Many investors in the US may be wondering why part of their portfolio is invested outside of the US, especially given a global backdrop riddled with challenging circumstances recently. In fact, for the five-year period ending August 31, 2022, the S&P 500 Index had an annualized return of 11.69% vs. the 2.04% return of the MSCI World ex USA Index and the 1.02% return of the MSCI Emerging Markets Index.
While there may be many reasons a US-based investor may prefer to stick with what they’re familiar with, it is important to remember that non-US stocks provide valuable diversification benefits, and that past performance is not a reliable predictor of the future. We discuss both these points in detail below:
- There’s a world of opportunities in global markets: As Exhibit 1 illustrates, nearly 40% of the investable stocks in global equity markets are outside of the US, and account for nearly 18,500 companies. Investing only in the US would not expose you to the performance of those markets or stocks
Exhibit 1:1 |
- The past is not a reliable predictor of the future: It is difficult to know which countries or even markets will outperform from year-to-year, in the same way it is difficult to know which stocks, sectors, or premiums will outperform. For example, for the period between 2000-2019, the average return of the best-performing developed market country was approximately 32%, while the average return of the worst-performing country was approximately -15%3. By diversifying, you are unlikely to have either the best or the worst outcome, but it also means you are likely to achieve a more consistent outcome and manage catastrophic losses that can accompany investing in a single country. By holding a globally diversified portfolio, investors are better positioned to capture returns wherever they occur.
- Case Study – The Lost Decade: The period between 2000-2009 is often called the “lost decade” by US investors as the S&P 500 Index recorded one of its worst 10-year performances with a total cumulative return of -9.1%. Those who remained diversified, however, would have felt some of that loss offset by the favorable returns in non-US markets, particularly emerging markets. Given recent geopolitical events, some investors may wonder about the validity of investing in emerging markets, which are sometimes considered riskier markets to invest in. However, this case study shows that by holding a globally diversified portfolio, investors may be better poised to capture returns wherever and whenever they occur.
Exhibit 2: Global Index Returns (January 2000 – December 2009)4
Past performance is not a guarantee of future results. |
Think about it from the standpoint of your own life. Some of your favorite goods and services may originate from companies that are not based in the US. Your coffee might originate in South America, your phone may be manufactured in Taiwan, your clothes could be woven from Egyptian fabrics, and your car might be German made. While it may be the case that an investor prefers to have a home-country bias for tax-related reasons, in general, diversifying globally can ensure investors decrease concentration risk and increase their investment opportunity set.
In conclusion, while both US and non-US asset classes offer the potential to return positive expected returns over the long run, they may perform differently over shorter time periods. A long-term investment strategy focused on global diversification can position an investor’s portfolio to capture the returns from thousands of companies across the globe.
Accompanying Resources:
• Global Diversification Can Make a World of Difference – The US stock market is the biggest in the world, but investors who ignore other global markets may miss out on a wealth of opportunity2.
• What Drives Investment Returns? Start with Ingenuity. – Owning a broad universe of stocks is the most effective way to participate in the rewards of ingenuity and innovation, wherever and whenever it takes place.
• Singled Out: Historical Performance of Individual Stocks – The chance of any single stock outperforming the market in the future is not meaningfully different when conditioning on its past performance.
Past performance is no guarantee of future results.
SOURCES:
Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.
1. In USD. Market cap data is free-float adjusted and meets minimum liquidity and listing requirements. Dimensional makes case-by-case determinations about the suitability of investing in each emerging market, making considerations that include local market accessibility, government stability, and property rights before making investments. China A-shares that are available for foreign investors through the Hong Kong Stock Connect program are included in China. 30% foreign ownership limit and 25% inclusion factor are applied to China A-shares. Many nations not displayed. Totals may not equal 100% due to rounding. For educational purposes; should not be used as investment advice. Data provided by Bloomberg.
2. Based on the free-float adjusted market capitalization.
4. S&P data © 2020 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. MSCI data © MSCI 2020, all rights reserved. Indices are not available for direct investment. Index performance does not reflect expenses associated with the management of an actual portfolio.