Why do investors need foreign stocks or funds? Why not just buy U.S. companies that do a great deal or even most of their business overseas? That list includes such blue chips as Coca-Cola, Colgate-Palmolive, McDonald's, Procter & Gamble, and 3M, for instance.
“Such companies are primarily consumer product-driven businesses that depend on consumer demand for profitability,” points out Marilyn CapelliDimitroff, who heads Capelli Financial Services in Bloomfield Hills, Michigan. “For effective diversification, clients should own companies in other sectors, including natural resources, health care, technology, finance and industrials. Good companies in these areas are often found globally.”
Similar comments come from Larry Swedroe, principal and director of research at St. Louis-based Buckingham Asset Management. “Multinationals tend to trade more like their local stocks than global stocks,” he says. “They also trade like other multinationals, more so than small international companies, which are more dependent on their local economies. If you want global diversification, you need to go small and you need to go into emerging markets in order to be most effective.”
DIVERSIFICATION AND FLEXIBILITY
Dimitroff lists some specific types of diversification as well as other reasons to hold foreign equities.
- Resource diversification. “Resources (natural, intellectual, scientific, labor, etc.) are not found uniformly around the world,” Dimitroff says. “Some major companies with outstanding resources are headquartered outside the U.S.”
- Currency diversification. Even though most companies hedge their exposure, currency valuations can influence returns. That adds another factor that can diversify a portfolio.
- Broader universe. If you buy only U.S. large-caps, you will miss some of the world’s great enterprises. “U.S. companies represent 35.6% of world stock values,” Dimitroff says. “Why would you want to limit your choices?”
Mark Balasa, co-CEO and chief investment officer at Balasa Dinverno Foltz, a private wealth management firm in Itasca, Illinois, agrees that the scope of the non-U.S. equity market provides advisors with excellent opportunities to add value. “We look at the international market as having four main categories,” he says. “You can invest in the developed nations of Europe, in Japan, in other developed nations, and in the emerging markets. If you want to underweight Europe and overweight emerging markets, for example, you can do that. Going global offers tremendous flexibility.”
Although there are times like late 2008 to early 2009, when global markets move in lockstep, there are also times when they diverge. For example, according to Dimitroff, in the early years of this century U.S. large-caps fell sharply while foreign stocks significantly outperformed. A lack of correlation can smooth the ride for investors. Dimitroff notes that the current correlation between U.S. and foreign stock markets is around 0.8 by many estimates, which leaves room for some disparate behavior.
“Countries have diverse regulatory, legal and tax structures,” says Dimitroff. “Demographics vary. Some areas are growing faster than others. Why not take advantage of opportunities when they exist?”
In order to take advantage of non-correlation and upside possibilities, a significant allocation might be necessary. “For the last two years,” says Dimitroff, “stocks from foreign developed and emerging countries have been about 30% of our core equity portfolio.” Balasa says that for his firm’s clients, the median exposure to foreign stocks is about 35% of their total equities.
As for Swedroe, he says he personally owns no stocks of large-cap companies based in developed countries. A reasonable allocation, in his view, might be 30% of an equity portfolio in small-caps from developed foreign nations and another 10% in emerging markets stocks.