The myths of international investing

Do you hold any of these common misconceptions about international stocks?

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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
Annualized returns 11.30% 10.30% 11.30%
Standard deviation 14.30% 15.10% 12.80%
Sharpe ratio 0.49 0.40 0.55
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
Consumer staples
General Mills (US) 0.55
Unilever (U.K.) 0.30
Auto
General Motors (US) 0.59
Honda (Japan) 0.54
Technology
Oracle (US) 0.72
SAP (Germany) 0.57
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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1. FactSet, as of Dec. 31, 2016
2. Fidelity Investments, "Some Active Funds Rise Above a Tough Year," March 2016.
Before investing, consider the funds' investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully.
Unless otherwise disclosed to you, in providing this information, Fidelity is not undertaking to provide impartial investment advice, or to give advice in a fiduciary capacity, in connection with any investment or transaction described herein. Fiduciaries are solely responsible for exercising independent judgment in evaluating any transaction(s) and are assumed to be capable of evaluating investment risks independently, both in general and with regard to particular transactions and investment strategies. Fidelity has a financial interest in any transaction(s) that fiduciaries, and if applicable, their clients, may enter into involving Fidelity’s products or services.
Glossary of Terms
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.
Correlation measures the interdependencies of 2 random variables that range in value from −1 to +1, indicating perfect negative correlation at −1, absence of correlation at 0, and perfect positive correlation at +1.
Price-to-earnings (P/E) ratio shows the relationship between a stock price and its company’s earnings (or profits) per share of stock.

Information presented herein is for discussion and illustrative purposes only and is not a recommendation or an offer or solicitation to buy or sell any securities. The views and opinions expressed by the Fidelity speaker are his or her own as of the date of the recording and do not necessarily represent the views of Fidelity Investments or its affiliates. Any such views are subject to change at any time based on market or other conditions, and Fidelity disclaims any responsibility to update such views. These views should not be relied on as investment advice and, because investment decisions are based on numerous factors, may not be relied on as an indication of trading intent on behalf of any Fidelity product. Neither Fidelity nor the Fidelity speaker can be held responsible for any direct or incidental loss incurred by applying any of the information offered. Please consult your tax or financial advisor for additional information concerning your specific situation.

This podcast is intended for U.S. persons only and is not a solicitation for any Fidelity product or service.

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Investment decisions should be based on an individual’s own goals, time horizon, and tolerance for risk.

Stock markets, especially foreign markets, are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments. Foreign securities are subject to interest rate, currency exchange rate, economic, and political risks. The securities of smaller, less well known companies can be more volatile than those of larger companies. There is no guarantee that a factor-based investing strategy will enhance performance or reduce risk. Before investing, make sure you understand how the fund’s factor investing strategy may differ from that of a more traditional index product. Depending on market conditions, funds may underperform compared with products that seek to track a more traditional index. The return of an index exchange-traded fund (ETF) is usually different from that of the index it tracks, because of fees, expenses, and tracking error. An ETF may trade at a premium or discount to its net asset value (NAV).

The securities of smaller, less well known companies can be more volatile than those of larger companies.

Growth stocks can perform differently from the market as a whole and other types of stocks, and can be more volatile than other types of stocks.

Investing involves risk, including risk of loss.

All indexes are unmanaged. You cannot invest directly in an index.

Past performance is no guarantee of future results.

Diversification and asset allocation do not ensure a profit or guarantee against loss.

Indexes are unmanaged. It is not possible to invest directly in an index.

Index definitions Standard & Poor’s 500 (S&P 500®) Index is a market capitalization–weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent US equity performance. S&P 500 is a registered service mark of The McGraw-Hill Companies, Inc., and has been licensed for use by Fidelity Distributors Corporation and its affiliates. MSCI All Country World Index ex-US is a free float–adjusted market capitalization–weighted index designed to measure the equity market performance of developed and emerging markets, excluding the US.MSCI Europe, Australasia, Far East Index (EAFE) is a market capitalization–weighted index that is designed to measure the investable equity market performance for global investors in developed markets, excluding the US & Canada. MSCI Emerging Markets (EM) Index is a market capitalization-weighted index designed to measure the investable equity market performance for global investors in emerging markets.

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