2017 was a great year for U.S. stocks. Large caps returned nearly 22%, while small caps returned nearly 15%. Nobody complained about those returns.
But do you know which asset had an even better year? International stocks.
Emerging market stocks—i.e. the MSCI Emerging Markets Index—returned a whopping 37.8% in 2017, while developed market international stocks—i.e. the MSCI EAFE Index—returned 25.6%. These were the two best-performing asset classes of the year.
This example may seem a little indulgent—we are, after all, comparing big winners with bigger winners, plus this was only one year—so let’s do another.
From 2002-2007, the S&P 500 returned 6.1% annually. The MSCI EAFE Index, which measures the equity market performance of developed markets outside of the U.S. and Canada (essentially the global equivalent to the S&P), returned 14.8% over that same period.
Both time periods are completely arbitrary, but they underscore an important point about global diversification. While there is no one-size-fits-all approach for everyone, having some sort of international allocation is critical to maintaining optimal performance in most long-term portfolios. This is one of the core principles of asset allocation that I try to get across to my clients.
The Benefits Of Having A Global Allocation
Because of globalization, it’s become increasingly difficult, perhaps impossible, to avoid having at least some sort of international exposure in your investment portfolio today. Most U.S. large caps count international sales as a major revenue source—for example, international sales accounted for 59% of Apple’s revenue and 40% of Starbucks’ revenue in the June 2019 quarter.
But owning Apple or Starbucks and saying you’re globally diversified is inadequate. A true allocation to global assets means looking beyond U.S. companies. According to Vanguard, U.S. equities accounted for 55% of the global equity market as of September 2018, leaving the remaining 45% available for capital allocation.
This is just one reason why I reinforce international allocations to my clients.
Diversifying Returns
Diversifying to global equities minimizes the likelihood that one market downturn will have an outsized effect on total portfolio performance. So when markets like the Hang Seng get punished, the damage is limited.
More importantly though, research has found that, historically, globally diversified portfolios have generally outperformed their non-diversified counterparts. According to Charles Schwab, not only did a globally diversified portfolio outperform both the S&P 500 and a conservative 60/40 U.S. stock/bond blend from Jan. 1, 2001 to Sept 30, 2019, but it also held up better during both economic recessions during that time.”
This happens because markets are cyclical. In the 1980s, international stocks crushed the U.S. That was followed by a stark reversal in the 1990s. This decade, the U.S. has dramatically outperformed the MSCI EAFE.
It may not seem like it, but the dominance of the U.S. over international stocks should eventually change, as it always has. Vanguard’s chief investment officer told CNBC last November that he expects international stocks to outperform their U.S. peers by 3-3.5% over the next 10 years, in part because of increased U.S. valuations.
Globally diversified portfolios are well-positioned to take advantage of growth over long-term time horizons—whichever market it comes from.