Why You May Not Want to Overlook International Investments

We speak with Founder of Strategic Wealth Capital Adrianne Yamaki, about why investors may want to consider diversifying their portfolios by owning companies outside of the U.S., and why now may be a good time to start. Yamaki also talks about why U.S. investors tend to overlook international opportunities.

Tell us why investing internationally, in addition to owning U.S.-based companies, is so important. 

It is understandable after a year like 2022 to think that diversification doesn’t work. Broad indexes were down across the board: the S&P declined 18.11%, the MSCI EAFE (composed of equities of developed foreign companies) was down 14% and emerging markets dropped 19.7%. Even investment grade bonds lost 15% of value.

But if we peel back the layers and look closer, we’ll observe that there is more nuance and variability. For example, not all developed country indexes lost as much as the U.S., and in fact, a number increased in value, such as Brazil and Chile. In fact, 70% of international country indexes outperformed the U.S. in 2022. And even in as short a timeframe as a year, we see that portfolios can benefit from this variance in returns to lower portfolio volatility. And over longer periods, this dynamic is even more pronounced.

In short, investing outside the U.S. allows us to capture equity returns from thousands of companies around the globe which offset weak performance in one market with stronger returns elsewhere.

Why do U.S. investors tend to overlook international investments? 

As humans we are influenced by cognitive biases, which among other things distort our perception of risk. Companies whose products we use regularly or where we work or hear about on the local news are more familiar to us. This can lead to a “home-country” bias whereby U.S. investors perceive the stocks of these companies as ‘safer’ and more likely to hold their value.

Another predisposition we suffer from is recency bias. In the last decade, U.S. large-cap stocks outperformed both international developed and emerging markets. Investors who did stick with a diversified portfolio saw their foreign investments lag, which led some to believe that such underperformance was likely to continue.

Lastly, I’ve had numerous conversations with investors who rightly point out that many foreign economies suffer from lackluster growth. But what they overlook is that we are investing in companies, not in countries. As an example, for demographic and monetary policy reasons, Japan’s GDP growth has averaged less than 2% since 1981. Yet Japan headquarters Toyota, which sold more cars last year than any other auto manufacturer globally and has revenues of $280 billion. Investors focusing primarily on U.S. companies are forgoing growth generated from companies like Toyota, which happen to be domiciled abroad. Public companies can and do move differently from the economies of countries where they are based.

Why is now a compelling time for international equities? 

One reason I believe the next decade will favor international equities is due to favorable valuations. S&P stocks are trading at 18x earnings, whereas international stocks are trading closer to 12x. So for the same dollar of earnings, you are paying a premium for a company which happens to be based domestically. This means you are dependent on higher future earnings for those companies to compensate for that cost.

Another reason geographic diversification now particularly makes sense is because the S&P 500 is dominated by technology and consumer discretionary sectors, which means that investors limited to such domestic investments are inadvertently overweighting these areas. In addition, other world regions specialize and excel in different sectors and industries than the U.S..

Three of the most profitable cosmetic and luxury goods companies – L’Oreal, LVMH and Richemont – are based in Europe. Two of the largest oil & gas firms are based in China, and Japan is home to several of the top auto manufacturers. So even simply diversifying properly amongst sectors and industries requires global consideration.

In sum, tempering our natural biases and incorporating investments in international companies with favorable valuations and earnings will not only lower portfolio volatility, but also increase the likelihood that we will benefit from the growth of these firms, despite (or perhaps even by virtue of) where they are domiciled.

This interview originally appeared in our TradeTalks newsletter. Sign up here to access exclusive market analysis by a new industry expert each week. We also spotlight must-see TradeTalks videos from the past week.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.