Is International Exposure Still Useful?

Investment fads come in all shapes and sizes, but you know you are dealing with one when you hear investors saying things like, “Why do we own anything other than (fill in the blank)?”

When that fad is a single stock, or even a small group of stocks, it is easy to point back to the concept of diversification and explain why overconcentration is a bad idea.  Same when that investment is Bitcoin or gold.

But what happens when that investment fad is something as broad and fundamental to our portfolios as the S&P 500?

The S&P 500 has been one of the best performing asset classes in the world for a very long time. Since 2009, with dividends reinvested, the S&P 500 (using a ticker of SPY as a proxy) is up more than 750% while a large cap international index fund (using ticker EFA as a proxy) is up only 270%. That’s annual returns of more than 14% per year in the U.S. versus less than 6.9% per year in the rest of the world. 

So why does anyone need to own anything besides the S&P 500? Because things change and it hasn’t always been this way.  Ben Carlson’s post, Diversification is About Decades, illustrates that well. 

Right now, the US equity markets have one of the highest forward PE ratios in the world and we are trading above our 10-year average.  That doesn’t mean we are due for a correction.  The valuation may be entirely justified.  However, international’s long-term underperformance has made some of the foreign stock markets look less expensive by comparison.   In the words of Nick Murray, “You don’t liquidate sound, out of-favor (and thus potentially undervalued) investments to chase hugely popular sectors that have already had an epic run.”

True diversification inside a portfolio always means we will be apologizing for something.  When US markets are up, we will regret owning international.  When large cap is up, we will regret owning small cap.  When growth is up, we will regret owning value.  But owning things that mute volatility in both directions is what risk management, and successful long-term investing, is all about.