4 reasons to consider overseas markets

Russ Koesterich, Portfolio Manager, BlackRock Global Allocation Fund

Key Points

  • Like most U.S. investors, you may be “under allocated” in overseas markets
  • Foreign markets currently offer lower valuations than the U.S. and attractive return potential
  • Japan and select emerging markets appear particularly compelling

Are stocks from overseas markets underrepresented in your portfolio? That may be the case for many U.S. investors, according to Russ Koesterich, BlackRock's Global Allocation Fund portfolio manager. In his opinion, it is not unusual for international investments to represent no more than 20% to 25% of a U.S. investor’s portfolio. Yet the global stock market (as measured by the MSCI All-Country World Index) is 50% non-U.S. On that basis, many investors could be 30% underweight in foreign markets.

This isn’t surprising. Most investors, regardless of where they live, tend to concentrate on investments based in their home country. This “home country bias” is even more evident today given pending elections and rising populism in Europe, uncertainty around China’s economic stability, and tensions in the South China Sea and the Korean Peninsula. But the opportunity may outweigh the uncertainty.

The case for boosting your investments overseas

Here are four reasons investors might contemplate looking beyond U.S. markets today:

  1. Comfort comes at a cost

U.S. stocks are expensive today, with valuations at more than 20x trailing price-to-earnings (P/E) according to Bloomberg. While U.S. markets may still have room to rise, current valuations have historically been associated with lower future returns. In contrast, equity markets in Europe, Japan and emerging markets (EMs) appear to be either fairly valued or relatively inexpensive, offering greater growth potential.

  1. Diversification matters

Investors need to consider what assets offer true diversification. If most of a portfolio is invested in U.S. stocks, for example, the portfolio is primarily dependent on the strength of the U.S. economy. Investors should consider three factors when building a portfolio:

  • Return expected for each asset
  • Risk expected for each asset (normally expressed as the standard deviation of return1)
  • Relative asset performance in comparison to each other

While diversification does not assume a profit or protect against loss, having a less correlated asset in the portfolio can make all the difference, and this is the value investments in foreign markets can provide.

  1. Emerging markets stand out

Emerging markets are outperforming the U.S. and other developed markets so far this year. Yet their valuations still appear inexpensive, particularly on a relative basis. The MSCI Emerging Market index recently traded at roughly 1.5x book value, nearly 50% cheaper than the S&P 500 Index of large-cap U.S. stocks, according to data from Bloomberg. Emerging markets entail increased risk, but they could represent compelling opportunities for long-term investors able to stomach the typically higher levels of volatility.

  1. Overseas markets benefit from a strong dollar

When U.S. stocks and interest rates rise, chances are the U.S. dollar is climbing as well. European and Japanese exporters reap a competitive price advantage as a result. Investors confident about the U.S. might benefit by being a bit more bullish on international developed markets as well, which can capitalize on an improving U.S. economy and a stronger dollar.

Where to find opportunity overseas

There are prime areas that may be worth investors’ attention, according to Russ Koesterich, BlackRock's Global Allocation Fund portfolio manager:

  • Japan – his pick as an attractively-priced developed stock market. It has benefited from supportive monetary policy, rising inflation and stronger company earnings. Japanese stocks, based on the Nikkei 225 Index, returned 5.9% in U.S. dollar terms (2.4% in JPY) in 2016 and he believes, still has the wind at their back.
  • Europe – he thinks opportunities may exist in select industries. One example: In a world starved for income, the European consumer staples sector offers up some stable companies that generate healthy yields.
  • Emerging Markets – he likes select countries, particularly in Asia. India is a good example. Those concerned about China can take some solace in the fact that India, given its large domestic economy and healthy local consumption, is less tied to China than the rest of the world.

Take a closer look at your options

The U.S. stock market still offers investors several desirable characteristics: a stable currency, high profit margins and world class companies. In today’s environment, it also comes with a high price tag. For long-term investors, this suggests looking beyond the comforts of home to diversify and enhance portfolios by boosting positions in overseas markets.

Keep in mind that international investing does involve certain risks and volatility due to potential political, economic or currency instabilities and different financial and accounting standards.

Consult with your advisor if you have questions about international strategies related to your portfolio.

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