If you recall from my post on Asset Allocation I include EX US Large Cap Stocks in my assets. I’ve read a number of articles on the subject of whether to include International Stocks in your investment accounts.
Emerging Markets are Risky
In fact, none other then John Bogle, the founder of Vanguard has weighed in on not needing to have the risk of reign stocks. His cited rationale for shunning emerging markets is because of their sovereign and financial instabilities. I actually agree with John in this case. I do not invest in emerging markets because while there is a lot of money to be made there, I’ve traveled to enough of these countries to understand just how corrupt their governments can be. The risk is just great that they might decide to nationalize my money for me to invest there.
International Developed Markets On Sale
John, meanwhile asks, “Why you would want to invest in large cap stable EX US countries, since the UK, Japan, and the EU are in the driver seat of this category of stocks?” Honestly, I do not agree. So, why do I think I know better then Mr. Bogle? Well, let’s look at these nations first. There is little to no risk of corruption or nationalization of your holdings in these 3 countries. However, each of these country’s market is depressed for various reasons. In Japan it is because of a decline in their market over the last 25 years to the point where their market has not recovered. The UK is currently being driven by Brexit. Finally, the EU is being driven by Brexit and some member states financial positions. As a result their stock prices are depressed compared to that of the US, which is currently not encountering those issues. As such the US S&P 500 stock market Price to Equity (P/E) is currently estimated at 24. The FTSE Developed Market ex US meanwhile has a P/E of 21 and are priced lower then US stocks.
Holdings and Dispersion of Revenue
So, let’s look at the top 10 holdings representing 10% of the stocks in this developed market international large cap index:
Nestle SA, Royal Dutch Shell plc, Novartis AG, Roche Holding AG, Toyota Motor Corp., Samsung Electronics, HSBC Holdings, Unilever, British American Tobacco, and GlaxoSmithKline.
What do you notice about these companies? Many of them are global companies like those in the S&P 500. On the whole their operations are no more concentrated in Europe than the stocks in the S&P 500. Lest you think this is true of only the top 10, let’s continue along the list. It took me almost 3 pages and 16% of holdings before I started encountering companies I don’t regularly do business with here in the US. Ironically, the first of these was from Australia. In a lot of ways I view these companies as the functional equivalent of our S&P 500 stock due to our globally connected world.
Home Country Risk
The differentiator in my view is mostly related to the location of their home country, not the view of the company itself. Given a similar dispersion of these companies’ business revenues across regions to the S&P 500, I view these risks less in terms of a slow down in business operations in the given country and more in relation to the laws and perception of that country. There are risks to this world view: Tax laws, GAP reporting requirements, and other head quarters country specific laws present differing risks. I view those risks as no more or less than those of US companies and as a potential diversifier. While GAP reporting requirements are quite comprehensive, most major countries have similar disclosure laws. In neither case has this stopped some unscrupulous individuals from cheating. While tax laws differ, taxation by the US is certainly not the most advantageous worldwide. Finally, that dispersion in revenue also mitigates most currency risk, but not all.
Expenses
The costs of an investment in these two classes are slightly different, the expense ratio of VEA (FTSE international developed markets) is .09% versus .05% for VOO (Vanguard S &P 500). So essentially your costs differ by 40 cents per 1000 dollars per year. Again, I don’t view the difference as enough to shun this asset category.
Our International Stocks Allocation
I am willing to put 10% of my stock market assets in the category of international stocks as a result of the above. Why? I don’t view the underlying holdings as any more or less risky than the S&P. I see them as a value position based on my conclusion, counter to the market. The coming slowdown in their home countries will impact them proportionally to the impact to the S&P. Since they have a lower price they have a potentially larger upside in the long term. Note the final word “long term”, I am not taking this position as market timing, but rather as a sustained allocation of my overall portfolio. The differences I have noted may take years to balance. Do you hold an international allocation? What countries do you include?
Note: I am not a financial or tax advisor. Any actions to adjust your portfolio are yours alone with any comments here based solely on my own analysis.
Interesting points. I agree with your assessment of emerging markets. In general I don’t touch anything in those countries. You couldn’t even pay me to invest my money in Brazil, South Africa, Argentina and a handful of other countries.
Good points on the other developed markets. I think the reason why many people don’t invest in other international developed markets is because of “home country” syndrome. In essence they believe feel like they know their home country better (laws, taxes, regulation, etc) and other countries are more “risky” because they are foreign. Admittedly I am somewhat in this category as well haha.
It does take effort to step around cognitive biases. That being said this is probably why their is a discount in the first place. “Be fearful when others are greedy, Be greedy when others are fearful” to quote Buffet.
I’m look you in that I don’t look at investing in International stocks as riskier but value driven. While I understand Bogle’s point of view I think it never hurts to spread your cash around and see if you can hit a couple of home runs with plays outside the norm.
I increased my international exposure slightly this week. I don’t have much EM exposure, just mostly EURO STOXX exposure outside of the US. It’s interesting how our economies around the world are becoming ever more interconnected.
Most definitely. I spent last week in Shangia for work. It always amazes me when I ask my counterparts in region what toys their kids grew up with and they point me to something we see here like Lego’s.
Interesting points, as much as I have to agree with the corruption in many countries, there’s still money to be made and I’ll open myself to a very small exposure of emerging markets. I’m currently less than 3% but I don’t think I’d ever go more than 5%
Everyone has a different risk tolerance. You never know it could end up being your moonshot, it could equal the rest of the market, or it could go to 0.