By John Lunt, Lunt Capital
Two years ago, Lunt Capital embarked on a 100-day, 70,000 miles, 24-country due diligence trip of the world we called Investment Trek. Me and my business partner, Ryan Hessenthaler, independently circled the globe, all the while talking to economists, money managers, stock exchanges, ETF and index providers, central banks, and government officials in the world’s most important financial markets. We produced more than 60 research reports and videos, many which can still be found at www.luntcapital.com.
Our efforts were richly rewarded with knowledge, insights, and many friends and contacts around the world. Every week since Investment Trek, we have connected or heard from a source gained from our travels. U.S. equities have outperformed broad international markets for many years, but relative performance has shifted in favor of international markets in 2017. Many investors and financial advisors find themselves significantly under-allocated to international markets. It is time for investors to take a fresh look at international financial markets. As we approach mid-year 2017, we want to highlight many of the principles we learned from our 2015 Lunt Capital Investment Trek:
“You must unlearn what you have learned.”
– Yoda from Star Wars Episode V: The Empire Strikes Back
Do we recognize the global opportunity set?
We will start with a statement that sits at the core of our investment philosophy: The United States is the greatest country in the history of the world, and it has been the home to the greatest investment opportunities in history. U.S. political and economic freedoms have combined to create a dynamic, growing investment environment. U.S. investments should act as the foundation for any U.S. dollar-based investor. However, a “home country” bias has led many to either ignore international investing, or to embrace an investment mindset that segments the world in two buckets: 1) the U.S., and 2) everything else. Here is another statement we believe: Over the next 20 years, the U.S. economy will continue to grow, but it is a near certainty the United States’ portion of the total global investment opportunity set will decline. As Wayne Gretzky famously said, “I skate to where the puck is going to be.” The puck is going international, and savvy investors can’t and won’t ignore the opportunities for growth that will come from international investing.
How do most investors approach international allocations?
As mentioned above, most investors think in terms of two equity buckets – the U.S. bucket, and the bucket with anything and everything international. Typically, this international bucket includes a very broad basket of countries and industries that are capitalization weighted (the allocation is weighted according to the size of the company). Discussion around any segmentation of the international bucket centers on categorizations of “International Developed Markets” and “Emerging Markets.” The largest debates center how to categorize countries – should Korea and Taiwan be categorized as developed markets or emerging markets? Weighting by market capitalization leads to large allocations and out-sized influence to a handful of countries, such as Japan, U.K., and Germany in the developed bucket, and China in the emerging bucket. Other countries with smaller allocations become completely insignificant to investment returns.
What do we notice when we review the international opportunity set?
A careful study of the “international bucket” reveals dramatic differences – the opportunity set is not homogenous! Culture, history, policy, and regulation vary dramatically, leading to divergences in economic performance and market outcomes. In many cases, countries are not synchronized in their approaches to currencies, interest rates, and monetary policy. We also recognize that geopolitical assumptions change along with more assertive foreign policies (Russia). Countries like China have become too big to ignore. Entire regions realign alliances or old frictions re-emerge (the Middle East). We see growth-friendly reforms contrasted by increased totalitarianism. We identify economic liberalization contrasted by centrally planned economies. Continued corruption is contrasted with rising rule of law. Conditions are dynamic, as regulations adjust, elections change policy, and even normal economic cycles drive the relative attractiveness of different countries, sectors, and currencies.
As investors, we see large dispersion in the performance of individual countries, currencies, sectors and factors. Typically, there is little, meaningful effort to capture this differentiation. Good or bad, high or low, it lands in the international bucket. This “catch-all” mindset towards international investing is the behavior that “must be unlearned.”
What should we learn about international investing?
There are new tools and disciplined strategies that provide the opportunity to capture growth and manage risk within the international bucket. Exchange traded funds (ETFs) allow targeted, transparent, and traded exposure to specific segments of the international bucket. What kinds of opportunities? How about the opportunity to own India’s equity market in an ETF? How about owning an international Healthcare sector ETF? If you think the Yen will weaken against the U.S. Dollar, you can own the currency-hedged Japan ETF. Do you want to capture a specific international factor? You can own the International Developed High Quality or Low Volatility ETFs. The list is almost endless. We can be deliberate in the countries, sectors, currencies, and factors we include or exclude within the international basket! These allocations can adapt and tactically rotate in an attempt to capture changing economic and market conditions.
“Many of the truths that we cling to depend on our point of view.”
– Yoda from Star Wars Episode VI: Return of the Jedi
It’s time to change our collective point of view: A U.S. investment core allocation must be complimented by a growing international allocation. However, a general, international bucket will not do. This international allocation should be deliberate in what it includes and excludes, and it should adapt as political, economic, and market conditions change.
What do we conclude?
Over the next decade, the way the industry invests in international equities will change more than any other asset class. The opportunity is available to skate to where the puck is going to be.