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Why you (still) want international stocks

- Kent Kramer, CFP, AIF, is chief investment officer/lead adviser at Foster Group. He writes about investing for IowaBiz.com

Suppose I offered you a choice between two broadly diversified, similarly volatile, well-known investments. Investment A had increased in value 23.8 percent over the past 10 years, while Investment B had grown 78.62 percent during the same time period. If that was all the information you had available, wouldn’t you be thinking Investment B sounds like the better deal?

This is the classic “past performance is no guarantee of future results” dilemma. We’ve read this kind of scenario so many times that we are just waiting to hear that the actual results over the next five years were just the reverse, and in this case they were. Investment A grew by 77.64 percent, while Investment B increased by only 7.78 percent. 

So what were (and are) the investment options? Investment A is a broad index of most U.S. stocks. Investment B is a very broad index of most non-U.S. stocks. The time periods? The first, 10-year, window was from 2001 through 2010. The second, five-year, time period was from 2011 through 2015.

What’s an investor in 2016 to do?

There are at least three good reasons for an investor to strongly consider including international stocks in their portfolio today: global opportunity, the relative lower prices of international stocks versus their U.S. counterparts, and broader diversification of risk.

Global Opportunity

As of the end of July, the value of all publicly traded companies worldwide totaled a little over $40.5 trillion, spread over 12,588 companies. Companies headquartered in the United States represented slightly over 53 percent of that total value.* For stock market investors, this means that approximately 47 percent of the opportunity for investment in publicly traded companies is located outside the United States, in places as diverse as the United Kingdom, China, Brazil, Nigeria and Turkey, just to name a few. History indicates while not all will, there is a high likelihood some of these companies, and their country’s broad equity market, will succeed, potentially with higher returns than their U.S. counterparts.     

Stocks on Sale?

In today’s global financial environment, investment capital moves very freely across borders and between exchanges as technology links the entire world in a virtual real-time exchange of information and capital flows. This results in (among other things) stock prices that reflect the most current pooled information and expectations regarding risk and return for virtually every company in the world today. Professional investors from the most sophisticated institutions trade these stocks with each other every day in an attempt to add value to their portfolios. There must be an agreement on price that is deemed to be fair to both the buyer and the seller before any transaction is completed.

For companies (and countries) where the perceived risks are higher, buyers demand lower prices. These lower prices represent a demand for higher potential return on investment as compensation for taking on this risk of ownership.

One interesting measure used to gauge how expensive (or how cheap) a company’s stock price may be is the price-to-book (P/B) ratio. This ratio illustrates how much investors are willing to pay (price) for the underlying value (book) of a company. As of July 30, 2016, aggregate price-to-book ratios for non-U.S. stocks averaged 1.48, while price-to-book ratios for U.S. companies came in at 2.31.* This indicates global investors were demanding an approximate 36 percent discount in price to entice them to own the book value of non-U.S. companies. Investors sense many non-U.S. companies are operating in riskier financial and political environments and are, therefore, only willing to buy the shares of these companies at relative discounts (i.e., “on sale”). International investors are basically buying more book value per dollar than they can with U.S. stocks.

Diversification of Risk

Dimensional Fund Advisors LP prepares a Global Markets Overview at the end of each month. At the end of July, 2016, their overview identified 12,588 publicly traded companies with shares available to private investors. Just over 3,500 U.S. companies offered shares, while over 9,000 foreign companies offered shares. For investors wanting to spread their risk among a wide variety of competitively priced investments in economic and politically diverse markets, these numbers represent opportunity for risk management.

While there is never any guarantee regarding which investments will do well and when that may happen, there are reasonable steps investors can take, based on readily available information, to put themselves in a diversified, opportunistic position. Precisely what percentage of an investor’s portfolio should be devoted to international stocks (or U.S. stocks, for that matter) will vary and should be considered in view of an investor’s overall risk, return and liquidity preferences.

*Data from Dimensional Fund Advisors LP.

PLEASE NOTE LIMITATIONS: Please see important disclosure information and the limitations of any ranking/recognitions at www.fostergrp.com/disclosures. The above discussion should be viewed in its entirety. The use of any portion thereof without reference to the remainder could result in a loss of context. Foster Group cannot be responsible for any resulting discrepancy. A copy of our current written disclosure statement as set forth on Part 2A of Form ADV is available at www.adviserinfo.sec.gov.


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