After More Than A Decade, It’s Easy to Forget The Benefits of Owning Non-U.S. Stock
It’s well known that the potential return and ongoing risk in a portfolio is a function of its asset allocation
and diversification decisions. The combination of these strategies provides both the possibility of growth
and potential protection against loss. Holding a broad range of investments helps lessen the impact that
one underperforming asset or asset class can have on the portfolio.
That’s not to suggest that anyone will be comfortable when a portion of his or her portfolio
underperforms. Especially if those losses persist over a long period of time.
To say that non-U.S. stocks, long an important component of smart asset allocation design, have failed
to keep pace with U.S. stocks would be generous. From the beginning of 2012 to the end of 2021, the
MSCI USA Index has routed the MSCI ACWI ex USA Index, and not by a small amount.
It’s Been Hard to Beat the U.S.
While it’s true that exchange rates can have a big impact on dollar-denominated
returns, very little of this nine-year performance gap can be attributed to currency movements. The difference is even more fundamental: It’s earnings.
The superior performance of U.S. companies, particularly those in the technology sector, has been
mostly due to earnings-growth rates much higher than those of non-U.S. companies.
U.S. companies across the board have outperformed their overseas counterparts in every sector.
Beyond tech stocks, non-technology companies including those from the financial, health care, and
communication-services sectors, have traded higher.
The outsized contribution of the U.S. technology sector cannot be overstated. Not only have
technology stocks been among the best performers of the past decade, but they represent
a meaningfully larger share, about 12%, of the U.S. market than non-U.S. markets.
Nothing Outperforms Forever
In this environment, who can blame investors for wanting to minimize their allocation to non-U.S.
equities, maybe even avoid the asset class altogether. After all, we tend to hold a much larger
allocation to our country of residence, the so-called “home-country bias”, even in normal markets.
But failing to look at shares of non-U.S. companies overseas, regardless of a performance gap,
overlooks the benefit of complementary assets — securities that might speed up when the U.S.
eventually slows down. And we can say with certainty that U.S. equities won’t outperform forever.
Over the past four-plus decades, stock market leadership has alternated between U.S. and non-U.S.
equities several times.
In fact, there have been lengthy periods of both outperformance and underperformance of U.S.
stocks relative to non-U.S. stocks. Allocating to both asset classes still makes sense because it
is impossible to predict which one will outperform in the future.
Still a Valuable Source of Diversification
After this extended run of underperformance, it’s easy to forget that an allocation to non-U.S.
stocks still improves a total portfolio’s expected risk-return profile versus a portfolio that includes
only U.S. equities.
Said another way, holding securities in a variety of countries that react differently to market
and economic conditions is still a benefit. By allocating to markets that experience downturns
and upturns at different times and degrees than the U.S., investors can reduce overall
portfolio volatility.
Bottom Line
Owning a diversi ed portfolio means that some assets will perform well while others don’t. Over what
has essentially been a one-way market for the last 10 years, allocations to non-U.S. stocks have been a
relative drag on portfolio returns. But there is still a case to own them. Allocating to non-U.S. equities
will eventually allow investors to take advantage of the potential periods of non-U.S. outperformance
while gaining the benefits of diversification at the portfolio level. Remember, a market can’t move in
one direction forever.
Important Information
This is for informational purposes only and does not constitute an offer to sell any investment. Indices
are unmanaged and do not include the effect of fees. One cannot invest in an index. Performance
data quoted represents past performance and does not guarantee future results.