negative long-term impacts are unlikely. It may be beneficial to remember the saying from Baron Rothschild following the Battle of Waterloo against Napoleon "buy when there's blood in the streets, even if the blood is your own." [4]

At Duncan Williams Asset Management, we take a holistic approach to analyzing international vs. U.S. equity investments for our clients to combat country bias and increase the diversification of asset classes. Specific asset allocation can vary based on each investor's risk and return expectations and their conviction towards or against particular asset classes. In conclusion, international holdings can play an essential role in an investment portfolio by utilizing the power of diversification.

[1] https://www.nber.org/system/files/working_papers/w3609/w3609.pdf

[2] https://www.fidelity.com/viewpoints/investing-ideas/international-investing-myths

[3] https://www.truist.com/content/dam/truist-bank/us/en/documents/article/wealth/insights/market-perspective-02-14-22.pdf

[4] https://www.forbes.com/2009/02/23/contrarian-markets-boeing-personal-finance_investopedia.html?sh=149b475db59a

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