International Equities' Still Credible Portfolio Diversifiers

Investors around the world often display home country bias — a penchant for investing in stocks of their country of residence. Whether it’s out of patriotism or preference, U.S. investors have overtly favored domestic stocks and the related exchange traded funds over than international stocks.

Long-running stretches of underperformance by the MSCI EAFE Index, its emerging markets counterpart and comparable benchmarks has validated this preference. Such scenarios aren’t permanent and ex-US equities remain compelling portfolio diversification tools, indicating investors shouldn’t ignore funds such as the Calvert International Responsible Index ETF (CVIE).

In recent years, an extended run of out-performance by mega-cap growth stocks challenged the merits of geographic and other forms of equity-level diversification. Market participants simply weren’t adequately rewarded for venturing from big growth equities into other domestic stocks, let alone embracing international fare.

Diversification Case Intact

Despite the aforementioned challenges to the notion of diversification, it remains a seminal piece in smart portfolio construction.

“Diversification is perhaps the most important idea in modern finance. Its power was shown in the 1950s by Harry Markowitz, an economist who died on June 22nd,” reported The Economist. “At the time, portfolio theory suggested investing in whichever stock held the highest present value of future dividends.”

Speaking of dividends, CVIE sports a distribution yield of 3.59%. That’s nearly 140 basis points ahead of the yield on the MSCI EAFE Index and more than double the 1.45% dividend yield on the S&P 500. Additionally, owing to strong exposure to markets such as Japan, the U.K. and Switzerland, CVIE has attractive long-term payout growth prospects.

Getting back to the case for diversification, some market observers argue that the long-running winning streak of U.S. stocks over international rivals isn’t heavily attributable to strong fundamentals possessed by domestic firms. Rather, it’s the byproduct of expanding earnings multiples. That could be a cautionary tale and one that suggests assets such as CVIE deserve more attention.

“A new paper by Cliff Asness and colleagues at aqr Capital Management sounds another note of caution. They adjust returns for changes in valuations, finding that most of American outperformance is down to soaring valuations,” according to The Economist. “Of the 4.6% premium American stocks have commanded, some 3.4% exists because price-to-equity ratios in America are higher. Just 1.2% comes from fundamentals, like higher earnings.”

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