Montag & Caldwell Strategies Commentaries Private Client Group People About Contact Us M&C Celebrates A 75 Year History Search for: Indirect exposure approach to international investing Posted by Montag Why an indirect exposure approach to international investing may offer the best portfolio benefits By Montag & Caldwell June 5, 2020 When it comes to investing, many asset allocation models include exposure to an international asset class for increased diversification through what many believe to be an uncorrelated market exposure. Allocations may range anywhere from 5% to 20%, depending on risk tolerance. While this may have been more relevant in the past, in today’s globally connected market, the idiosyncratic risks associated with this asset class may overwhelm any potential portfolio benefit. Today, the correlation argument for adding international is less relevant because of the exposure that may already exist in a domestic equity allocation. Ultimately, international allocations may only result in increased complexity and expense. Consider the S&P 500, a market capitalization weighted index of the 500 largest U.S. publicly traded companies. As of March 31, 2020, investment research firm MSCI estimates of the large cap S&P 500’s economic exposure, which is the geographic distribution of revenues, is 62.4% for North America. Revenues from the rest of the world (ROW) account for 37.6%. Breaking down the S&P 500 revenues from the ROW: Emerging markets represent 19.3%. Europe represents 12.3%. Pacific Rim represents 4.4%. Frontier markets represent 1.6%. As this analysis demonstrates, investors should consider that they likely already have exposure to international markets, particularly from their existing large cap investment. While this exposure isn’t direct, the indirect exposure from a large cap allocation comes without taking many of the risks associated with investing directly in this market. Consider risks such as: Currency volatility. Investing directly means that you have to exchange your domestic currency into a foreign currency at the current exchange rate in order to purchase the foreign stock. When selling, investors need to convert the foreign currency back to the U.S. dollar at the current exchange rate; this creates return uncertainties given the fluctuation of future exchange rates. Liquidity risks (not being able to sell a stock quickly at a fair price). This is particularly true with emerging markets exposure. Political risks. Investments may be domiciled in countries that have unstable, immature or volatile political systems. Economic risks. Investments may be domiciled in countries that have either high inflation or deflation, unregulated markets and unsophisticated monetary policies. Higher fees. Becoming knowledgeable about foreign markets involves spending more time and resources on research. This may include hiring more analysts that are familiar with the market, accounting standards, and governance, all of which may increase the investment management fee. Typically, there are fewer concerns with the lack of transparency, governance, or accounting issues with large cap U.S. companies as they follow U.S. laws and adhere to the standards common to businesses operating in the United States. Some investors will argue that the indirect approach ignores the correlation benefits. However, this argument can be challenged empirically. Correlation is the extent to which two or more variables fluctuate together: a positive correlation indicates the extent that they increase or decrease in parallel; a negative correlation indicates the extent to which one variable increases as the other decreases. According to a national consulting firm’s performance evaluation software, correlations between the S&P 500 and the MSCI EAFE Index (a stock market index that approximates the equity performance of developed markets outside of the U.S. and Canada) over the past five years is .9422 (1 is a perfect correlation, meaning that they move in perfect parallel). Over the past ten years, it is .8889 and the past 20 years it is .8887. As evidenced with these correlations, the integration and correlation of the global economy has grown stronger over time, which diminishes the need for discrete allocations to international stocks. For the average investor, international can be a frustrating asset class because you need to pick the right stock, in the right country, and at the right time. In addition to the challenge of market timing, the indirect exposure approach may offer a “best of both worlds” solution as investors profit from the economic growth overseas and at the same time benefit from owning an American corporation. Montag & Caldwell is committed to producing superior investment results for our clients. Learn more. Montag & Caldwell, LLC was founded in Atlanta, Georgia in 1945 and has served both private clients and institutional investors for 75 years. While primarily known for managing equity securities, our firm’s experience also includes fixed income and asset allocation strategies – with an emphasis on managing risk. Post navigation ← Why mid cap stocks might be a better option Why investors should consider a bias towards high-quality investments in a volatile market Connect with Us Principal Spotlight Quarterly Commentaries 2Q21 Market Commentary 1Q21 Market Commentary 4Q20 Market Commentary 3Q20 Market Commentary 2Q20 Market Commentary Articles & Commentaries De-Risk Your Portfolio with Active Management M&C Celebrates 75 Years Montag & Caldwell’s Approach to Asset Allocation A High Quality Approach To Portfolio Management Fixed Income is All You Need for Diversification Achieve a true diversification benefit in your investment portfolio Indirect exposure approach to international investing What to consider before including alternative asset classes Why mid cap stocks might be a better option Why investors should consider a bias towards high-quality investments in a volatile market Strategies Commentaries Private Client Group People About Contact Us M&C Celebrates A 75 Year History Search for: Phone (404) 836-7100marketingwebcontact@montag.com 3455 Peachtree Road, NESuite 1500Atlanta, Georgia 30326-4202