The Benefits of International Diversification

Key Takeaways

  • Investors often think of diversification as spreading their assets across various sectors or styles, adding international investments to your portfolio can be another crucial way to diversify.
  • International diversification could help reduce portfolio volatility over the long term.
  • The rotation of country leadership between US and non-US stocks over time could help your internationally diversified portfolio capture more growth.

The idea of diversifying your portfolio among different sectors or market capitalization to reduce volatility makes intuitive sense. Investors often have diversification in mind when developing an investment strategy, but many US investors aren’t as diversified as they should be. Often, they fail to look outside of their home country—forgoing additional investment opportunities.

While it is true the US is the world’s biggest, most dynamic and diverse economy, other countries make up a significant part of the global economy. The US represents more than half the value of the world’s stock market and about 25% of the global economy.[i]

Exhibit 1: MSCI Country Weights

Source: FactSet, as of 6/30/2018. Values may not sum up to 100% due to rounding. The MSCI World Index measures the performance of selected stocks in 23 developed countries. Europe and Middle East includes 15 developed market countries: Australia, Belgium, Denmark, Finland, France, Germany, Ireland, Israel, Italy, the Netherlands, Norway, Portugal, Spain, Sweden and Switzerland. Pacific includes Australia, Hong Kong, New Zealand and Singapore.

Leadership among these different countries tends to rotate. Investors have no easy way of knowing which country will outperform in a given year, so it can be a good idea to invest in both US and international markets at any given time.

The good news is US investors have several choices when it comes to investing in international equity markets. If you have a smaller portfolio, you could invest in international-focused mutual funds and exchange traded funds (ETFs). However, high net worth investors with larger portfolios may be able to achieve sufficient diversification purchasing individual non-US stocks, US stocks and other securities.

While global investing may involve additional research, having the ability to reduce volatility over time and take part in additional growth opportunities can increase your chances of meeting your long-term investing goals.

A Potentially Smoother Ride

International and US equities can yield significantly different returns year to year. However, these differences can even out over long periods of time. We believe all well-constructed, broad market indexes should yield similar returns over the long run. Generally, the more diversified an index is, the lower the volatility will be. For example, if you invest in a benchmark based only on US small cap growth stocks, that group of companies will likely experience more volatility over time than a broader US index like the S&P 500. Similarly, tracking a global stock benchmark may reduce your portfolio’s volatility even further than tracking a US stock benchmark over time. This is because the broader global approach helps offset the risk of steep dips or spikes experienced by a single country, sector or business.

We live in a global economy, and many of the macro-economic forces acting on US stocks may impact international stocks much differently. Though the two are often correlated, US and non-US stocks don’t always behave similarly. Blending US and non-US stocks may help lower volatility over the long term.

Rotating Leadership with International Diversification

In addition to exposing you to additional risk, investing only in US stocks can also lead to missed growth opportunities. Exhibit 2 shows the US was in the top five performing countries only six times between 1999 and 2018.[ii] If you failed to invest outside of the US, you may have missed out on some of the best growth opportunities in 14 of those years.

Exhibit 2: Top 5 Performing Stock Markets Over the Past 20 Years

Source: FactSet, as of 5/3/2019. The above returns reflect the Total Returns of the top 5 performers of the 23 developed countries that comprise the MSCI World Index, from 12/31/1998 - 12/31/2018. Country returns are represented by the respective MSCI World country index, except for US returns which use the S&P 500 Total Return Index. All returns are presented in USD. All returns are presented net international witholding taxes, except for US returns, which are presented inclusive of gross dividends as international witholding taxes which are presented inclusive of gross dividends due to data availability.

No single country is a top performer all the time. Investing in international markets can help spread risk across countries, currencies, industries and companies. Think of it as a way to diversify away some of the risk related to regional geopolitical tensions, changes in economic conditions, natural disasters or other unexpected events. By diversifying in this way, you reduce the risk of investing in only one country. There is no perfect way to know whether US or international stocks will emerge as a leader and for how long. Deciding to invest only one part of the world at the wrong time could prove to be a costly mistake.

In addition, some of today’s largest and fastest-growing companies are located outside of the US. While the US might make up a significant portion of certain sectors—like Information Technology and Industrials—some of the largest Materials and Energy companies are actually located outside of the US.[iii] The broader your investment choices, the more you could diversify away sector, size, style and single-country risk. You can still experience downside volatility, but diversifying across global stocks can smooth the bumps a bit and build more of a cushion than a narrower index might.

We Can Help with International Investments

Analyzing financial markets is no easy task, and navigating global markets can be even more difficult. If you would like to learn how Fisher Investments can help you diversify your portfolio amongst US and international investments, contact us today!

[i] Source: FactSet, as of 6/30/2018. Values may not sum up to 100% due to rounding. The MSCI World Index measures the performance of selected stocks in 23 developed countries. Europe and Middle East includes 15 developed market countries: Australia, Belgium, Denmark, Finland, France, Germany, Ireland, Israel, Italy, the Netherlands, Norway, Portugal, Spain, Sweden and Switzerland. Pacific includes Australia, Hong Kong, New Zealand and Singapore.

[ii] Source: FactSet, as of 5/3/2019. The above returns reflect the Total Returns of the top 5 performers of the 23 developed countries that comprise the MSCI World Index, from 12/31/1998 - 12/31/2018. Country returns are represented by the respective MSCI World country index, except for US returns which use the S&P 500 Total Return Index. All returns are presented in USD. All returns are presented net international witholding taxes, except for US returns, which are presented inclusive of gross dividends as international witholding taxes which are presented inclusive of gross dividends due to data availability.

[iii] Source: FactSet; MSCI World Index as of 8/30/2018

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Investing in securities involves a risk of loss. Past performance is never a guarantee of future returns. Investing in foreign stock markets involves additional risks, such as the risk of currency fluctuations.