On the recent webcast, Why Smart-Beta Works for International Markets Too, Matthew Miskin, Senior Capital Markets Research Analyst at John Hancock Investments, outlined some of the risks that still remain in the global markets, pointing to upcoming elections and ongoing political risks in Europe that threaten to upset the status quo, such as a presidential election in France that shows a far-right party, which advocates leaving the European Union, having a chance of winning.
Nevertheless, the European Central Bank could continue to provide support in face of increased risks, deflationary pressures and weak growth. ECB assets are expected to reach unprecedented levels in response to Brexit and other crisis, Miskin said.
Miskin also argued that valuations look more attractive in international markets, especially after the record run-up in U.S. equities that pushed valuations at home to the extremes. For instance, Japan shows a forward price-to-earnings ratio of 16.02, U.K. 7.07 P/E, France 15.83 P/E, Switzerland 17.87 P/E and Germany 14.62 P/E, whereas the U.S. is trading at a 18.83 P/E.
“Historically, periods of underperformance by international equities have been followed by periods of outuperformance,” Miskin said.
Steve Deroian, Head of ETF Strategy at John Hancock Investments, also warned that investors are missing out if they are too focused on domestic markets. While U.S. stocks are a big component in global markets, international equities still make up 47.3% of the MSCI All Country World Index.
“Our research shows that advisors are underweight in international equities compared to both market-weighted index and institutional exposure,” Deroian said.
In survey of financial advisors attending the webcast, 43% indicated that they plan on increasing international exposure in 2017 while 51% will stay their hand. The majority, 39%, still believe that U.S. markets will offer the most potential in the year ahead, followed by 32% pointing to Asia.
Investors can gain exposure to international markets through a number of ETF strategies, but the majority follow market capitalization-weighted methodologies that may overweight toward overbought segments of the global economy. Alternatively, Joe Hohn, Portfolio Manager at Dimensional Fund Advisors, argued in favor of a customized multi-factor or smart-beta index based strategy that screens for favorable factors to help enhance returns.
Specifically, Hohn pointed to four major factors, including market equity premium, small-cap premium, value premium and profitability premium. Equity premium refers to stocks over bonds. Small-cap premium refers to small companies over larger company stocks. Value premium refers to value stocks over the growth style. Lastly, profitability premium refers to profitable company stocks over less profitable companies.
These four factors have been academically proven to provide long-term outperformance.
“A landmark 1992 study by University of Chicago Professor Eugene Fama and Dartmouth College Professor Kenneth French argued that, based on history, focusing on smaller stocks and those with lower relative prices1 may improve a portfolio’s expected return,” Hohn said. “Subsequent research conducted by University of Rochester Professor Robert Novy-Marx identified profitability as another factor that enhances expected returns.”
Investors who are interested in international market exposure and want to capitalize on these strong market factors can take a look at the John Hancock Multifactor Developed International ETF (NYSEArca: JHMD), which tries to reflect the performance of the John Hancock Dimensional Developed International Index. The underlying index is comprised of developed market companies outside the U.S. and Canada, and it also implements a Dimensional Fund Advisors’ rules-based or multi-factor screening process that singles out small-caps, lower relative price and higher profitability.
Financial advisors who are interested in learning more about international market risks and opportunities can watch the webcast here on demand.