International Exposure in Investing

[arrete]

I know not everyone is a fan of international investing, but this was interesting, especially if you think by investing in international funds, you're getting world-wide exposure. According to this article, you mostly get European exposure.

Glassman writes:

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Asia is the fastest-growing part of the world and already accounts for one-quarter of all global economic output. Yet Asia gets almost no respect from U.S. investors. ... Part of the problem, of course, is Japan.

The movement of Asian stocks often bears no resemblance to the movement of U.S. stocks -- a condition that can smooth the ride of an investor who owns both. Compare Matthews Pacific Tiger (MAPTX), a typical regional fund, with Vanguard Index 500 (VFINX), the largest fund that mimics the U.S. benchmark, the Standard & Poor's 500-stock index. In 1997, the Asia fund lost 41 percent while the U.S. fund gained 33 percent; in 1999, the Asia fund gained 83 percent while the U.S. fund rose only 21 percent; in 2001, the Asia fund gained 8 percent while the U.S. fund lost 12 percent.

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http://www.washingtonpost.com/ac2/wp-dyn/A11373-2003Feb15

Curious as to what others think of investing overseas.

arrete

 

[1HappyFool]

I don't intentionally invest in overseas companies. I read Gillette Edmunds book and decided it wasn't worth the risk unless the companies were purchased through ADRs.

1HF

 

[Michael]

Actively managed foreign mutual funds tend to have higher expense ratios, which can offset many of the benefits of a "buy and hold" international diversification strategy. Additionally, they do not have records extending back to 1871 like the S&P does, so it is hard to quantify them for long term risk management planning purposes. Some people have had success buying individual foreign sectors when they had periodic dips, but this regional rotation style is also hard to quantify for purposes of long term planning, since individual results vary so markedly. IOW, there may not be any easy way to quantify whether or not actively managed Asia ex Japan mutual funds will help your portfolio over the next 50 years. They should probably be limited to a small percentage of a total portfolio for risk management purposes. That said, there are some good foreign funds/stocks worth considering at certain points in their region's economic cycles, as long as one doesn't go overboard. That is my amateur opinion anyway.

Mike

 

[BigMoneyJim]

Good question; it's one I thought of again recently.

At one time I had some international exposure with an international mutual fund but later found out it was mostly European like you said plus some Japanese stock. Also it was performing horribly and had a high expense ratio.

For me, the domestic (USA) investment landscape is complicated enough for me to understand, so for the past few years I've kept out of international investments. Part of me thinks technology will cause leapfrog growth in Asian and maybe even African markets before I die, but that's based on idle obervation and speculation which I've learned is not a good investment tool.

 

[arrete]

Someone once pointed out that so many large companies do so much business overseas, that you are getting a lot of international exposure just by buying the large companies, and many indices are as well. Think of all the stuff "made in China".

As sort of a counterpoint, I own a little of a foreign banking concern, Allied Irish Banks (AIB), that had a major flap because a Baltimore bank they owned had some shennanigans going on. So it's not always easy to tell where the risk is :-/

arrete

 

[Ted]

In theory, the benefit to international investing is that it will produce about the same return over time as investing in equivalent U.S. securities, but will reduce portfolio volatility through diversification.

This theory, however, assumes that the expenses of owning foreign securities are equivalent to those for U.S.
securities. In general, the costs associated with owning a diversified selection of foreign securities, as through a mutual fund, are substantially higher, to the point that the benefit of the minor reduction in volatility is questionable.

Also, the long-term returns in the U.S. have been higher than elsewhere, presumably because of the superior political/economic climate in the U.S. I can't think of any fundamental reason why the economies of other developed countries should perform better than that of the U.S. in the future. A possible exception is Japan because its financial markets are so depressed that they could respond favorably for a while to more effective economic policies by the Japanese government, but that hasn't happened for over ten years now, and who knows if it will in the future?

Unless you would like to "gamble" with a small percentage of your assets on "emerging markets," I would only invest in foreign stocks through low cost mutual funds like Vanguard's foreign index funds. Considering how the expenses involved in owning foreign bonds will reduce their total return, I would not own them at all. There are enough types of assets available in the U.S. to provide a decent level of diversification and, in particular, to provide a safe "reserve" of short term securities that pay enough interest to at least cover inflation.

 

[Alec]

I was browsing the site (which is excellent by the way), and thought I'd suggest a good argument for international diversification. It's located over on the Morningstar (www.morningstar.com) discussion boards, in the Vanguard Diehard forum. Conversation # 25144.

Plus, I wanted to respond to Ted's response. From what I've seen, the long-term returns of the MSCI EAFE have been almost equal to that of the U.S. stock market. Also, Emerging Market stock should have produced higher returns (which they have) because they are riskier than U.S. stocks.

Also, I can't think of a fundamental reason why the economies of other developed countries should NOT perform better than that of the U.S. in the future. The reason being that I certainly do not know what will happen in the future. And I don't want to project current political and economic climates into the future, because they always change. There have been years and decades when int'l stocks outperformed U.S. stocks (1970's and 1980's), and vice versa (1990's). Wouldn't only owning U.S. stocks be gambling more than owning U.S. and int'l stocks?

If we believe that U.S. stocks are "safer" than international stocks, shouldn't we then expect lower returns from U.S. stocks, since less risk means lower expected returns. I definitely have to agree w/ Ted that if one does choose to invest internationally, he/she use low cost funds. Thanks for the opportunity to express my opinions.

Alec

 

[Mr._johngalt]

This is interesting. I had a conversation only today
where I made a statement that I would not own any common stocks , under any conditions no matter
what my age. Once I could see that early retirement was possible, I dismissed common stocks as an
investment. I wanted predictability. Common stocks
don't offer it. Truth be told, I can not understand why
anyone with the desire and means to retire would own even one share.

 

[Ted]

In response to Alec, I'd like to point out a couple of basic economic facts regarding the U.S. stock market in comparison to the markets of other "developed" countries.
1. It is true that the market returns of other countries periodically exceed those of the U.S., and some almost certainly will for certain periods in the future (but nobody knows which or when). However, if one looks at the returns of the U.S. stock market over a period going back into the 1800's (as the data in FIRECalc does) it turns out that the returns have exceeded those of every other major developed country.

The fundamental reason for this was that the U.S. was a "young" country with untapped natural resources, a relatively stable political system, relatively low taxes, and a relatively high and well diffused level of education. In comparison to other "developed" countries, the U.S. still has these advantages. As I have noted in other posts, the aging of the U.S. population is likely to impose a drag on its economic growth rate, but most European countries and Japan are experiencing this phenomenon to an even greater degree. (in fact, it may be one reason for the economic malaise in Japan.) So in general, I would expect the U.S. economy, and thus its stock market, to continue to outperform those of other developed countries, but not to experience as high a growth rate as in the past.

2. As the economies of the U.S. and other developed countries have become increasingly interdependent (generally a good thing for all of them) the performance of their respective stock markets has become more highly correlated, thereby reducing the main advantage of international diversification. So I don't regard it as "unwise" to own some foreign stocks, but I don't think that there is a compelling reason to do so.

In response to johngalt, I'd like to acknowledge that stocks certainly are risky -- particularly in the short run -- but that the only investment which involves practically no risk of losing real value (other than a minor amount in the short term) is inflation-protected Treasury securities (TIPS).

Historically, however, stocks have provided the highest long-term rate of return and thus the best hedge against inflation. It is particularly interesting that the portfolio combination of stocks and corporate or conventional Treasury bonds having the lowest annual volatility has been about 20% stocks and 80% bonds. So unless a person is willing and able to live off the rather modest (but guaranteed) returns offered by TIPS, I think that it is prudent to have at least 20% of their assets in a well diversified selection of stocks -- especially through a low cost index fund. Whether or not a part of these stocks are foreign is not likely to affect the portfolio performance very much.

 

[Mr._johngalt]

I certainly accept that over the long haul common
stocks can be shown to have outperformed any number
of more conservative investments. I can stand
a very low rate of return, what I can not stand is any
erosion of my base. Thus, for me, avoiding common
stocks is a very easy decision. I have several close
friends (all older) who continue to have a large portion
of their money in common stocks. They have all
suffered what for me would be devastating losses.

 

[Ted]

The dilemma that every person faces is that if they have wealth, it has to be invested in something, and there is no asset other than TIPS that guarantees a return greater than the inflation rate. Even if a person invests in short term conventional Treasury securities or federally guaranteed bank CD's, there is a definite possibility that they will lose real purchasing power as the result of inflation. That is another form of "erosion of the base," which retirees understandably want to prevent.

Unless a retiree is very old or has financial assets less than, say $50,000, I regard it as more "conservative" for them to have about 20% of their assets in stocks, than to have no stocks, in that it reduces the chances of losing out to inflation. This strategy is completely different than one of having "a large portion" (say, 70% or more) of one's assets in stocks. A key component of the strategy of having a modest percentage of assets in stocks is to be able to live off of the income from the bonds, and even to liquidate some bonds, when the value of the stocks drops, as it will periodically do.

Of course, I can't promise that stocks won't continue to decline for another 5 years or more, but that seems less likely to me than the prospect of inflation increasing to substantially more than 3% annually. With all these uncertainties, diversification and TIPS are the best approach.

 

[Mr._johngalt]

Stay out of common stocks. In any other direction lies
madness. You will thank me later.

 

[Ted]

Stay out of common stocks.  In any other direction lies
madness.  You will thank me later.

If you "know" that stocks are going to perform poorly, then you could cash in on that by selling call options on stock indexes, or going short on stock index futures. In my opinion, that would be either madness or extraordinary ability to predict the future. Do you have the courage of your convictions to do it?

 

[Mr._johngalt]

Obviously I haven't made myself clear (and no one has
more "courage of convictions" than I do - ask my wife .

I do not know anything about what stocks might do
or not do. Nothing! That's the point. In spite of what has gone on in common stocks in the past, no one
can predict the future. Think of it this way. If I knew
for certain that common stocks would go up or down
by 100%, it wouldn't mean a thing if I did not know when. I don't have a very large "window of opportunity"
and am working with a small "base" to invest. Thus, I
am risk averse in the extreme. There exists a
plethora of investments with little (or none) of the
downside associated with common stock. I recognize
if everyone thought as I do it would cause a
revolution in the markets. But, I direct my advice mostly
to ERs, and stand by it.

 

[Ted]

I do not know anything about what stocks might do
or not do.  Nothing!  That's the point.  In spite of what has gone on in common stocks in the past, no one
can predict the future.  Think of it this way.  If I knew
for certain that common stocks would go up or down
by 100%, it wouldn't mean a thing if I did not know when.

I agree that neither johngalt nor I nor anyone else knows for certain what stock prices will do, or when.  The problem that johngalt's advice fails to address is that nobody knows what will happen to the real rate of return (purchasing power after inflation) of any other assets, either (although TIPs are more certain than any other investment in this respect.)

The fact that stocks (especially, U.S. stocks) have been the long-term investment with the highest rate of return in the past certainly does not prove that they will continue to be in the future.  However, there are certain fundamental economic reasons why stocks are likely to be -- one of which is that corporate profits tend to rise with inflation (whereas the interest paid by conventional bonds does not).

So the most conservative thing that an investor (who expects to live for more than a year) can do is to invest exclusively in TIPs.  But  beyond that, a blend of perhaps 15% stocks, 8% REITs, 8% high yield bond funds, and 69% short to intermediate term bonds is actually less risky than 100% in "cash."  And an important strategy for insuring that this mixture will, in fact, deliver higher returns over an extended period of time, is to periodically re-balance the asset mix.  That means that in times of stock market declines, a person will be liquidating mostly their fixed income investments.  Likewise, when a stock market bubble starts to develop, they will be liquidating stocks.

FIRECalc demonstrates how this strategy has worked in the past, and most genuine experts in financial economics (as opposed to stockbrokers and other salesmen) believe that it is the best strategy in a world of uncertainty.

 

[Mr._johngalt]

"Genuine experts" are all suspect. As far as
"purchasing power after inflation" being unknown,
this is true. However, I retain some control over the
impact of this as I can always cut back my spending still further if I see trouble ahead. On the other hand, I have
no control over the DJIA. If the market tanks I am dead
in the water. Nope, steady income with low (or no)
price volatility. That's the way to go for most REs.

 

[Ted]

How people invest their money is, of course, entirely their own business. But any retiree whose strategy for dealing with potentially-high future inflation is simply to "reduce spending" is taking a big financial risk. I hope that most people who use this website are wise enough to understand that fact in determining their own investment strategy.

 

[Mr._johngalt]

Hi Ted! And I view it as no risk at all (reducing spending
in response to inflation). Maybe I missed a run up or 2
in common stocks in the 90s. I don't care. I had predictability all the way,
and thus could plan with as much certainty as we are
allowed in this life. It's only my opinion, but I avoid
common stocks like the plague and can not fathom why
any ERs would give them a second thought.

 

[bongo2]

John, I understand your leeriness of stocks, but what is your alternative? Short-term treasuries? CDs? TIPS? You mentioned real-estate in another thread, looking at all the people that have gone bankrupt in real-estate I would classify that as just as risky as stocks.

I think you also raise an interesting point about inflation. Theoretically, it is just as bad to have half your income with no inflation, as it is to have your original nominal income with 100% inflation. Psychologically, however, the second situation is far more palatable.

 

[Mr._johngalt]

As you well know. common stocks are not an option for me under any circumstances. As far as real estate, I
have owned virtually every kind available, i.e.
single family, apartments, raw land, commercial, you
name it. I have never lost a dime in over 30 years of
real estate investing. So........................if it's between
real estate and common stock, I would not have a
problem deciding. Other options include CDs., TIPs,
preferred stock, corporate notes, bonds, etc. I would
encourage this approach if only because it reduces
your options if you eliminate common stock. That alone
is worth a lot, in my opinion.

 

[Ted]

 As far as real estate, I
have owned virtually every kind available, i.e.
single family, apartments, raw land, commercial, you
name it.  I have never lost a dime in over 30 years of
real estate investing.  So........................if it's between
real estate and common stock, I would not have a
problem deciding.  

This discussion has morphed into a continuation of the discussion of "real estate as an investment" (which is OK!)

A couple of financial facts:

1. For anybody with more than a few thousand dollars to invest, investing is not an "either/or" proposition. It is both practical (through mutual funds) and desirable (because of the principle of low correlation of annual total returns) to simultaneously invest in numerous categories of assets.

2. Owning real estate directly is a combination of a "job" and an investment. The time spent managing the property should enhance the rate of return on the investment, but has an "imputed cost," which, if valued at, say, $25 per hour, will substantially reduce the apparent return on the invested equity.

For most people who don't want to become "real estate enterpreneurs," the best approach is to include REITs in their investment portfolio. Over the past 15 years, REITs have had about the same cumulative total return as U.S. stocks, with virtually zero correlation in annual total returns. That is a strong argument for owning some of each.

 

[Mr._johngalt]

Hello Ted! Morphed indeed!

I confess that my life long fondness for real estate
(in all of its forms) along with my strong aversion to common stocks colours my advice significantly. The extra
time required by active involvement in real estate (as opposed to REIT
investing) once seemed like a small price to pay. Now, I am no longer interested in actively managing
anything more demanding than deciding what fishing bait to use, or the selection of the proper
time to begin cocktail hour. All kidding aside. There
is not a single thing I need that I can rely on common stock investing to provide. Thus, it is all downside for me,
because there is no reason to take the risks involved.
Only a fool would go in that direction.