Does your portfolio suffer from home country bias? If so, you’re not alone. Despite the fact that almost 80% of global economic output and about two-thirds of the world’s equity market capitalization come from countries outside of the United States, the typical U.S. investment portfolio is disproportionately weighted toward domestic securities.
Whether this home bias is inadvertent or intended, it’s a phenomenon worth addressing. A strategic allocation to international securities can help enhance a portfolio’s risk-adjusted returns, provide portfolio diversification and even offer opportunities for higher performance. And in light of the economic uncertainty and market volatility happening in the U.S. right now, it may be an ideal time to look beyond our borders for investing ideas abroad.
So what are the current international investment trends? We analyzed recent ETF flow data to identify the big themes we’re seeing right now, then asked our Chief Investment Strategist Russ Koesterich to weigh in:
- Japan
What the flows show: Riding the wave of Prime Minister Abe’s growth-oriented economic policies, Japan has experienced the largest stock rally in the developed world this year (year-to-date, the Nikkei 225 Index is up nearly 40%). Japanese equity ETFs have been huge beneficiaries of this upward momentum, experiencing 20 straight months of inflows and $2.3 billion in October alone.
What Russ K says: “We continue to believe that Japan offers more upside potential, particularly if investors can hedge out the foreign currency exposure. However, while we like the near-term prospects, the longer-term outlook remains unclear. For Japan to represent more than just a trade, it will need to address both lagging productivity and a shrinking workforce.”
Potential iShares solution: iShares MSCI Japan ETF (EWJ)
- Europe
What the flows show: This past summer was the first in three years that the Eurozone did not experience an economic crisis, prompting speculation that a recovery could be on the horizon. As a result, pan-European equity ETF inflows have been building momentum, adding $19.9 billion this year.
What Russ K says: “Economic data continues to look promising, but we still only advocate a neutral weight to European equities until two major issues are resolved. First, the region must integrate its fragmented banking system. Also, critical structural reforms and budget cuts are still needed.”
Potential iShares solution: iShares Europe ETF (IEV)
- Emerging markets
What the flows show: While it’s too soon to call it a turnaround, emerging market (EM) equity ETFs have seen an uptick in flows the past two months ($8.5 billion since Sep 1st 2013). This is a marked improvement over the 7 months of outflows the category has experienced between February and August. Recent flows have been highly focused in broad funds, but emerging markets country funds also saw some action with China and India together gathering $2.4 billion since the beginning of September.
What Russ K says: “We continue to like emerging market stocks over the next three to five years. EM equities still look cheap considering their growth and corporate profit prospects, especially relative to U.S. stocks. EMs still face some headwinds and investing in them is not for everyone, but we believe that growth-oriented investors should maintain exposure to these stocks.”
Potential iShares solution: iShares Core MSCI Emerging Markets ETF (IEMG)
Sources: World Bank, Bloomberg
Dodd Kittsley, CFA, is the Head of Global ETP Market Trends Research for BlackRock and a regulator contributor to the The Blog. You can find more of his posts here.
In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Securities focusing on a single country may be subject to higher volatility.