“Why invest in international funds? It’s a mystery.” At the time of writing this post there was one individual who commented that this was the “dumbest article I have ever read.” This commenter may have a valid point.
For one thing, the asset flow data presented in the article is misleading—it ignores ETF flows. More money did flow into international investments last year ($109 billion into U.S., $150 into international), but nowhere near what is portrayed in the article ($35 billion into U.S., $228 billion into international) when considering ETF flows.1
Then the author lists two “factors” that are necessary for an international holding to beat a U.S. holding. First, “you need international markets to fare better than the U.S.,” which is incorrect because international markets can fare worse than U.S. and still outperform if currency movement makes up the difference as was the case in 1975.2 Second, “you need the dollar to fall against foreign currencies.” This is also incorrect. If the local market return is strong enough to offset currency movements, international can outperform U.S. as was the case in 2006. 3
The article is a classic example of time-period bias. Yes, U.S. has outperformed international recently; however, there is nothing to suggest that the outperformance will continue. We could see a reversal of fortune and the U.S. could underperform over the next 5 or 10 years.
I think of articles like this as X-Rated investment pornography that has little value to clients.
We have put out a lot of pieces lately that touch on the topic of diversification, and specifically international diversification. Here are a few you can use if the topic comes up during discussions with your clients:
- Q4 QIR touches a lot on the currency movements and impact on international investments
- February Portfolio Perspectives touches on the importance of diversification
- Asset Class Investing FYI: Why Invest in International stocks highlights the importance of international diversification
International markets involve additional risks, including, but not limited to, currency fluctuation, political instability, foreign taxes, and different methods of accounting and financial reporting. As a result, they may not be suitable investment options for everyone.
1Source: Morningstar Direct February 2015
2 In 1975, the MSCI EAFE return was 35.39 % in local currency, underperforming the S&P 500 return of 37.21%. After exchange rate effect, MSCI EAFE returned 44.07%, outperforming the S&P 500 Index.
3 In 2006, MSCI EAFE return was 26.34% in local currency and 16.46% in U.S. dollars. The MSCI EAFE outperformed the S&P 500 Index despite the currency effect.