Why Didn’t My Portfolio Keep Pace With The “Market”?

If you have been holding a diversified portfolio, it's been a frustrating few years.  Nothing outside of US stocks has been working.  We have been counseling clients that sticking with their original plan of global diversification still makes a lot of sense since the tides will turn eventually.  We may be seeing those shifts sooner than we thought.  Below is a chart of showing the first month of the year:

Although a short time period, things have shifted in 2015.  After a month, the US stock market (black line) is the clear loser when compared to the developed foreign markets (gold line) and the emerging markets (blue line).  For the past five years, US stocks have gone up over 15% per year, while foreign developed stocks are up 5% and emerging market stocks are up 2% per year.  It is not hard to understand why people might abandon diversification and just decide to stick with the US markets.  The problem is that trends don't last forever.  At some point the tides will change.  This is not dissimilar from the 1990s.  This decade was a great period for the US stock market with substantial economic growth ending with the technology boom.  The US stock market had tremendous gains and outperformed almost every other asset class.  Those choosing to concentrate their assets in large US companies at the end of this decade, because of that great performance, found that the next 10 years were horrific (taken from the Irrelevant Investor Blog):

Investors need to remember that if you are properly diversified, there two truths that you ALWAYS have to live with:

  1. You will always have something to complain about- something in your portfolio will be out of favor every year if you are properly diversified.  
  2. You will never outperform the best asset class- in fact your portfolio will always fall somewhere in the middle of the asset classes you are invested in.  In the case of 2014, if you have adopted a diversified portfolio, you should be upset you underperformed the S&P 500.  It was one of the best performers

The upside of all of this is that your portfolio will never be as bad as the worst asset class in the portfolio, you don't have to try to "guess" which asset class to rotate into each year, and your returns will be much less volatile. We believe that this is a worthwhile tradeoff.

Does International Investing Still Add Value?

For those of you keeping score, the US stock market has been trouncing its foreign brethern for the last 5 years.  The S&P 500 has generated a return of 15.96% for the 5 years ending on 11/30/2014.  Conversely, the MSCI EAFE and MSCI Emerging Market Indices have returned a meager 6.38% and 3.88%, respectively.  To put it another way $1 million invested in each of these three markets would have produced the following results:

  • US (S&P 500)- $2.22 million
  • International (MSCI EAFE)- $1.39 million
  • Emerging Markets (MSCI EM)- $1.26 million

While all have been positive, the US is the clear winner and these results are causing some to question whether international diversification is really necessary.  The argument is typically something along the lines of US companies sell globally now, so does it really matter where a company is domiciled.  I think it is a fair statement and one that is worth exploring in more depth.  Because of that we went back for the past 44 years to see if this is a common occurance or one we should be concerned about.  Here are the results (click on image):

Stock markets

The highlighted cells show the years where each market was the best performer.  At first glance what you see is that each market has had its day in the sun and there doesn't seem to be any rhyme or reason for which market is going to outperform.  In fact, over the past 44 years the US stock market and Emerging markets have both outperformed 16 of those years, while the International stock market has outperformed 12 of those years.  In addition, there was a time from around 2001 until 2007 where many were questioning whether investors should have exposure to US stocks, since Emerging Markets seemed to be the place to be.  Like always, that trend reversed and the pendulum has swung the opposite direction.  Instead of trying to guess which market is going to outperform in the future, we continue to stress that it is important to own some of each.  You'll always be happy (that you have the best performer in your portfolio) and upset (that you have the worst performer in your portfolio).  If you are interested in what that balance of US/International/Emerging Markets should be, please read our thoughts on the topic.

How Much Of My Stock Portfolio Should Be In Foreign Companies?

Yesterday, we wrote about the value of adding foreign stocks to a portfolio.  The next question we wanted to answer was how much of your portfolio should be in foreign stocks.  Unfortunately, there isn’t a right answer to the question.  It is probably more art that science, but we do think there are some key points investors should be aware of.  

  • The US Market represents about 40% of the total market capitalization of the world.  This is a good starting point to determine how much of your portfolio should be in US versus foreign stocks.
  • Our own research shows that adding foreign stocks to an all US stock portfolio brings down the risk of the total portfolio, so we recommend that most clients have at least 30% of their equities in foreign stocks

If the US market makes up 40% of the total world stock market, why would we advocate having 60 or 70% of our client’s portfolio in US equities?  There is good reason for this “home country bias” that investors should consider when designing their portfolio:

  • Fees for US equity funds are less than foreign equity funds.  According to Morningstar, the average expense of a US Large Blend Fund is 0.48%, Foreign Large Blend is 0.74% and Emerging Markets is 1.10%.
  • Trading costs are lower.  One study found that trading costs for US Equity funds averaged 0.36%, Foreign funds 0.45% and Emerging market funds were 0.61%.
  • Behavioral- when investors significantly weight foreign stocks in a portfolio there can be more of a tendency to tweak the portfolio over time since there will be many years with significant underperformance to indices like the S&P 500.  Since most of us tend to compare our portfolio to the market we see on TV or on the internet (like the Dow Jones or S&P 500), we must ask ourselves the question whether we would feel comfortable significantly trailing the US market during some years.  I have found that the more a client deviates from their perceived “home market” the higher the possibility for tinkering with the portfolio.

For all these reasons, most clients would be well served by keeping a larger portion of their equities in US stocks.

Do Foreign Stocks Add Value In A Portfolio?

With the US stock market generating substantial gains over the past several years, many investors are questioning why they should have exposure to foreign stocks in their portfolio.  Over the past 3 years (ending 4/30/14), the MSCI World Index (ex-US) has averaged 5.0% per year while the S&P 500 has gained 13.8% per year, so you can see why investors may be questioning a strategy of diversification.  We must go back longer (over multiple periods) to really see why diversification can add value:

                                                   S&P 500         MSCI World (ex-US)

  • 1970-1980                   5.9%                     9.6%
  • 1980-1990                   17.6%                  20.7%
  • 1990-2000                  18.2%                   7.1%
  • 2000-2010                  -1.0%                   1.6%
  • 2010-4/2014              15.3%                   7.7%

In addition, since 1970 foreign stocks have outperformed US stocks in 54% of all rolling 10 year periods.  Abandoning an asset class just because it has not performed well recently is a bad strategy, especially when you look a the historical data showing the value this asset class can add to a portfolio.  

If you believe that foreign stocks should remain a fixture in a portfolio, the next question logically is how much?  We’ll dive into that question in a future blog post.

Markets Reverse Course Again

Last year the US stock market vastly outperformed their peers in the international and emerging markets.  With US markets up over 30% and emerging stocks negative for the year, some people were questioning whether they should maintain exposure to emerging markets at all.  As we came into 2014 this thought process was exacerbated with the events happening over in Ukraine.  Our response has been that those that maintain diversification across markets would be very happy they didn’t put everything in US stocks at some point in the future.  Well that time we were speaking of came quicker than many thought.  Here is a chart of the US markets (blue) vs. emerging markets (green) over the past month:

Chart forSPDR S&P 500 (SPY)

Emerging markets are up nearly 5% in the last month while US markets are down close to 2% during that same period.  Now, we don’t know if this trend will last, but that is the whole point.  No one knows what the future will bring.  Rather than betting the farm on one area of the market, it is much more prudent to spread your capital to other markets in order to avoid the inevitable volatility you experience when you concentrate your assets.

Information contained herein has been obtained from sources considered reliable, but its accuracy and completeness are not guaranteed. It is not intended as the primary basis for financial planning or investment decisions and should not be construed as advice meeting the particular investment needs of any investor. This material has been prepared for information purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Past performance is no guarantee of future results.