Some investors may be thinking about trimming their international exchange traded fund exposure after the recent outperformance, but it may not be time to let up just yet.
The revival in foreign equities is only just beginning, so investors who are itching to rebalance by diminishing exposure to outperforming overseas stocks could do more harm than good, writes Jonathan Clements for the Wall Street Journal.
For a diversified investment portfolio, an investor may hold 40% bonds, 35% U.S. equities, 20% foreign developed markets and 5% emerging market stocks, Clements said.
Normally, an investor would also rebalance positions to bring allocations close to their target percentages to help control risk. For instance, after the recent run in international markets, rebalancing would tell an investor to reduce outperforming foreign stock exposure to bolster positions in lagging markets, such as U.S. equities.
However, it may be premature to diminish foreign exposure this time around as investors should also consider the shifting global market cycles.
“Should you be rebalancing this year?” investment adviser William Bernstein, author of “The Intelligent Asset Allocator,” asked. “It’s a matter of personal taste. But my bias is somewhat against it.”
Specifically, Bernstein pointed to cheaper overseas valuations. For example, the Vanguard FTSE All-World ex-US (NYSEArca: VEU), which tracks international stocks and excludes the U.S. markets, shows a 16.2 price-to-earnings and 1.6 price-to-book. In contrast, the Vanguard Total Stock Market ETF (NYSEArca: VTI), which tracks the U.S. markets, has a 18.8 P/E and a 2.5 P/B. [Why It Is A Good Time To Consider International ETFs]
Moreover, academic research has found that outperforming markets over three to 12 months typically continue to perform for another three to 12 months. This type of momentum trading is fueled by a number a factors, including the bandwagon effect where investors chase hot sectors or an initial under reaction to positive news.
Consequently, momentum eventually could give way to mean reversion, and after years of underperforming U.S. markets, international stocks could have a long ways to go.
“These are still early days,” Bernstein said in the article. “This is a time to be patient.”
For those who don’t feel comfortable without some kind of rebalancing regiment, Bernstein suggested using a so-called threshold rebalancing technique, which involves trimming exposure after a position hits a target threshold, such as growing 5 percentage points in the overall portfolio. Alternatively, Bernstein advises rebalancing every two years instead of every year, which could cause international positions to become more overweight.
For more information on international markets, visit our global ETFs category.
Max Chen contributed to this article.