Prolonged periods of underperformance versus the mighty US equity market have cast a shadow over international equity allocations. In these periods of US-market dominance, US domiciled clients habitually ask us to defend their exposure to foreign markets. With international equities and currencies delivering inferior recent performance, and market correlations at high levels, why bother venturing from home? One could argue that overall superior country and company management continues to distinguish US companies from non-US peers.
Furthermore, the recovery in US gross domestic product (GDP) from the 2008 crisis is far more advanced than in any other developed country. These conditions have led to the most desynchronized global monetary policy in 25 years, according to the global equity strategy team at Credit Suisse.1
Perhaps this will allow US stocks to dislocate even further from the rest of the world. Under that scenario, international (both developed and emerging markets) allocations would continue to detract from overall performance.
Over the past decade, our response to “Why invest internationally?” has remained consistent. Invest globally, we urge clients. By definition, an expanded opportunity set of investments brings more buy candidates - and a greater opportunity to capture upside potential, we argue. Over time, we have become convinced that top-down geographic allocations do not benefit clients. Most importantly, these allocations do not incorporate a full array of
risk factors; they simply classify stocks in the portfolio by domicile, country of listing or similar criteria. We prefer to invest across as broad a geographic mandate as our clients will allow. We believe that the investment manager may be in the best position to spread geographic (and other) risks in order to obtain the highest projected risk-adjusted return. Despite the dominance of the US equity market this decade, many (and we emphasize many) attractive stocks—especially those likely on the cusp of a cyclical recovery— have proliferated in non-US markets. However, in order to build an optimal portfolio from a return versus risk perspective, buying well-managed companies in various industries globally makes the most sense to us. This portfolio construction process results in a deliberate allocation of risk across multiple factors.
For the past several years, non-US equity markets—both developed and emerging—have traded “cheaper” than the US market. However, that undervaluation has not led to a surge in international equity performance to close the valuation gap. Some of this US valuation premium can be attributed to the average US market constituent boasting superior profit margins, earnings per share (EPS) growth and returns on capital in excess of the non-US developed markets average. The growth gap favoring emerging markets stocks has also narrowed in the recent past.
US equity market performance has far surpassed other regions over the past five years, even after adjusting for the rising US dollar. How much of this recent outperformance by the US market should continue in the next few years? No one knows. But we should ask, if unconstrained by geography, where are the best investment opportunities today? Causeway’s (preferred) mandate, namely “Global Opportunities”, is benchmarked to the MSCI All Country World Index, and increased its exposure in 2014 to emerging markets to over 11% of the total portfolio. US stocks represent approximately 58% of the MSCI World Index, and 52% of the MSCI ACWI Index. By contrast, at December 31, 2014, the Causeway Global Opportunities portfolio had only a 38% exposure to USlisted stocks.
