Political and market change
Bernard Chua, CFA, Client Portfolio Manager, American Century Investments
International equity exposure and your portfolio
International equity markets have grown dramatically in both size and importance over the past decade. In fact, leaving out the United States, companies residing in the other established, developed economies of the world now represent nearly a quarter of the global market. Yet investors average only a nine-percent equity allocation to these investments. This may not be enough exposure to international stocks for long-term wealth accumulation. In addition to missing out on potential gains from areas like Europe that appear to be in early stages of recoveries, underexposure to these investments limits the diversification benefits they can provide.
Diversify across markets to fight volatility
The principle of diversification is to have a broad mix of investments that experience ups and downs at different times, which can smooth out returns. Economic downturns in one country or region could be offset by growth in another. Although it cannot eliminate entirely the risk of loss, diversification can lead to more consistent returns over time with lower volatility.
These factors may make international mutual funds an attractive complement to your U.S. investments. Of course, you need to think about your comfort with risk when selecting your mix. Funds that invest primarily in developed markets throughout the world, such as Europe, Japan, Australia and Canada, typically are less volatile than funds that invest in emerging markets, like China, Brazil and India, or in specific countries or regions.
To benefit from global diversification, a common suggestion for long-term investors is a starting allocation between 20% and 30% of their stock portfolios to international equities. These numbers are based on the increased opportunities in these markets — developed non-U.S. markets now account for 30% of the global market capitalization, 40% of global gross domestic product (GDP), 33% of global public company profit, 42% of the world's middle class and 39% of the world's 1,000 largest companies.1
Consider countries, companies and correlations
The growing global economy and recovery from the recent financial crisis have improved the investment environment. Looking at the country level, the restructuring process in both Europe and Japan has taken some time, but the fruits of this process are beginning to become apparent.2
European Union countries and Japan represent the world's second and fourth largest economies, respectively.3 With a major share of public company profit and middle class consumers, they present opportunities for firms poised to capitalize on and benefit from the renewal of growth in these markets.
As countries have emerged from the downturn, many companies also have restructured and are more competitive than ever, with some announcing better than expected earnings. Portfolio managers of international mutual funds can cast a wider net when searching for stocks with the potential for strong investment returns.
Another positive sign for investors is that stocks are not reacting to macroeconomic factors — such as central bank policies, inflation, interest rate trends, natural disasters, or political events — as uniformly as they once did. Intra-index correlation (i.e., how closely individual stocks move in tandem with the index)4 for the global MSCI World Index has declined to levels of less than half the all-time highs reached in late 2011. Declining correlations suggest the focus has shifted to company fundamentals over economic forces, and favors investment managers who select individual stocks on their own merits.
Review your international exposure
Now may be a good time to talk with your advisor about your portfolio's international allocation in relation to your overall investment goals. You may want to take advantage of developed, non-U.S. equity markets that appear to be in early stages of recovery.
Although there is no one right answer for all investors, the appropriate amount of international equity investments will depend on your goals, portfolio objective and tolerance for risk. Review your investments with your advisor to determine how much of your portfolio should be invested internationally, and decide if any changes are needed.
1 Source: McKinsey & Company.
2 The rolling 12-month change in the Composite of Leading Indicators (CLI) has been positive for the Eurozone and Japan from January 2013 through March 2014. The CLI is published by the Organisation for Economic Co-operation and Development (OECD) and measures numerous components of a country's economic output. A positive number indicates growth.
3 Gross domestic product (GDP) is a measure of the total economic output in goods and services for an economy. The European Union ranked second when all of the countries in the union were combined.
4 Correlation measures the relationship between two investments--the higher the correlation, the more likely they are to move in the same direction for a given set of economic or market events. A correlation of 1.0 means a stock and its index move in perfect tandem, which a correlation of negative 1.0 means a stock and its index move in opposite directions.
Used by permission of American Century Investments. American Century Investments is not affiliated with Ameriprise Financial and may offer different investment perspectives.
International investing involves special risks, such as political instability and currency fluctuations. Investing in emerging markets may accentuate these risks.
Diversification does not assure a profit nor does it protect against loss of principal.
The MSCI World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets. It is not an investment product available for purchase.
For educational use only. This information is not intended to serve as investment advice.