The real story
- In any given year, the best performing stock market is usually outside the US.
- International diversification has historically improved risk-adjusted returns.
- History suggest that actively managed funds may offer potential outperformance in international markets.
The long-term rally in US stocks has benefited many investors. However, it's also led some investors to have more of their portfolio devoted to US stocks than they may have intended. Overexposure to a single geography breeds diversification risk in a portfolio, leaving it vulnerable to a downturn in that geography and underexposed to a rally in other parts of the world. With that in mind, investors may want to re-examine the global mix of their stock allocations, and consider increasing their international exposure.
There are powerful reasons to invest outside the US, such as enhanced diversification, the potential for better risk-adjusted portfolio returns, and a larger opportunity set, among others. Nevertheless, many investors still lack international exposure, often due to misperceptions about the asset class. Here are 4 myths that investors might cite for not investing overseas, contrasted by what Fidelity believes are more realistic perspectives about the asset class.
Myth 1: The US is the world’s best-performing stock market
Reality: Not true. While US stocks have had higher returns than overseas stocks in aggregate for the past several years, the best-performing stock market in 6 of the last 8 years has been located outside the US (The graphic above shows the best-performing developed stock market during the past dozen years). Historically, developed market international and US stock performance is cyclical: One typically outperforms the other for several years until the cycle reverses (see chart). Timing these rotations is difficult, though, which is why it’s important to have both US and non-US exposure in an equity portfolio. Investors underexposed to foreign stocks could miss significant gains when overseas markets rally, or suffer losses when US stocks decline.
Myth 2: International investing is too risky
Reality: International stocks in combination with US. stocks have historically lowered long-term risk in a stock portfolio, compared with an all-US portfolio. That's because historically, the performance of US and international stocks has not typically been perfectly correlated,1 which thereby reduces risk. Fidelity’s research on strategic allocation indicates that a range of between 30 to 50% exposure to international markets, as a percentage of total equity, can help provide an appropriate level of diversification and enhanced portfolio risk-adjusted returns in a multi-asset class portfolio. Also, the absolute return of the globally balanced portfolio is almost level with that of the all-US portfolio, despite the recent multiyear rally in US stocks. And given the cyclicality of US and foreign stock returns, history suggests their relationship could revert to its historical norms at some stage.
|International equity exposure may decrease portfolio risk over the long term|
|1950 to 2019||US Portfolio||International Portfolio||Globally Balanced Portfolio 70% US/30% Int'l|
|Hypothetical "globally balanced portfolio" is rebalanced annually in 70% US and 30% foreign stocks. US equities: S&P 500 Total Return Index; Internationalequities: MSCI ACWI ex-USA Index. Source: Bloomberg Finance L.P., Fidelity Investments (AART), as of April 30, 2019. Past performance is no guarantee of future results. It is not possible to invest directly in an index. All indexes are unmanaged. Please see disclosures for index definitions.|
Myth 3: US multinationals provide adequate international diversification
Reality: The stocks of large US companies with operations overseas (multinationals) are sometimes highly correlated to the performance of the overall domestic stock market. Highly correlated stocks in a portfolio may indicate a lack of diversification. Therefore, US multinationals are not always good replacements for international stocks for diversification purposes. The table below compares the average correlations of several US multinationals to their foreign counterparts with US-listed shares. The non-US stocks shown have had lower correlations to the S&P 500 over the past 3 years, which typically signals better diversification benefits.
|International stocks can provide more diversification benefits than US multinationals|
|3-year correlations with the S&P 500, 2016 to 2019|
|General Mills (US)||0.55|
|General Motors (US)||0.59|
|Source: Morningstar, as of September 30, 2019. Company names shown here are for illustrative purposes only, are not representative of all companies, and are not a recommendation or an offer or solicitation to buy or sell any securities. Past performance is not a guarantee of future results.|
Myth 4: One needs to hedge currency to improve international stock returns
Reality: Actually, history shows that hedging currency returns doesn't improve international stock returns—at least not over the long term. Currency hedging (holding a stock denominated in a foreign currency and an equal but opposite short position in the currency itself) is intended to prevent currency fluctuations from hurting the stock price. While it sounds good in theory, the time and cost it takes to hedge currency has not paid off over time. Since 1973, currency hedging has detracted from returns in 50% of quarters, and contributed to returns in 50% of all quarters (see chart).
Timing currency movements is extremely difficult, even for professional investors. Plus, currency tends to be a relatively small component of returns over time, especially compared to earnings growth and price-to-earnings ratio expansion.
For each of the past 30 years, the best-performing stock markets have been located outside the United States. That means investors who were focused solely on US stocks missed out on attractive opportunities for growth and diversification. So consider increasing your allocation to international stocks. It could make a world of difference in your portfolio.
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Sharpe ratio compares portfolio returns above the risk-free rate relative to overall portfolio volatility. The Sharpe ratio is a standardized measure of return per unit of risk. A higher Sharpe ratio implies better risk-adjusted returns. Standard deviation is a statistical measure of market volatility, measuring how widely prices are dispersed from the average price. A low standard deviation indicates that the data points tend to be very close to the average, and a high standard deviation indicates the data points are spread over a larger range of values. A higher standard deviation represents greater relative risk.
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