Don't let home bias undermine your portfolio

Here's why international stocks may lessen the impact of volatility.

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Key takeaways

  • International stocks can play a key role in diversification of investor portfolios.
  • Historically, exposure to overseas stocks as part of a hypothetical diversified portfolio may lead to strong long-term results and lower volatility.
  • Many of the same factors that are driving volatility in US markets in 2022 are also putting pressure on international markets, but the long-term outlook remains positive.

Much like US stocks, international stocks have experienced high volatility so far this year. The war in Ukraine, China's struggles with COVID, supply chain disruptions, and unusually high inflation have impacted countless people around the world.

But also much like the US, most major global economies are weathering these conditions relatively well so far. "While stocks have been volatile, what we're seeing globally right now is a typical movement in the business cycle. Some countries are still in mid-cycle, while others are getting closer to late cycle. Think of something red hot cooling off to something warm—but not going cold," says Naveen Malwal, institutional portfolio manager with Strategic Advisers, LLC, the portfolio investment team for many managed account clients at Fidelity. "Overall, most international economies are experiencing positive growth, but at a slower pace."

This backdrop may lead to positive but more modest returns for international stocks. As a result, the investment team at Strategic Advisers, LLC has slightly trimmed international stock holdings within client portfolios—but plans to maintain exposure to the asset class. "Given all the news headlines, it's not surprising that clients might be questioning the benefits of holding non-US stocks. But when I look at client portfolios, I see that international stocks may have provided important diversification benefits this year," Malwal says. For example, from January through mid-June 2022, international stocks fell by about 5% less than US stocks.1

Investors who stay "close to home" may miss growth opportunities

Many US investors tend to favor investing in US stocks, a phenomenon known as home country bias. Part of the reason is the human tendency to prefer the familiar, in all parts of life. By default, we tend to choose the foods we grew up with, buy brands we've purchased before, and hang out with people we already know. In investing, that usually means sticking with companies we've heard of—maybe even one you or your family has worked for. "But whether you know of or use a company's products has virtually no bearing on the future performance of its stock," says Malwal.

In addition, some investors may wish to steer clear of certain countries because of political concerns or issues with market transparency. However, "international portfolio managers think about global businesses with worldwide revenues," says Malwal. "But international investing doesn't have to mean having trust in the governments or entire economies of specific countries. Rather, it's about looking at specific business opportunities that happen to be headquartered outside of the US."

In fact, many popular goods or brands that are familiar to US households are headquartered overseas. Within developed markets, this could include cars from German auto companies, luxury goods from France or Italy, medicine from Swiss pharmaceuticals, or coats and yoga pants from Canadian clothing brands. Meanwhile, popular goods or brands in emerging markets could include phone and high-end electronics manufacturers in Asia, food companies from Central and South America, or energy producers in the Middle East.

Home country bias can limit your investment opportunities

International can help mitigate volatility

Because US stocks have outpaced international stocks over the last few years, many investors may believe that non-US equities tend to underperform compared to their US counterparts. Historically, that hasn't always been the case, according to Malwal. Over the past 2 decades, there have been calendar years in which international stocks have outperformed US stocks and vice versa. Long-term, however, the returns on a globally balanced and US-only portfolio have been similar. Between 1950 and 2021, a hypothetical, globally balanced portfolio made up of 70% US stocks and 30% international stocks would have returned an annualized 11.6%, almost matching the returns on a hypothetical portfolio invested solely in US stocks, which would have returned an annualized 11.7%. However, in this hypothetical example, the globally balanced portfolio had a lower standard deviation, a widely accepted measure of volatility.2 "This shows how a 70/30 portfolio could potentially provide strong return potential with less volatility than a 100% US stock portfolio," Malwal says. In addition, he notes, Fidelity's Asset Allocation Research Team (AART) expects international stocks to outperform US stocks over the next 20 years.

US multinational exposure may provide limited benefits

Some investors may also believe that investing in US multinational companies can provide adequate exposure to international markets. They may point to the fact that about a third of S&P 500 revenue comes from overseas3—what is known as the passthrough effect. But according to Malwal, there's only so much international exposure one can get by investing in multinationals. "For example, if there's an economic boom happening in some countries, those local businesses are more likely to directly benefit from that than a US-based company with some foreign earnings exposure," he says.

Currently, given that many of the world's economies are similarly positioned in terms of their economic cycles, investors may also wonder if international diversification might have limited potential. Yet in tumultuous times, international investments can offer exposure to companies that may be affected differently by geopolitical situations. For example, while higher commodity prices often create headwinds for US stocks, non-US commodity producers have generally seen their revenues soar. These companies rely on selling energy, metals, or agricultural products (food and fertilizers) for their earnings. "Even this year, which has been a volatile year for stocks, international portfolio managers are finding opportunities to add exposure to stocks that are experiencing strong earnings growth," Malwal says.

International portfolio managers can help balance risk and long-term returns

Given the breadth of investing opportunities in a global world, international investing can seem daunting, especially since exposure to foreign currency movements or geopolitical developments are part of international investing. This makes both careful security selection and diversification within portfolios important for spotting opportunity while seeking to avoid undue risk, Malwal suggests. With those factors in place, some exposure to international stocks may help investors reach their financial goals. "The world population continues to grow and more people are moving up from poverty to the middle class," Malwal says, "so global corporate earnings are likely to head higher over time. Historically, corporate earnings growth has led to rising stock prices. That's why I believe international stocks can be an important part of a well-diversified portfolio." Strategic Advisers, LLC will continue to closely watch any developments that could meaningfully impact international markets and rebalance and reallocate managed accounts for clients accordingly.

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