Most investors show a preference to their home countries, or “home country bias,” but with exchange traded funds, portfolio diversification and global markets are easy to access.
Investment experts argue that a stock portfolio that is widely diversified across global markets can provide protection against a prolonged downturn in an investor’s domestic market, reports Liam Pleven for the Wall Street Journal.
Currently, some market observers argue that U.S. stocks look a little expensive or at least fairly price, whereas many foreign markets appear relatively cheap, which could increase the chances of foreign markets outperforming. The iShares MSCI ACWI ex U.S. ETF (NasdaqGM: ACWX) shows a 15.79 price-to-earnings ratio and a 1.86 price-to-book. In contrast, the S&P 500 index has a 17.42 P/E ratio and a 2.39 P/B ratio.
“The U.S. stock market at the moment has one of the lowest expected returns for the next five years of all the developed markets,” Joachim Klement, chief investment officer at Wellershoff & Partners, said in the article. “This is probably a good time for U.S. investors to broaden their international diversification and buy stocks outside the U.S.” [Most Searched ETFs: Going Global]
Potential investors should keep in mind that international markets behave differently. For instance, Germany’s stocks have gained 2.5% this year, India’s rose 25%, Japan’s dipped 5.3% and Saudi Arabia’s increased 22%, according to MSCI data. In comparison, the S&P 500 is up 8.8% year-to-date. Given the range of returns, international exposure could help bolster an investor’s portfolio if U.S. stocks begin to decline. [A Look at the New International Focus 5 ETF]
“The real risk that you face is that you’re going to have crummy returns in one part of your portfolio over 30 years. And you’re certainly reducing that risk if you are internationally diversified,” William Bernstein, co-principal of portfolio manager Efficient Frontier Advisors, said in the article.
According to Morningstar, a portfolio consisting of Wilshire 5000 index stocks generated an average loss of 0.4% annually from 2000 through 2008, whereas a portfolio with 50% allocated toward foreign stocks would have averaged a 0.9% return annually.
However, it is not enough for investors to have exposure to large multinational companies. International diversification means including exposure to foreign-listed stocks.
“You have to invest in a company whose executives are trying to post a profit in local currency,” Bruno Solnik, a finance professor at Hong Kong University of Science and Technology, said in the article.
Currently, the average 401(k) account holds less than 18% in foreign stocks. Meanwhile, the foreign equity market represents about 50% to 60% of the total market value of globally trade stocks. Investment experts, though, suggest that investors should hold at least 20% to 30% of their equity portfolio in foreign stocks.
Additionally, investors who are looking to diversify shouldn’t put all of their money into one or two country-specific ETFs as it could end up increasing their risk exposure. To put country exposure in perspective, the emerging markets represents about 11% of companies in the MSCI All-Country World Index + Frontier Markets Index, and frontier markets makes up 0.3%. The remaining 89% of value are from companies listed in developed markets.
For more information on investing with ETFs, visit our ETF 101 category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.