If you read magazines, watch the news or even just log on to social media, you may see a common theme: the world is more interconnected than ever before.
However, this isn’t a new phenomenon. As every decade in modern history passes, the world continuously grows closer—economically speaking. Unfortunately, many investors are just beginning to understand the effects. And even though they acknowledge it, some still ignore investments outside of their home countries. This means many investors are missing out on some of the best investing opportunities in the world.
One reason some investors fail to invest globally is they perceive foreign stocks are riskier than domestic stocks. There’s an inherent fear of the “unknown.” But the real risk is missing out on global investing opportunities and being too concentrated in just one country. For most investors, the logic of diversification is intuitive. Spreading your risk across various countries can help protect yourself from crises, trends, or other events that disproportionately impact a single country’s market.
Capital Markets—Global for Centuries
The connection between global economies may seem intuitive today, but it wasn’t just a few decades ago: What happens in one country has measurable effects on another. This extends to capital markets, too. While market returns may differ, market direction rarely does. And if markets do move differently, they often snap back fast.
Just as finance theory suggests, well-constructed indexes should arrive at a similar place over the long term. As far back as reliable market data goes, non-US developed markets have annualised 9.1% and US stocks 10.2%.[i] Figure 1 shows just how closely related global indexes are over nearly 50 years of history. The S&P 500 and the MSCI EAFE are stock indexes that represent the US and non-US developed markets respectively.
Figure 1 S&P 500 and MSCI EAFE Annual Returns—Strongly Correlated
Sources: Global Financial Data, S&P 500 total return, MSCI EAFE net return, from 31/12/1969 to 31/12/2018. Returns presented in US dollars, Currency fluctuations between the US dollar and pound may result in higher or lower investment returns.
These factors have long impacted stocks. You can look even further back than the aforementioned data. Most of the information about the 1929 crash and the Great Depression puts an emphasis on US stocks and the US economy, failing to mention the subsequent events that took place around the globe. In reality, stock markets plummeted around the globe, beginning outside of the US. The UK and Germany peaked back in 1928, while France stayed flat and markets in the US continued to rise into 1929. Global markets were sending warning signs of a major selloff, but those in the US were too blind to notice. This is a prime example of how closely correlated global markets are and why it makes sense to monitor markets around the globe even if you don’t anticipate owning equities in non US countries.
This isn’t to say that US and Non-US markets always move in lockstep. Far from it. They can deviate from time to time—and often for quite a while, too. And there are certainly times when US stocks may be in a prolonged slump—like a bear market—and Non-US stocks are still charging on (or vice versa). However, over a long enough time period, Non-US and US stock performance almost always converge.
Manage Risk, Enhance Performance
Investors understand diversification in regards to asset classes—even sectors—so why does the concept of diversifying equities across other counties seem to baffle? Agreed upon between academia and financial professionals alike, diversifying to protect you from company-specific risks is almost never a bad idea. What better way to accomplish this spreading your assets across various countries?
On the performance side, the more countries you include, the more opportunities you get to make potentially performance-enhancing market bets. If you think German Industrials are likely to outperform, increase your stock exposure there. If you are optimistic about European banks, increase your holdings there. You don’t need to get all of your bets right, but one or two can increase your chances of outperforming.
Historically speaking, countries rotate leadership. Figure 2 displays how the 23 developed markets have rotated leadership over the last 15 years. So, if you did not invest outside of your home country, you likely missed out on some of the best investment opportunities. Failing to realise this can prove costly over time.
Figure 2: Top 5 Performing Stock Markets
Source: FactSet, as of 9/1/2019. The above returns reflect the Total Returns of the top 5 performers of the 23 developed countries that comprise the MSCI World Index, from 31/12/2013 to 31/12/2018. All returns presented in euros. Currency fluctuations may result in higher or lower investment returns. All returns are net foreign withholding taxes.
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Fisher Investments Europe Limited, trading as Fisher Investments UK, is authorised and regulated by the UK Financial Conduct Authority (FCA Number 191609) and is registered in England (Company Number 3850593). Fisher Investments Europe Limited has its registered office at: 2nd Floor, 6-10 Whitfield Street, London, W1T 2RE, United Kingdom.
Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission. Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.
[i] Source: Global Financial Data, S&P 500 total return, MSCI EAFE net return, from 31/12/1969 to 31/12/2018. Returns presented in US dollars, Currency fluctuations between the US dollar and pound may result in higher or lower investment returns.