In rising rate environments, the MSCI World ex U.S. Index tends to outperform the S&P 500. The exact opposite is true during periods of falling interest rates: domestic equities historically out-pace international stocks. These findings have profound implications for an investor’s portfolio, if used in the correct way. Figure 4 summarizes the performance of these mutually exclusive environments since December 31, 1969. The table sheds light on the fact that rising rate environments can present challenges for U.S.-centric investors. However, one can potentially take advantage of temporary price misalignments with tactical asset allocation through selection/rotation of countries included in the international allocation of a portfolio.
Comparing rising versus falling interest rate environments, U.S. equity returns tend to be lower while international market equity returns tend to be higher, without exhibiting increased volatility. Furthermore, the correlation between U.S. and international equity markets tends to be lower during rising-rate regimes, suggesting additional diversification benefits. By tactically rotating the sovereignties included in a portfolio, asset managers can take advantage of opportunities that arise in the widely disparate macroeconomic environments beyond our borders.
Expectations for shifts in monetary policy will continue to be one of the drivers of capital market trends. Global macro shifts, however, have the increasing potential to disrupt the relative calm, as do still-simmering geopolitical tensions. All the while, broadly stretched equity market valuations continue to leave less-than normal opportunities to add beta. While the Investment Committee continues to monitor the range of exposures available to the Innealta Portfolios for attractive risk-relative return opportunities, the broader stance remains one of conservatism. We expect capital markets to prove challenging for the balance of 2015 and into 2016, but we also expect them to present greater opportunities for tactical equity investments as volatility increases. Consequently, taking a look into international equity markets, or selecting a manager who can effectively and efficiently navigate international markets, could prove extremely valuable in the coming years.
Dr. Vito Sciaraffia is the Co-Chief Investment Officer at Innealta Capital, a participant in the ETF Strategist Channel.
Important Information
The information provided comes from independent sources believed reliable, but accuracy is not guaranteed and has not been independently verified. The security information, portfolio management and tactical decision process are opinions of Innealta Capital (Innealta), a division of AFAM Capital, Inc. and the performance results of such recommendations are subject to risks and uncertainties. For more information about AFAM Capital, Inc. please visit afamcapital.com. Past performance is not a guarantee of future results.
Any investment is subject to risk. Exchange traded funds (ETFs) are subject to risks similar to those of stocks, such as market risk, and investors that have their funds invested in accordance with the portfolios may experience losses. Additionally, fixed income (bond) ETFs are subject to interest rate risk which is the risk that debt securities in a portfolio will decline in value because of increases in market interest rates. The value of an investment and the return on invested capital will fluctuate over time and, when sold or redeemed, may be worth less than its original cost. This material is not intended as and should not be used to provide investment advice and is not an offer to sell a security or a solicitation or an offer, or a recommendation, to buy a security. Investors should consult with an investment advisor to determine the appropriate investment vehicle. Investment decisions should be made based on the investor’s specific financial needs and objectives, goals, time horizon and risk tolerance. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice.
Sector ETFs, such as Real Estate Investment Trusts (“REITs”) are subject to industry concentration risk, which is the chance that stocks comprising the sector ETF will decline due to adverse developments in the respective industry.
The use of leverage (borrowed capital) by an ETF increases the risk to the fund. The more a fund invests in leveraged instruments, the more the leverage will magnify gains or losses on those investments.
Country/Regional risk is the chance that world events such as political upheaval or natural disaster will adversely affect the value of securities issued by companies in foreign countries or regions. Country/Regional risk is especially high in emerging markets.
Emerging markets risk is that chance that stocks of companies located in emerging markets will be substantially more volatile, and substantially less liquid, than the stocks of companies located in more developed foreign markets.
The MSCI All Country World Index Ex-U.S. is a market-capitalization-weighted index designed to provide a broad measure of stock performance throughout the world, with the exception of U.S.-based companies. It includes both developed and emerging markets. The S&P 500 Index is S&P’s broadbased market index representing a sample of leading companies in leading industries. A person cannot invest directly in an index. Blended benchmarks are rebalanced quarterly.
Securities rated below investment grade, commonly referred to as “junk bonds,” may involve greater risks than securities in higher rating categories. Junk bonds are regarded as speculative in nature, involve greater risk of default by the issuing entity, and may be subject to greater market fluctuations than higher rated fixed income securities.
Diversification does not protect against loss in declining markets.
Registration of an investment adviser does not imply any certain level of skill or training.
AFAM Capital, Inc. is an Investment Adviser, registered with the Securities & Exchange Commission and notice filed in the State of California and various other states. For more information, please visit afamcapital.com. Registration as an investment advisor does not imply any certain level of skill or training. Innealta is an asset manager specializing in the active management of portfolios of ETFs.
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