Only 45 percent of American citizens have a passport, which implies that 55 percent of Americans only travel domestically. Slowly, however, Americans are warming up to the virtues of international travel, as 2016 was a record year for Americans traveling overseas.
Similarly, many U.S. investors are disinclined to look outside of the United States for investment opportunities. The U.S. economy is the single largest economy in the world, which makes investors believe there is little to gain from venturing elsewhere. However, there are three crucial reasons why investors should ensure they have a meaningful allocation to international equities in their portfolios.
1. The world is a big place. The share of the global economy found outside of the United States has been steadily rising, from 78 percent in 1990 to 85 percent in 2016. The ability to invest in that overseas growth has also increased, with international markets now representing 60 percent of global public capital markets, compared to 53 percent in 1990. This trend is set to continue, yet international equities and bonds represent only 21 percent of U.S. investors’ portfolios.
2. Go straight to the source. Investing internationally helps to diversify a portfolio. Overseas markets move up or down based on local developments that affect domestic company fundamentals; what may affect a U.S.-based company may not be relevant to a Brazil-based company, for example. As a result, the correlation between U.S. and international equities tends to be fairly low outside of crises.
It’s important to remember that while investing in U.S. companies that have a significant portion of their revenues coming from abroad may sound like a solution, the only way to truly be insulated from U.S.-specific fluctuations is by investing in international directly.
3. Variety is the spice of life. An equity portfolio that has both U.S. and international should have a better risk-and-return profile than a U.S.-only portfolio because it taps into a wider opportunity set and has lower correlations between assets. However, over the past 15 years the result was not particularly encouraging, with the addition of international equities not providing enough additional return to justify the higher volatility. This was due to the poor performance of developed markets ex-U.S. during this time.
Over the next 10 to 15 years, U.S. equity returns will likely be lower than in the past, given a continued low-growth environment and current elevated valuations. A possible way for investors to achieve similar returns to those provided by U.S. equities in the past is to have a meaningful allocation to international.
Oftentimes, common fears get in the way of larger, international exposure. So why would international actually deliver? Investors may wonder whether the future will look different for international investing or whether it is a tourist trap. These factors suggest that international equities are actually a hidden gem: growth, earnings, valuations and currencies.
Investors have gotten used to thinking that the United States is the only worthwhile place to visit. Indeed, the U.S. economy has seen steady growth for eight years since the global financial crisis, while other regions were beset by issues such as a double-dip recession in Europe caused by the sovereign debt crisis and a slowdown in emerging markets as a result of the commodity price collapse. However, after several improvements many regions are now attractive places to visit once again. In fact, the greatest acceleration in growth is happening abroad in regions in earlier stages of their expansion relative to the United States.