Here’s a reader question on international equities that reflects some of what I’ve been reading elsewhere and thinking about in my head:
I was doing my mid-year rebalance and noticed that international equity funds did terrible over the past 10 years, I have a fair amount of money in international equities, as do you. I’m considering lowering the % because they generally under perform US funds. Would love your thoughts.
First, let’s look back at some history (i.e. my old posts). Is it really true that US stocks historically perform better than International stocks? Also, the diversification benefit comes from the very fact that these asset classes don’t always move in sync (not perfectly correlated), allowing you to attain a higher risk-adjusted return by holding some of both as opposed to just one or the other.
From 1970-2006, foreign stocks outperformed US stocks, while the point of optimal risk-adjusted returns was a split of 76% US and 24% Foreign Developed (EAFE) (70% is a typo). The chart is taken from a past edition of A Random Walk Down Wall Street by Burton Malkiel.
From 1970-2013, the same chart shows that US stocks now outperformed foreign stocks on average, with the point of optimal risk-adjusted returns at 70% US and 30% Foreign Developed. From Rick Ferri:
From 1970 to 2015, the average annualized return of the S&P 500 has been 10.3%, while MSCI Europe has returned 10.0%. Sometimes US wins. Sometimes International wins. Here’s a chart from Ben Carlson of A Wealth of Common Sense showing the rolling 5 year over- and underperformance of U.S. stocks relative to European markets (MSCI Europe):
This is an example of why “staying the course” sounds easy but it isn’t in real life. On one hand, some of the recent doubt about Europe and Emerging Markets has to be about performance chasing. Look at the recent divergence in two major mutual funds that track Total US (VTSAX) and Total International (VTIAX) indexes, taken from Morningstar. This shows the growth of $10,000 invested 5 years ago:
On the other hand, there are real reasons behind the performance difference. The US economy has been more resilient and the future does look more bright. Europe and Emerging markets have more obvious problems without a visible solution. But that also means that US stocks are more richly valued, and International stocks are “cheaper”. Every model that uses historical data shows that International stocks have a higher future expected return. Here is Research Affiliates as one example:
Summary. The formal advice is that you should have a written “investment policy statement” (IPS) that states why you hold your current asset allocation in the first place. In other words, what where the reasons behind your current allocation? Have they changed? For me, nothing has really changed about why I bought both US and international stocks in the first place. Their long-term historical returns remain similar, and while the US may be slightly ahead at this moment, this could easily change again in the next decade.
It’s not fun to hold these international stocks right now, but I focus on the fact that European and Emerging Markets valuations are relatively cheaper and the dividend payout rates are relatively higher. By owning a globally-diversified passive portfolio, I choose to rely on the markets to work themselves out over time.
© MyMoneyBlog.com, 2016.