Why International

Sep 29, 2020
  • Jeff Spiegel
  • Jennifer Delaney

Home country bias is commonly exhibited among U.S. investor portfolios. With a bull market running longer than in an average cycle, U.S. investors have been slowly shifting away from international stocks, missing out on diversification benefits and global opportunities. The average international equity allocation for U.S. financial professionals' equity sleeve is 25.3%, down from 30% in 2018, according to BlackRock’s advisor portfolio analysis.1 This is significantly lower than the share of economic impact of those international economies, and much lower than the weight of international markets in the MSCI ACWI index (Figure 1).

Figure 1: World equity index composition vs. average financial professional’s portfolio

chart international allocation

Source: MSCI, BlackRock, as of June 2020.

In the coming years, we believe this may change, spurred by a more divergent world.  International exposures are likely to play an increasingly important role both in the global economy and in investors’ portfolios in our view for three reasons:

  • The rising diversification benefits brought about by deglobalization trends
  • We believe that the unique growth opportunities in international markets provide investor unique access to the full supply chain, accelerating investment trends in less mature markets, and additional innovation outside the U.S.
  • International equity markets are more diverse compared with 20 years ago across sectors and styles, which makes is simpler today to incorporate international exposure into more portfolios.

International investing offers a unique set of opportunities including access to:

(1) The full supply chain

International investing offers opportunity up and down the value chain across industries that can be overlooked in U.S.-centric portfolios. Supply chains have many layers, including manufacturing, services and technology. Often, companies best positioned to benefit from the various stages of the supply chain are located around the globe. Take electric vehicles. Norway is the global leader in electric vehicles in terms of electric car market share, while China and continental Europe both have more electric vehicles on the road than the U.S.2 Leading battery suppliers to the electric vehicle industry are typically found in Asia.

(2) Accelerating investment trends in less mature markets

In less developed markets, investment trends that might be mature in the U.S. still have opportunity to accelerate from a lower starting point, and local players can capture such growth. Take e-commerce: Growth in this industry has been significantly faster for leaders in Southeast Asia, where e-commerce penetration is still in the single digits versus teens in Europe, 27% in China and 18% in the U.S.3 As a result, both user growth and e-commerce penetration are growing more rapidly in the region, accelerated further by the COVID-19-related behavioral changes.

(3) Innovation

In addition, there is world-leading innovation coming outside of the U.S., such as industrial automation, payments and renewable energy. For instance, the transaction value of payments in China is five times more than the combined total of Visa and Mastercard.4

 International equity markets are not the same as they were 20 years ago.  International investing no longer just means opportunities in Europe.  Today the international equity universe is a diverse and diversified one, and truly global. 

The MSCI ACWI ex USA Index captures opportunities across 46 countries including 22 Developed Markets (DM) countries and 26 Emerging Markets (EM) countries[i], encompassing close to 2500 stocks. The universe is well balanced between Asia which represents 42% of the investment universe and Europe which also represents 42%, with the remainder coming from the Americas. 

No single country dominates the universe, with no country making up over 20% of the universe.  5 countries across Asia and Europe make up the top 50%. This is a broad exciting universe of opportunities from Austria to Taiwan with all types of industry type and businesses to choose from, and one often overlooked by investors. In addition, the gradual opening of many foreign stock markets has provided investors more access to markets where they were previously not allowed to participate in, such as Saudi Arabia and China. 

The universe is also diversified by sector and offers diversifying exposure to investors existing U.S. allocations. Figure 2 illustrates how MSCI ex US has a higher weight to Industrials and Financials and lower weight to Technology and Healthcare than MSCI USA.  No one sector has over 20% weight in the index.

Figure 2: MSCI USA sector weights v MSCI ex US sector weights

chart us sector weights

Source: MSCI, as of June 2020.

 While the potential diversification benefits of international assets feel well-worn and have disappointed investors over the last decade there are reasons to think these benefits may reassert themselves in future.

Several forces could drive the correlation between U.S. equities and international equities lower in the next few years. The renewed geopolitical tensions between the U.S. and China is exacerbating deglobalization trends and leading to more bifurcated supply chains. The increased weight of domestic sectors such as consumer, healthcare and technology versus the role of more globally correlated sectors such as Energy and Materials could also contribute to more divergent outcomes across countries.

Even without a drop in correlations, diversification benefits can come from other aspects such as foreign currency holdings and from the diverse sector, factor and style exposures which international investing offers. Factors and styles are not the same across regions. For example, the MSCI EAFE Growth Index is made up of health care and consumer staples exposure while the MSCI USA Growth Index is dominated by technology companies.

We can also look through the lens of factors, an investment approach that involves targeting specific drivers of return across asset classes. A recent analysis shows that the commonality driving the momentum factor, tendency of winning stocks to continue performing in the near term, is 62% in the MSCI USA Index, while the measurement is only 47% in the MSCI Europe Index (Figure 3). In other words, what’s considered “momentum” in the U.S. right now is more highly correlated to one another than momentum in Europe. As a result, increasing the weight of international allocation in a U.S. biased equity portfolio could serve as an efficient tool for investors to diversify their style and factor exposures, potentially reducing the risk of a strong momentum reversal that could adversely impact their portfolio returns.

Figure 3: U.S. stocks are more concentrated within the momentum factor

chart momentum factor

Source: Bloomberg, as of 7/20/2020. Momentum concentration is the cross-sectional explanatory power (R-Squared) of momentum exposure using risk model factors, including styles, sectors and countries, for a given universe at a point in time. This metric measures the extent to which momentum is driven by common factors, rather than idiosyncratic returns from stocks. High explanatory power (R squared) suggests low dimensionality of the momentum factor.

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