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Strengthen your core

U-WEN KOK, CFA 16-Oct-2018

A strong core is the key to success for just about any athletic endeavor. The same holds true with regard to long-term investment goals. Yet we believe that too many investors continue to overlook global companies for their core equities allocation. 

This might be the result of simple human nature and home country bias. We all tend to focus on (and invest in) what we know best. And given the strong relative performance of domestic versus international equities since the Global Financial Crisis, it’s understandable why many U.S. investors have over-allocated inside our borders.

But such a narrow focus might actually be elevating risks for investors—exactly the opposite of how a core allocation should anchor a portfolio. What happens if and when relative performance between domestic and global markets reverts to the mean? Does anyone think that the S&P 500 Index®, for example, will continue to outpace global markets in perpetuity? Simply put, relying too heavily on domestic companies for equity returns can skew the risk profile of a portfolio. Different countries and regions tend to pass through cyclical peaks and valleys at different times. Allocating more broadly lets investors take advantage of unsynchronized economic cycles and the subsequent dispersion of returns. Over time, this may result in a portfolio with greater diversity and, potentially, more stable risk-adjusted returns. The ability to lower correlations could be especially helpful in times during difficult markets, though it’s important to remember that in periods when fear and volatility spike, the performance of assets across regions may be closely correlated over the short term.

Neglecting global stocks also comes at a price in terms of opportunity cost. Consider that there are 23 developed nations and 24 emerging markets in the MSCI AC World Index—one popular benchmark for global managers. We see appealing opportunities to capture growth outside the U.S. that investors should not disregard. Take a look at this map. Although the U.S. has its share of international behemoths, there are industry leaders domiciled outside the U.S. across wide swaths of the economy, including: household durables, automakers, mining, insurance, and others. We believe that many of these industry leaders, and even more smaller niche companies, deserve consideration in a core equities allocation.


Another point to remember is that the U.S. is on a trajectory of becoming less dominant as a key driver for the global economy. As a percentage of market capitalization, the U.S. is barely 40% now, but back in 1970, the U.S. accounted for 66% of the world's market cap, according to World Bank statistics. A similar trend is evident when looking at a percentage of global GDP.  Ultimately, we believe that there are exciting opportunities across a very large opportunity set that should not be ignored by investors. The long-term trends, the depth and breadth of investable ideas, and the potential diversification benefits exemplify why we believe global equities can strengthen a core portfolio.