Is Large Increase in Foreign Holdings Justified?

This Morningstar article provides some additional perspective on this question.
There are two schools of thought that go from very little to almost equal weight in in market value allocating between domestic and international, but somewhere in between is probably the sweet spot for most folks:

See How Much Foreign Stock and Bond Exposure Do You Need?
On a conceptual level, hedging as far as I can tell only makes sense (from a risk perspective) in the long term if both:

  • Your costs are dependent on one currency (determined by where you live + the size and diversity of one's economy), and income / assets are in another (likewise)
  • Currency exchange rates after correcting for interest rates diverge strongly in the long term
The last item seems only able to happen if the risk profile of the two regions involved are perceived as very divergent. In developed markets I don't see that divergence permanently, only in times of crisis (2008/2009, 2012, lingering eurocrisis).

In the short term hedging is useful if your currency (either costs or income) or part of a small system with high risk of implosion. That's basically any country except for the US, Eurozone, India and China.

So if I were a US citizen living in the US, especially with SS, I wouldn't expose myself too much to internatonal beyond the automatic exposure you get through multinational companies listed there. As a Eurozone citizen I diversify fully though (Vanguard VT).

There is of course an entirely different question regarding which companies (listed in the US or elsewhere) will tend to perform best in the future. No clear way to tell, the US was a good bet in the past though and still is a huge chunk of world market cap. Better run companies, less risk/uncertainty (talking about fraud here).
One other note, one of the reasons Vanguard put out the articles is because it was changing several of its own mutual funds in that same direction. So if you own any of the target date funds (which I do for my long term 401k money), those were already shifted to a larger portion of international funds. When I went to re-balance, I actually didn't need to because their shift had already added almost 10% to my international overall %.
I think I get your point, it does seem that when investing in equities there is a "right time", which is usually in the past or before the current run-up, and a wrong time, which is now. :)

Regarding hedging, the point Tweedy Browne make (and I agree with) is that over a long period, which I think is probably 5 years or so, the hedged vs non-hedged int'l investment in a developed market will probably produce about the same return. Their point would be that you can choose either, but you need to stick with the choice you make. IMO that favors unhedged int'l, the investment options (funds and ETFs) are far better. Thee are just a couple of hedged options.

If I were considering adding international equity to a portfolio that has none I would probably set a target allocation and then do it in batches over a year or so.

I would think over time the cost of hedging a portfolio will act like a management fee reducing returns, I have always been against hedging unless there was a short term need. If a stock market in a country increases as a result of currency issues (for instance such as Russia recently) then currency forces and investing is actually providing the income not stock market investing.
I had looked into this a while ago when Vanguard increased their foreign equity allocation from 30% to 40% of total equities for their target date funds. Their World fund, which proports to represent the global equities market, is ~48% international stocks, is it looks to me like they split the difference.

My target AA has been 30% equities. My plan is to just let international equities drift upward with market movements and rebalance only when it is below 30% until it gets to ~40% and then I'll change my target to 40% and rebalance from that point forward.
When you compare the Vanguard total stock mutual fund for the past 5,10 or 15 years it has done much better than the Vanguard total international stock fund. So, long term international hasn't done well by my standards. I have kept some money in international and emerging markets and have done much better with Vanguard emerging markets over the past 10 years.

I don't know the future but I'm not convinced, based on the long term past, that international is the place I want to put a lot of my money. Again, I could be wrong but I sleep good at night!
I would think over time the cost of hedging a portfolio will act like a management fee reducing returns, I have always been against hedging unless there was a short term need. If a stock market in a country increases as a result of currency issues (for instance such as Russia recently) then currency forces and investing is actually providing the income not stock market investing.
The Tweedy Browne paper I linked earlier says that over time, hedging costs are not meaningful, and in some parts of economic cycle represent income opportunities. I would add that this only applies to developed countries with strong currencies, definitely not emerging economies.

Over the past 18 years I've never had less than 40% of our portfolio in int'l and this is the first time I hedged. This choice was entirely based on the expectation of Euro area QE and it's impact on the currency and equity markets and expect this to not continue over time.

I'm not too comfortable with hedging because there aren't enough deep, broad, liquid investable options. Even HEDJ is flawed because it focuses on a "select sub-segment" of European global businesses.

While I think there is room for the Euro to decline vs the US$, any new money I put in int'l (including EM) goes back to broad index unhedged. In my view the US$ will, over time, slowly lose value vs the trade weighted basket of currencies.
looking back at Less Antman's position

Paul Merriman, Bill Bernstein and Less Antman showed that historically, 50/50 US/foreign gave lower volatility and a little better ROI. While non-correlation has narrowed in the past decade or two, I figure there are enough differences between the markets for me to keep 50/50.
I just ran across an old posting by Less Antman that I kept and decided it was time to take another look. This may be helpful for those wondering about adding non-US to their portfolios.

A long time ago (15? 20? years?) Less proposed a Vanguard equivalent to his recommendations to his clients consisting of 1/3 cash equivalents (TIPS, as VIPSX), 1/3 large US stocks (as VTSMX, V Total Stock Market Index) and 1/3 large international stocks (V Total International Index). I graphed them from 29 June 2000, when one of the funds started, up to today. I also rebalanced them once a year and also compared Vanguard's S&P 500 fund, VFINX (did not plot them, though, only calc'd the ROI), and Wellington, VWELX, for the same period. The data came from Yahoo Finance, Historical prices, normalizing the Adjusted Close (for total return) to the value on 29 June 2000. And I calculated the annualized ROI for each. Here are the results.

If I did this correctly, TIPs did better than either of his two stock mutual funds :eek: and VWELX, 60/40 US stocks/bonds, did better than all of them. BTW, I am using an average 6% ROI for my own projections, which I thought was conservative.

As it happens, I do not use this particular set of funds (and I have not evaluated my personal portfolio yet; still hopeful about a carefully selected 50/50). I use some funds and some individual stocks (some may remember that I was dabbling in Oil & Gas and Pipelines) for my 50/50 US/foreign mix. Some time back I mentioned that my various strategies were not as good as I had hoped :blush: and that I just might move everything into Wellington and forgeddaboutit. I am unwrapping my traditional IRA into Roths for the next three years, and when I am done, the plan is to have virtually everything in VWELX and a MMF to catch the earnings for distribution. I am in the drawdown phase now so simplifying the portfolio and abandoning unfruitful strategies is in order. The market can stay irrational longer than I can stay solvent.

I could go back and check Paul Merriman's strategy as well but it may show the same problem over the last 14+ years as the US component is the S&P 500 and I am not in a good mood right now. :( Maybe, "This time it's [really] different!" :confused:


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Maybe I didn't do all that bad after all. After taking two substantial withdrawals and paying taxes on Roth conversions, Vanguard says the balance represents a 7.4+% annualized growth over the last 10 years.

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Another point, when the uncertainty of greece goes away (one way or the other) i think europe overall will benefit and valuations will rise, especially if euro-easing is still in effect.

Unless ISIS invades.

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