The Importance of Global Diversification

Written by: Ryan Bouchey

Hindsight is always 20/20, but in the case of a well-diversified portfolio you shouldn’t need to worry about the clarity of investment hindsight. I mention this as I look back to the first quarter numbers from 2015 and see how international equities have performed compared to U.S. equities. Unfortunately, many investors saw how poorly international stocks (especially emerging markets) performed the last two years relative to the U.S. markets and may have pulled out of international stocks all together. Let’s take a look at the past three years at three separate asset classes – U.S. large cap stocks, emerging market stocks and developed market stocks and discuss reasons why you should allocate overseas in your portfolio.

 

Asset Class	2012	2013	2014	Qtr 1- 2015
U.S. Large Cap	16%	32.4%	13.7%	1%
Developed International	17.9%	23.3%	-4.5%	5%
Emerging Markets	18.6%	-2.3%	-1.8%	2.3%

 

After two years of underperformance by international stocks many investors have forgotten that they even exist. They point to the great returns in the U.S. in 2013 and 2014 as well as the “uncertainty” of foreign equities. It’s hard to beat the run U.S. Large Caps have been on lately but history has shown us that all asset classes have their ups and downs and it would be a bad idea to completely write-off international markets. For one, we live in a global economy which is reflected by the market share of public companies. The United States for instance only makes up 52% of the global equity market. It’s also important to look at fundamentals when investing and international stocks, both developed and emerging markets, have had a lower price-to-earnings ratio compared to their U.S. counterparts giving them better valuations at this time.

 

Within the figures above let’s look more closely at three ETF’s we utilize in our client’s portfolios through Friday, April 10th. SCHX is the Schwab U.S Large Cap ETF which tracks the S&P 500 and is up 3.1%. SCHE is the Schwab Emerging Markets Equity ETF and is up 9.4%. Lastly, we were invested in HEDJ through the first quarter which is the Wisdom Tree European Hedged Equity and it has returned 23.3%. You can see three very separate asset classes and three very different results.

 

As a firm, we build our clients’ portfolio with anywhere from 25% – 35% of their equity allocation invested overseas. This allows us to capture a big segment of the market while also diversifying and reducing risk since international asset classes have a lower correlation to U.S. equities, thereby maximizing risk-adjusted returns. It’s important to remember that timing the markets is a losing game and that certain asset classes may be a drag to your portfolio in the short term. But if you stay disciplined and invested for the long-term, global diversification should be part of your investment strategy.