The Case For International Diversification

Observant1

Whether or not an investor should own foreign equities is a contentious topic in some circles.
Some prominent investors (Warren Buffett, Jack Bogle) have stated
that international diversification is not required.

"If you could predict the future there would be no reason to diversify but no one has the ability to know what comes next in the markets or global economy."

"Diversification is hard because you just know there is always going to be something in your portfolio that’s going to underperform. You just don’t know what that asset class or strategy it will be at any given time."

"Global diversification is about accepting good enough returns to avoid the potential for terrible returns at an inopportune time."

The author compares returns for the S&P 500 and MSCI World ex-U.S. indexes below.

We have MSCI data for international stocks going back to 1970.
Here are the annual returns for the S&P 500 and MSCI World ex-U.S. through April 2023:
U.S. stocks +10.5%
International stocks +9.1%

It’s also true that much of the outperformance has taken place during the latest cycle.
From 1970-2012, the annual returns were basically dead even:
U.S. stocks +9.7%
International stocks +9.6%

Link

Crash

every time i go overseas i get skrunched. Exception: JRSH and NHYDY. Very small positions. My fund managers have me 8 percent in foreign stuff.

Tarwheel

I continue to hold international stock funds but have let the percentage decline as they continue to underperform. Most foreign funds are doing relatively well so far this year, but I never have high expectations because they have disappointed so much in the past. I’m a strong believer in diversification and asset allocation, so I expect parts of my portfolio will almost always lag, just as other parts will shine.

hank

There’s a whole other issue of whether the fund is dollar hedged, partially so, or not at all. You can find international funds in each camp depending on whether or not you want to hedge against potential dollar weakness. If you believe the dollar will remain strong, use dollar-hedged funds.

Buffet sold a lot of U.S. stocks first quarter, but increased his holdings in Japan. I suspect part of his thinking involves relative currency valuations (dollar vs yen).

Another question is how much of a premium you’re willing to pay for a more diversified portfolio. ISTM that if all of your investments are rising together there’s a pretty good chance that at some future date they will all decline together.

It’s interesting that some really accomplished heads of corporations look out 5-10 years when making spending decisions about acquisitions, expensive new infrastructure, new streams of income. But a lot of us (self included) react to gains / losses much nearer term. I mention that only because international investing involves calculated longer term risk taking. Past may not be precursor to future.

Observant1

Tarwheel,

Like you, I believe in diversification.
I've had mixed results (from a total return perspective) with foreign equities.
My foreign equity funds outperfomed from approximately 2000 to 2010.
U.S. equities have significantly outperformed since then.
Since I don't know which of these asset classes will have superior future performance,
I stay invested in both.

bee

FMIJX has had two unusually bad patches (2020) and (2022) surrounded by some very strong years verses its peers.

fmijx/performance

Not International, but "Global Investing without the indigestion" might be another approach for diversifying away from the US:

investing-without-an-ulcer

Observant1

FMIJX is an international equity fund which hedges currency (most foreign funds don't hedge).
The strong U.S. dollar provided a tailwind for FMIJX.
FMI introduced an unhedged version of its International Fund (FMIFX) on 12/31/2019.
The link below shows the portfolio backtest results for both funds.

FMIJX vs. FMIFX

Observant1

The MSCI EAFE 100% Hedged to USD Index provides a close estimation of developed market currency performance when compared to its parent index.
PDF

Sven

Same here on the diversification benefit. Also the world is enter a new phase of de-globalization as geopolitical conflicts rise. Some world class companies are located in Europe and Japan. In addition, the oversea stock valuation is quite attractive relative to US stocks.

yogibearbull

Dollar diversification is one of the reasons for foreign exposure. Dollar has been strong for last several years, but may have peaked in September 2022. Since then, the pattern is of a decline (look at declining 50d-MA and 200-dMA) with wiggles up/down.

As has been noted, strong dollar is a headwind for foreign funds held by the US investors, while weak dollar provides tailwind. The currency-hedged foreign funds become popular in strong dollar eras.

But currency movements/trends are hard to predict.

https://stockcharts.com/h-sc/ui?s=$USD&p=D&yr=1&mn=0&dy=0&id=p35088383212

davidrmoran

this influenced my decisionmaking 8y ago and I have not regretted it

https://www.usatoday.com/story/money/2015/01/16/investing-international-funds/21825245/

Tarwheel

Good article.

Regex

Here is an article from T. Rowe Price that makes the case for international investing in this economic environment of higher inflation and business loans that actually have a real cost associated with them: https://www.troweprice.com/personal-investing/resources/insights/international-equities-are-positioned-for-a-comeback.html

WABAC

I don't know about regime change. IHDG is the top performer in my taxable account over the last twelve months. It's closely followed by two tech funds and FSMEX. VWIGX is in between the tech and health funds.

In the IRA, GRID, XBI, and FSCSX outperformed IHDG. Due to the price at which I bought XBI, I am still well underwater.

If it wasn't so early in the morning here, I'ld try to come up with some clever twist on regime change, and Keynes observation about how long markets can remain irrational.

I have always figured the point of diversification is to already be there when the market turns in a new direction. If indeed, the market is turning in a new direction, many people will end up paying a premium to join up--like me buying XBI. I was luckier with my timing on the tech funds and GRID.

BenWP

@WABAC: can one assume IHDG has outperformed this year due to currency hedging? Foreign exchange adds another layer of risk to international investing, as @davidrmoran pointed out not long ago in a link that supported the view that a domestic portfolio may be adequate. I dabble in overseas funds, but I doubt I add much alpha to my returns.

Crash

I bought PRISX and TUHYX at just the wrong time. I dumped the former but am keeping the latter. They are two different animals. My Fund Managers will have to worry about the diversification in the funds I own, including geographical. (But I'm just 8% foreign, and that won't change dramatically, going forward. Every time I "go foreign," I get burned.) In my single-stock sleeve, I'm diversified across industries. The stock-sleeve is still just 12% of my total. I do own ONE foreign outfit. I'm "geographically happy" these days.

Observant1

BenWP said:

@WABAC: can one assume IHDG has outperformed this year due to currency hedging? Foreign exchange adds another layer of risk to international investing, as @davidrmoran pointed out not long ago in a link that supported the view that a domestic portfolio may be adequate. I dabble in overseas funds, but I doubt I add much alpha to my returns.

I'm not familiar with IHDG and don't know why it has outperformed.
From a US investor perspective, the strong US dollar has decreased returns
for international funds which don't hedge currencies (many funds are unhedged).

The FMI International Fund (FMIJX) is an international fund which hedges currencies.
FMI introduced an unhedged version of this fund (FMIFX) on 12/31/2019.
Trailing returns for both funds are listed below.

Ticker____12 mo.____3yr.

FMIJX____11.68%___14.00
FMIFX_____7.80%___11.06%

BenWP

Very helpful numbers, @Observant1, on the two versions of the FMI fund. I don’t know IHDG, either, but it is called WisdomTree International Hedged Quality Dividend Growth Fund, so I made an assumption.

Observant1

@BenWP,

IHDG has performed well since inception.
I used Portfolio Visualizer and compared IHDG to three other international funds.
The WisdomTree fund had the highest return, lowest volatility,
and lowest max. drawdown for the period from June 2014 - April 2023.

Link

Sven

Good comparison. Someone posted here that DIVI, Franklin International Core Dividend Tilt Index, which also has a comparable 5 year performance record with respect to annual returns, drawdown and Martin ratio (obtained from MFO Premium).

Tarwheel

I am a long term investor with TRowe Price, and they have maintained large stakes in foreign stocks and bonds in their allocation funds for many, many years. Over the past decade or so, this has been a huge drag on the returns for their balanced, allocation and target date funds. TRPs best performing funds are PRWCX and other funds that primarily invest in domestic stocks.

For comparison, I have had large holdings in TRPBX (TRP Spectrum Moderate Allocation) and FBALX (Fidelity Balanced) for 20+ years. Two decades ago, their performances were pretty comparable, but FBALX has greatly outperformed TRPBX over the past 10 years or so. Ironically, FBALX has continued to outshine TRPBX in 2023, despite the recent awakening of foreign stock markets.

WABAC

WABAC said:

I don't know about regime change. IHDG is the top performer in my taxable account over the last twelve months. It's closely followed by two tech funds and FSMEX. VWIGX is in between the tech and health funds.

In the IRA, GRID, XBI, and FSCSX outperformed IHDG. Due to the price at which I bought XBI, I am still well underwater.

If it wasn't so early in the morning here, I'ld try to come up with some clever twist on regime change, and Keynes observation about how long markets can remain irrational.

I have always figured the point of diversification is to already be there when the market turns in a new direction. If indeed, the market is turning in a new direction, many people will end up paying a premium to join up--like me buying XBI. I was luckier with my timing on the tech funds and GRID.

@BenWP. I'm not educated enough to venture an opinion on hedging, except I wouldn't buy a fund that tried to time when to hop back and forth. I picked the fund because of its showing on mutual fund observer premium.

My guess is that the success has more to do with it's dividend growth strategy. The thesis seems to translate well so far.

At the same time i bought IHDG, I bought FYLD, which has done nothing for me so far. The thesis makes sense to me. So I'll give it some more time to see if it translates..

BenWP

@WABAC: thanks for your reply. During the relatively short time I have been invested in or following the Cambria funds (in my case SYLD, EYLD, and FYLD) I am struck by the streakiness of their performance. SYLD is hurting this year (down 6+%) after very good years in 21 and 22. I agree that Faber’s approach should produce results, but it does appear that one needs to be patient. Value is not in favor in 23.

Sven

The debt ceiling deal is not done yet until President Biden signs it. The right hardliners don’t like the proposal and they may vote McCarthy out. Too many balls in the air right now. I recommend to wait until the dust settle.

Regex

I noticed Vanguard is also projecting better returns from unhedged 'Ex-U.S. Developed' equities over the next decade ( https://www.morningstar.com/markets/markets-brief-why-vanguard-sees-brighter-outlook-investors-portfolios).