One can excuse 401k investors and mutual fund owners for being confused over whether they should invest in foreign mutual funds or not. Even though it’s easy to grasp the concept of a global economy, deciding on just how to put it to work in your investment portfolio is a more formidable task.
Is it sufficient for a U.S. investor to allocate 10% or 20% of their stock portfolio to foreign companies? Do the big U.S. multinational firms owned by domestic stock fund managers provide enough foreign flavor to your portfolio given their global reach, as Jack Bogle would have you believe? And what about those currency fluctuations?
Then, there’s a more basic question: Is now a good time to be invested in foreign stock markets? You could have asked this a year ago or five years ago, though, and my answer wouldn’t have changed. Yes, absolutely.
Here are a few reasons your portfolio could benefit from some global diversification.
Diversification Does Matter
Folks like former Vanguard chairman Jack Bogle and his acolytes argue that there’s little diversification benefit in foreign mutual funds since U.S. companies already derive a large share of revenues, and often an even larger share of earnings, from business conducted overseas.
I would counter that thinking by suggesting that companies with feet-on-the-ground expertise in foreign markets often have a distinct advantage over multinationals, particularly when it comes to more localized businesses.
Yes, an oil company or a major drug producer may be able to sell its wares as easily overseas as it does in the U.S., but local cement makers, retailers and service providers probably have a good leg up on their foreign competitors.
An example: Google (GOOG). Overseas, the company to watch is Baidu (BIDU). No wonder Baillie Gifford — which runs chunks of Vanguard Global Equity (VHGEX) and International Growth (VWIGX) as well as a piece of Growth Equity (VGEQX) — has a huge stake in the Chinese web giant, which happens to be a top holding at International Growth.
Currency Cuts Both Ways
Some will tell you that you’re adding a new and unique risk to your portfolio when you invest in stocks that are denominated in non-dollar currencies. But it cuts both ways. Currencies can hurt, or they can help.
With the dollar in a long decline since 2003 (but trending up at the moment) investors in the U.S. got more bang for their buck by taking on currency risk.
Timing Is a Fool’s Game
Click to Enlarge Finally, there are those who’ll argue there are times to be heavily invested overseas, and other times when you should keep your money at home. Thanks.
But market-timing is tough already, and trying to decide whether to focus here vs. there is not as easy as the sound-biters would have you believe.
Take a look at the chart to the right, for example, which shows the relative performance of Vanguard Total Stock Market (VTSMX) and Vanguard Total International (VGTSX) since the foreign index fund’s inception.
When the line in the chart is rising, U.S. stocks are outperforming foreign stocks (all based on U.S. dollar returns of course). When the line is falling, foreign stocks are tops.
Clearly, there was a long pull favoring U.S. stocks from the mid-’90s to early 2002. That was followed by a period of outperformance for foreign stocks until the middle of 2008. Obviously there were some reversals during the period, so how you were supposed to time those is beyond me.
Now look what’s happened over the past five years: U.S. stocks on top from Oct. 2007 to Oct. 2008, then foreign stocks winning through Oct. 2009. U.S. stocks were on top again through April 2010, followed by a sharp reversal favoring foreign stocks the next month, and a stagger-step climb for U.S. markets until May of 2012.Then another reversal to the foreign side that October. Since then, U.S. stocks have outperformed.
Care to guess which way the pendulum will swing next?
I don’t want to make a market-timing bet, so my advice is the same as it’s always been: Buy foreign funds run by good managers and make an allocation in your portfolio that suits your risk temperament and long-term return aspirations.
Daniel P. Wiener is editor of The Independent Adviser for Vanguard Investors, a monthly newsletter that keeps abreast of recent developments at Vanguard.
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