With evidence now suggesting that international stocks could be poised for long-term relative outperformance versus U.S. equities, it may be time for advisors to take a closer look at their international stock exposure. Our research found that (1) many advisor models are underweight international equities; (2) advisors typically do not broadly diversify their international equity allocations; and (3) diversifying international equity allocations across developed and emerging markets, different investment style such as growth and value, and market capitalization has historically improved returns as well as consistency.
U.S. OUTPERFORMANCE IS AT RECORD LENGTH
U.S. stocks have outpaced international developed markets, but the cycle may be shifting.
U.S. equities have outperformed international developed markets stocks since the 2008-2009 global financial crisis, driven in part by the U.S.’s rapid resort to aggressive monetary easing that enabled an earlier economic recovery. As the U.S. economic cycle ages and the Federal Reserve gradually normalizes monetary policy, relative performance could be poised for a change.
Rolling Three-Year Returns: The performance difference between International (MSCI EAFE Index) and U.S. (S&P 500 Index)
January 1, 1970 - March 31, 2019
Past performance cannot guarantee future results.
Shading represents full market cycle from peak to trough.
Sources: FactSet, MSCI, S&P, and T. Rowe Price.
GROWTH CYCLE FAVORS INTERNATIONAL
Developed markets outside the U.S. are earlier in the growth cycle, with longer runways.
International developed countries are earlier in the economic cycle than the U.S. and benefit from still-supportive monetary policies. Europe and Japan should benefit as global growth drives a pickup in trade, although rising trade tensions pose a risk. Equity valuations outside the U.S. are relatively attractive and have room to improve.
Purchasing Managers Index (PMI) Levels, 0-100
As of March 31, 2019
Sources: Institute for Supply Management, FactSet, IHS Markit, Nikkei/IHS Markit, and China National Bureau of Statistics/Haver.
ADVISORS MAY BE MISSING OUT
Many advisors are not fully diversified.
93% of advisors allocate a portion of their models to international equites but the majority are not diversifying by style and market capitalization. T. Rowe Price believes a well balanced portfolio utilizes value, core, and growth investment styles as well as a dedicated portion to emerging markets and foreign small and mid caps.
International Equity Usage in Moderate Risk Models
As of March 31, 2019
Sources: T. Rowe Price USIS-IPG proprietary Client Investment Platform (CIP) database
The Portfolio Construction Group attempts to align the model portfolio with the most similar Morningstar Target Risk index, which determines the corresponding risk model classification assigned to the model. The benchmark alignment and corresponding risk-model assignment is determined based on the model’s underlying allocations and the historical risk/return behavior of the model portfolio. Models that align closest with the Morningstar Moderate Target Risk index are classified as Moderate Risk Models. These models typically have between 50% and 70% of the model allocated to equity.
THE IMPACT OF DIVERSIFICATION
Asset allocation decisions can have a quantifiable impact on investment portfolios.
Applying the same principles often used in U.S. equity allocations, diversification across international investment styles and market capitalizations offer the potential for better risk-adjusted returns. Emerging markets stocks, for example, are a unique opportunity set and could be viewed as a key component of a broader international equity allocation.
The Impact of Diversification
Trailing 20-Year Returns from April 1, 1999 to March 31, 2019
Percentages may not equal 100% due to rounding.
Sources: Morningstar Direct. Analysis by T. Rowe Price
Diversification cannot assure a profit or protect against loss in a declining market. Performance does not reflect the expenses associated with the active management of an actual portfolio. Illustration assumes reinvestment of income and no transaction costs or taxes.
Category average performance is calculated net of fees and the underlying allocations are rebalanced monthly. Dividends and capital gains distributions are reinvested monthly. The performance shown is hypothetical and for illustrative purposes only and does not represent the performance of a specific investment product. For illustrative purposes.
See important disclosure below for definitions.
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T. Rowe Price USIS-IPG proprietary Client Investment Platform (CIP) database
Copyright ©2019 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.
Batting Average: The number of months where the portfolio beat the index, MSCI EAFE
Sharpe Ratio: Is an investment measurement that is used to calculate the average return beyond the risk free rate of volatility per unit.
Standard Deviation: Indicates the volatility of a portfolio's total returns as measured against its mean performance.