By Paul Jacobs
Investors in foreign stocks have suffered through several years of underperformance. The result today? A great opportunity for rebalancing.
It is an excellent time to rebalance your equity portfolio and put at least 35 percent of it in foreign stocks. The U.S. stock market has been on quite a run and that has made many investors doubt the benefits of foreign investing. But the U.S. cannot and will not outperform forever.
While no one can predict how foreign stocks will do in the short run, there is certainly long-term value to be had abroad. Limiting your investment choices to the country where you live is just as arbitrary as limiting them to companies headquartered in your state. A smart investor would never invest only in companies headquartered in New York or in California. The same principle applies when considering national and international equity investments.
If, like most investors, you”™re underweighted in foreign stocks, how should you invest overseas? Stick to mutual funds or exchange traded funds (ETFs); individual stocks are too risky.
Allocate the single biggest piece of your international stock portfolio ”“ around 40 percent ”“ to Europe. The bulk of your European investments should be in strong economies like the United Kingdom, Germany, Switzerland and France.
Many of the world”™s best multinational companies are based in Europe, even if European stocks currently still lag America somewhat. Western Europe offers both income and long-term growth potential. Despite the eurozone”™s recent struggles, it still has attractive and efficient markets. Be warier of Eastern Europe and Russia, however, given the region”™s relative instability and historical disrespect for foreign owners”™ property rights.
If a fund is heavy in a country, like Russia, that is unreliable or unstable, don”™t invest in it. You might accept a 2 percent incidental exposure to a country you”™re not comfortable with, but nothing more substantial.
However, even in less stable countries, there are some strong companies worthy of investment. What about China? Be cautious, despite the country”™s economic growth. In other words, keep your exposure carefully focused. Virtually all the Chinese stock exposure in our clients”™ portfolios is purchased through the Hong Kong exchange, which has superior disclosure and openness to foreign investors, rather than mainland China. Do not avoid China, but keep the level controlled because of the risks the political situation creates.
In addition to the 40 percent of your international investments you should allocate to stable European economies, look to other established markets for international equity investment: Australia, Canada and Japan. Invest about 10 percent of your international stock portfolio in Australia and Canada and 12.5 percent in Japan via index funds or ETFs. These markets are established and efficient, so index funds are likely to offer better because they have lower management fees than actively managed funds.
Investing in emerging markets is important too, but it is trickier because of the potential lack of transparency. For developing economies, use active managers instead of index funds, as skilled fund managers can often outperform these less-efficient markets. Experienced fund managers can sift through each company”™s financial statements and separate attractive investments from unattractive ones.
Many investors will also find it appropriate to allocate a portion of their international portfolio to real estate investment trusts (REITs), including those with international holdings. Investing in global property markets further boosts your portfolio”™s diversification, another way to minimize overall risk.
The fate of large companies is tied to location more loosely than ever before. U.S. stocks make up less than 50 percent of the global stock market. Even if you do decide only to hold U.S. stocks, your portfolio will still be affected by what happens outside this country. Investing in isolation not only does not make sense, but in a real way, it is no longer even possible.
Unless you believe that foreign companies are fundamentally less attractive investments than U.S. companies, investing a substantial portion of your portfolio abroad is the right thing to do.
Paul Jacobs is chief investment officer of Palisades Hudson Financial Group in Scarsdale. Palisades Hudson (palisadeshudson.com) is a fee-only financial planning firm and investment adviser with $1.2 billion under management. Jacobs can be reached at paul@palisadeshudson.com.
