“Eyes Wide Open: Responses to the Increased Complexity of Global Investing” from Thornburg Investment Management, notes that US investors boosted their allocation to global and international funds in the years between 2007 and 2011, but argues they should do more. Sending $150 million in new inflow to overseas funds was a canny move, as those funds managed to shine in spite of the Euro crisis. Still, Americans tend to have the same “home bias” shared by investors around the world. The average American investor’s mutual fund portfolio is 73% allocated to US stocks. But the US only accounts for 22% of the world’s GDP. Even accounting for the country’s structural advantages, including rule of law, stable and peaceful political system and so on, that’s still an overweight of three times the norm relative to GDP, according to the paper’s author, portfolio manager Connor Wilson.
Wilson makes the case that the average US investor has made an even more concentrated bet on their home market than they realize. Residential real estate accounts for the biggest portion of net worth for most Americans. That means much of their net worth is dictated by their local housing market. Add to that the fact that most Americans work for businesses in their local market, and he sees a dangerous tilt to the local economy. “Most Americans’ wealth remains tied up in two assets - property and human capital – that cannot be disentangled from their country of residence,” he writes. “Still, most investment portfolios remain heavily weighted to the U.S.”
The good news is that the US giants that make up the heart of many large cap portfolios now get much of their income from overseas. In fact, 51% of revenues underlying the Dow Jones Industrial Index came from abroad in 2011, up from 45% in 2006. This “built-in diversification” helps US investors a bit to spread their risk. But, Wilson points out that it still didn’t protect US investors during the 2008-2009 market crisis, which saw home prices careen down, the Dow shed 50% of its value and created pressure on wages and jobs.
Wilson cites a paper by hedge fund giant Clifford Asness and others showing that in the long term, a globally diversified portfolio will beat a domestic-only portfolio in downside protection and total returns. But he cautions investors against the traditional solution of simply boosting exposure to all international assets. He argues that a more nuanced eye is needed, because globalization has changed the meaning of geographic risk exposure. He notes that Israeli company Teva Pharmaceuticals and Chinese trading company Li & Fung both sell primarily to the US. His solution: “Instead of relying on outdated concepts of geographical risk exposure, investors should recognize that underlying risk exposures matter more.”
Which means advisors must roll up their sleeves and do some serious stock analysis, or hire managers who do, rather than top-down asset allocators.