Global markets may provide investors with many opportunities, but they come with their own set of risks. Nevertheless, investors may consider multi-factor, smart-beta international exchange traded funds to diversify into global equities while keeping the swings at a minimum.
When accessing international markets, investors will find many opportunities to capture growth, but they are also exposed to various risks associated with the varying markets.
“Global markets provide diversified risk exposure and diversified sources of return,” Samantha Azzarello, Vice President and Global Market Strategist at J.P. Morgan Asset Management, said on the recent webcast, A Better Way to Access International Markets.
Azzarello pointed out that manufacturing momentum is picking up globally, helped by the global themes of reflation and a shift toward more accommodative fiscal policy.
Corporate earnings are also recovering internationally, which could help make international equities a key component in a diversified portfolio. Azzarello argued that investors may have an opportunity to diversify into international stocks on the cheap as many global markets are trading below their 25-year average price-to-earnings and hovering near the bottom end of their 25-year price-to-book.
In a survey of financial advisors attending the webcast, 32% of respondents pointed to Asia’s stock market as an area of the world that has the most stock potential, followed by 20% looking at Europe and 9% seeing Latin America. While 51% say they will keep their international the same in the year ahead, 43% of those surveyed want to increase their international exposure in 2017.
However, Yasmin Dahya, Vice President of ETF Product Development at J.P. Morgan Asset Management, warned investors that utilizing traditional beta-index or market cap-weighted index strategies could expose investors to undue risks. Instead, investors can take a look at the evolving ETF industry where factor-based investments could help better manage the risk premium.
For example, over the past decade, MSCI has introduced factor-based indices that screen for value, small capitalization, momentum and minimum volatility to potentially enhance returns and reduce drawdowns during sell-offs. The strategic beta solution would neutralize some risks, better diversify a portfolio and potentially generate improved risk-adjusted returns.
“A multi-factor approach created a more diversified solution with a more consistent return structure,” Chris Shuba, Founder of Helios Quantitative Research, said. “The result is a more comprehensive and durable product for our risk managed models.”
By screening for these factors and others, investors may limit overconcetration of risks. For instance, Dahya pointed out that global developed equities from the FTSE Developed Index during the pre-financial crisis in January 2007 had a 28% tilt toward financials, which took on 44% of the risk in the financial downturn sell-off. A market cap-weighted index may also included overvalued securities, such as Yahoo (NasdaqGS: YHOO) and Cisco (NasdaqGS: CSCO) in the Nasdaq-100 during the peak of the tech bubble.
To better diversify away from overweighting toward potentially overvalued areas of the market, J.P. Morgan has developed a line of smart-beta or multi-factor ETF strategies, including the JPMorgan Diversified Return International Equity ETF (NYSEArca: JPIN), which screens for value, momentum, size and low volatility. The resulting portfolio includes a more evenly distributed sector and individual component weights.
“Traditional indices allow market cap to dictate allocations, leading to risk concentrations,” Dahya said. “Market cap is not predictive of future returns. We believe equal distribution of risk across regions and sectors is a more prudent allocation approach.”
Financial advisors who are interested in learning more about international market investments can watch the webcast here on demand to earn CE Credit.