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A Reboot for International Equities

September 2017

Much like popular film franchises often are restarted to renewed popularity, interest in international investing may be poised to be rekindled.


Every couple of years, a popular movie series fans once loved gets a fresh start. Hollywood producers take what was a tired or defunct film franchise and wipe the slate clean. We get a new take on a familiar concept. It’s called a reboot.

Well, it looks like equity investors may be in for a reboot of their own—except this one isn’t going to be playing down at the local multiplex. This time, it’s international equities that may be primed to get a fresh start.

 

The Big Draw

Moviegoers over the past 10 years more often than not went to see an action adventure film featuring comic book heroes, giant robots, or someone driving a fast car. For the last decade, the big draws in equity investing also have been fairly consistent: US equities (Figure 1).

US equities filled the top three spots of global equity returns over that time span. In fact, US equities in the past three decades delivered returns (7.9%) that exceeded the longer-term average (5.7%) going back to 1965.1 Which begs the question: Do the strong returns of the past make it less likely that investors will enjoy such returns going forward? The future could be more challenging.

 

Figure 1

US Equities Have Outperformed Over the Past Decade

Calendar Year Returns (%) (2007-2016)

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The performance shown above is index performance and is not representative of any Hartford fund’s performance. Indices are unmanaged and not available for direct investment. Performance data quoted represents past performance and does not guarantee future results. For illustrative purposes only. Source: Morningstar, 6/17. Regions/sectors are represented by the following indices: US Large Cap (S&P 500), US Mid Cap (Russell Mid Cap), US Small Cap (Russell 2000), Europe (MSCI Europe), Japan (MSCI Japan), Pacific ex Japan (MSCI Pacific ex Japan), Emerging Markets (MSCI Emerging Markets), International Equities (MSCI ACWI ex USA), Global Equities (MSCI World). Please see below for representative index definitions.

 

What’s Old Is New Again

Over the years, we’ve all seen how trends in movie genres come and go and then come back around again. Westerns were once all the rage. Then they weren’t. But eventually a new crop of films made people reconsider the genre. The same has also been true for investing.

Looking back at 5-year rolling returns since the mid-70s, notice how cyclical the equity market can be, too (Figure 2). There are periods of US outperformance, followed up by one of international outperformance, and then back again to US dominance. On average, each cycle has run 7.2 years. As of June 30, we’re 6.3 years into the current run of US outperformance, which suggests the cycle may be getting ready to turn.2

 

Figure 2

US and International Markets Have Moved in Cycles of 7-Plus Years

US Equity vs. International Equity 5-Year Rolling Returns (1/1/1970-6/30/2017) 

 

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Source: Morningstar; Calculations: Hartford Funds, 6/17. Performance data quoted represents past performance and does not guarantee future results. The performance shown above is index performance and is not representative of any Hartford fund’s performance. Indices are unmanaged and not available for direct investment. The chart shows the values of the S&P 500 index’s returns minus the MSCI World ex USA Index. When the line is above 0., domestic stocks outperformed international stocks. When the line is below 0, international stocks outperformed domestic stocks. US equity is represented by S&P 500 Index; International equity is represented by the MSCI World ex USA Index. Please see below for representative index definitions. For illustrative purposes only.

 

A Growing Market Overseas

Just like film studio distribution now puts extra emphasis on a film’s overseas take, international markets may be crucial for investors looking for returns to supplement domestically driven ones. Most projected growth is not expected to be found in the US in the future—it’s actually anticipated to be outside of it.3

With buoyant financial markets and a long-awaited cyclical recovery in manufacturing and trade underway, world growth is projected to rise—especially for developing, or emerging market (EM), economies (FIGURE 3). Like box office receipts for a major motion picture release, equity returns for international markets have begun to show they may be as important as domestic numbers, as well. As of June 30, international equities, as measured by the MSCI All Country World ex USA Index (14.5%), have outperformed the domestic equities, as measured by the S&P 500 Index (9.3%), in 2017 by over 5%.4

 

Figure 3

Growth Has Gained Momentum Outside the US

Real Gross Domestic Product (GDP)5 Growth, Annual Percentage Change, 2017

 

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Source: IMF, World Economic Outlook, 4/17. For illustrative purposes only.

 

An Open Call

Movie producers aim to discover and groom a young actor or actress before he or she becomes a big star. The same goes for investors looking to buy equities. (FIGURE 4). After taking their valuations into consideration, EM and developed markets (DM) appear to be inexpensive when compared with their US equivalents. Add in their dividend growth and dividend yield, and it may potentially be worth taking another look at these regions.

 

Figure 4

Global Equities Characteristics(12/31/2016)

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Source: MSCI Research, 2016. Decomposition of MSCI ACWI Index total return analysis, Dec 1994 - Sept 2015. Percentages may not total 100 due to rounding.

 

Tomorrow’s Marquee Names?

Paying too much to hire a big name star, who ultimately fails to put people in seats, is a regular occurrence in Hollywood. Sometimes the less-hyped talent end up surprising everyone. Likewise, the developed markets with higher country returns may not be what many would expect (FIGURE 5). 

While returns have generally been strong across the board, many other countries fared as well or better than the US. Surprisingly, other countries typically associated with being some of the world’s economic generators also returned less. They had forward P/E ratios9 higher than less expensive countries that provided better returns over the past year. That means those big name markets are predicted to cost investors more, but may offer less in returns. 

 

Figure 5

International Markets Have Offered Attractive Valuations

1-Year Performance and Forward P/E Ratios 

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As of 6/30/17. Performance data quoted represents past performance and does not guarantee future results. Returns and P/E based on the individual region/country returns of the MSCI ACWI Index. Please see below for representative index definitions. Countries listed by market-cap size. A simple average was used to calculate the return and P/E for countries in the “Other” category. Source: FactSet, 7/17. Country portfolios are capitalization-weighted with free-float market cap. The portfolios are theoretical and assume no fees, trading costs, or any short selling restrictions. Actual results may differ significantly. Performance is based on annual “total returns,” which includes reinvested dividends but not interest, capital gains, taxes, or transaction costs. MSCI EM Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance in the global emerging markets, consisting of 24 emerging market country indices. MSCI performance is shown net of dividend withholding tax. Data source: Compustat. Calculations by Hartford Funds. For illustrative purposes only. Results are subject to change. Source: MSCI. Index is unmanaged and not available for direct investment. Past performance is no guarantee of future results.

 

Searching for the Next Big Thing

A talent agent’s goal is to scout out that next superstar actor, screen writer, or director before they hit it big. That’s true for active managers, too. Active managers have historically outperformed passive funds in EM equities (FIGURE 6). Why? Active managers benefited from the broader, more diverse EM investment universe with less analyst coverage. They have the potential to spot what others haven’t seen yet.

 

Figure 6

Active Emerging Markets Funds Have Added Value in the Post-Crisis Recovery

Rolling 3-Year Performance Relative to the MSCI Emerging Markets Index (2009-2016) 

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Source: Morningstar, 3/17. Performance data quoted represents past performance and does not guarantee future results. Fund information based on the Morningstar Diversified EM Equity Category. The Average Active is the average of all the active funds (non- “Index Funds” and non- “Enhanced Index Funds”) in the Morningstar Diversified EM Equity Category. The Average Passive is the average of all the Index Funds in the Morningstar Diversified EM Equity Category. For illustrative purposes only.

 

A Ticket to International Investing

While US stocks still continue to grind higher, it may be time to consider looking abroad to diversify equity exposure. How can an investor be more than a passive viewer in this reboot? Hartford Funds may not offer popcorn and candy, but it does feature the following equity funds that focus on global and international equities.

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* For a full list of Hartford Funds, please visit hartfordfunds.com 

Performance data quoted represents past performance and does not guarantee future results. Other share classes may have different ratings. The Morningstar RatingTM for funds, or “star rating”, is calculated for funds and separate accounts with at least a 3-year history. Exchange-traded funds and open-ended mutual funds are considered a single population for comparative purposes. Star rating based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a managed product’s monthly excess performance (without adjusting for any sales load, if applicable), placing more emphasis on downward variations and rewarding consistent performance. 5 stars are assigned to the top 10%, 4 stars to the next 22.5%, 3 stars to the next 35%, 2 stars to the next 22.5%, and 1 star to the bottom 10%. Overall Morningstar Rating is derived from a weighted average of the performance figures associated with its 3-, 5-, and 10-year (if applicable) Morningstar Rating metrics. For more information about the Morningstar Fund Ratings, including their methodology, please go to global.morningstar.com/managerdisclosures. © 2017 Morningstar, Inc. All rights reserved. The information contained herein: (1) is proprietary to Morningstar and/ or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information.

 


1 Source: “Diminishing Returns: Why Investors May Need to Lower Their Expectations”, McKinsey & Co., 5/16. The performance shown above is index performance and is not representative of any Hartford fund’s performance. Indices are unmanaged and not available for direct investment. For illustrative purposes only.

2 Source: Morningstar; Calculations: Hartford Funds, 6/17

3 Projections are subject to change due to changing market and economic conditions.

4 Source: Morningstar, 6/17. Performance data quoted represents past performance and does not guarantee future results. The performance shown above is index performance and is not representative of any Hartford fund’s performance. Indices are unmanaged and not available for direct investment.

5 Gross Domestic Product (GDP) is the monetary value of all the finished goods and services produced within a country’s borders in a specific time period.

6 Price/Earnings (P/E) is the ratio of a stock’s price to its earnings per share.

7 Dividend growth is is the annualized percentage rate of growth that a particular stock’s dividend undergoes over a period of time.

8 Dividend yield is a financial ratio that indicates how much a company pays out in dividends each year relative to its share price.

9 Forward Price/Earnings (P/E) is is a measure of the price-to-earnings (P/E) ratio using forecasted earnings for the P/E calculation. 

S&P 500 Index is a market capitalization-weighted price index composed of 500 widely held common stocks.

Russell Mid Cap Index measures the performance of the mid-cap segment of the U.S. equity universe. The Russell Midcap is a subset of the Russell 1000® Index. It includes approximately 800 of the smallest securities based on a combination of their market cap and current index membership. The Russell Midcap represents approximately 31% of the total market capitalization of the Russell 1000 companies.

Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 is a subset of the Russell 3000® Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership.

MSCI Europe Index captures large- and mid-cap representation across 15 developed markets countries in Europe.

MSCI Japan Index is a free-float adjusted market-capitalization index designed to measure large- and mid-cap Japanese equity market performance. 

MSCI Pacific ex Japan Index captures large- and mid-cap representation across 4 of 5 developed markets countries in the Pacific region (excluding Japan). 

MSCI Emerging Markets Index captures large- and mid-cap representation across 24 emerging market countries. 

MSCI All Country World ex USA Index captures large- and mid-cap representation across 22 of 23 developed markets (excluding the US) and 24 emerging markets countries. 

MSCI World Index captures large- and mid-cap representation across 23 developed markets countries.

MSCI World ex USA Index captures large and mid cap representation across 22 of 23 developed market  countries—excluding the United States.MSCI All Country World Index captures large- and mid-cap representation across 23 developed markets and 24 emerging markets countries.

 

 

All investments are subject to risks, including the possible loss of principal. Foreign investments can be riskier and more volatile than U.S. investments due to the adverse effects of currency exchange rates, differences in market structure and liquidity, as well as political and economic developments in foreign countries and regions (e.g., “Brexit”). These risks are generally greater for investments in emerging markets. Small- and mid-cap securities can have greater risk and volatility than large-cap securities. Diversification does not ensure a profit or protect against a loss in a declining market. Risks of focusing investments on the utilities and industrials sectors include regulatory and legal developments, competitive pressures, pricing and rate pressures (utilities), rapid technological changes, potential product obsolescence, and liquidity risk. Risks of focusing on investments that involve sustainability and environmentally responsible investment criteria may influence investment performance relative to the Hartford Global Impact Fund’s and Hartford Environmental Opportunities Fund’s benchmark or competing funds and expose the Funds to increased risks related to downturns or other adverse developments in that market segment.

Investing in companies that seek to address major social and environmental challenges may cause the Hartford Global Impact Fund to forego certain investment opportunities and underperform Funds that do not have a similar focus. By investing in cash and money market investments, the Hartford Global Impact Fund may lose the benefit of market upswings. Because it invests in a master portfolio, the Hartford Global Impact Fund is also subject to the risks related to a master-feeder structure.

This information should not be considered investment advice or a recommendation to buy/sell any security. In addition, it does not take into account the specific investment objectives, tax and financial condition of any specific person. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. This material and/or its contents are current at the time of writing and are subject to change without notice. This material may not be copied, photocopied or duplicated in any form or distributed in whole or in part, for any purpose, without the express written consent of Hartford Funds.

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