There often seems to be a headline event deterring investors from investing abroad. It’s true that macroeconomic events can drive markets—and have a habit of being extremely difficult to predict in terms of timing, intensity, and duration. But what if macro events aren’t a deterrent, but rather an argument in favor of maintaining a strategic allocation to international equities?
Performance during the last decade has favored domestic equities so drastically that many investors have found it hard to justify a continued allocation to international equities (FIGURE 1). It simply hasn’t felt like the “right” time to invest abroad. But what if we rewind the clock and look at the performance of those same indices a decade earlier (FIGURE 2)?
US Equities Have Outperformed International Equities for the Last Decade
Growth of $10,000 (2011-2021)
Past performance does not guarantee future results. As of 12/31/21. US Equities represented by the Russell 1000 Index. Developed-International Equities represented by the MSCI World ex USA Index. All International Equities represented by the MSCI ACWI ex USA Index (includes both developed-international and emerging-markets equities). Emerging-Markets Equities represented by the MSCI Emerging Market Index. See below for index definitions. For illustrative purposes only. Source: Morningstar, 5/22.
International Equities Significantly Outperformed US Equities in the Prior Decade
Growth of $10,000 (2001-2011)
Past performance does not guarantee future results. As of 12/31/21. For illustrative purposes only. Source: Morningstar, 5/22.
Which macro events were headwinds for US equities from 2001-2011? At the beginning of the period, the tech bubble was deflating in the US, in addition to rampant fraud at firms such as Worldcom, Enron, and Arthur Andersen. Not only that, but this period also includes the Global Financial Crisis (GFC). International equities generated more than double the return of US equities and outperformed in seven calendar years during the decade ended 12/31/11.
Timing the market is always impossible and there will always be negative events. So rather than trying to time entry and exit points tactically, maintaining an allocation to non-US equities could help investors take advantage of inflection points the moment they happen.
Big differences in the composition of global equity markets also play a role in their performance gap.
What’s Under the Surface Matters
Beyond the fact that unpredictability makes tactical moves extremely difficult, there are also big differences in the composition of global equity markets. The last decade was all about big tech: it accounted for more than a third of US equities’ outperformance between 2011 and 2021 (FIGURE 3); international equities had low tech exposure (FIGURE 4).
Especially today, as we face the highest inflation in many investors’ lifetimes, international indices tend to hold much more exposure to cyclical sectors (MSCI ACWI ex USA exposure: 59% vs. Russell 1000 Index: 40% as of 12/31/21)1 that may be better suited to outpace inflation. The current inflationary environment could also potentially benefit areas such as materials and energy, sectors to which international equities are more exposed. And as central banks raise interest rates to rein in inflation, rising rates could also benefit financials—another sector to which international equities are more heavily exposed (FIGURE 4).
Tech Drove Domestic Outperformance for the Last Decade
Share of Russell 1000 Index Outperformance (2011-2021)
International Equities May Be Better Positioned for Rising Rates and Inflation
Difference in Sector Weights (2011-2021)
US equities represented by the Russell 1000 Index, international equities represented by the MSCI ACWI ex USA Index. For illustrative purposes only. Source: Morningstar
With a strategic allocation, rather than a tactical allocation, investors can avoid missing out on potential benefits that can come from unforeseen inflection points abroad.
Today, economic weakness and tightening regulation in China, as well as the Russia-Ukraine war, are two of the most frequently cited concerns about investing internationally. However, both macro events are also likely to cause dislocations that professional, active managers can identify and seek to capitalize on—but this can only benefit those who are invested when they happen.
With that backdrop, a prudent investor may want to consider maintaining strategic allocations across asset classes, including international equities, rather than trying to time the right tactical entry and exit points in their international equity allocation. By keeping strategic exposures, investors can avoid missing out on potential benefits that can come from unforeseen inflection points. And especially today, as the US Federal Reserve and other global central banks seek to cool off inflation by raising interest rates, maintaining international exposure can also help investors diversify into multiple inflationary and interest-rate environments.
In other words, maintaining a strategic allocation to international equities can help investors make the most of macro events, multiple inflationary environments, and a variety of interest-rate regimes. It’s one way investors can turn lemons into lemonade.
Talk to your financial professional about the amount of international investing that’s right for you.
1 Sources: Refinitiv Datastream and Schroders, 2/22.
MSCI ACWI ex USA is a broad-based, unmanaged, market-capitalization weighted, total-return index that measures the performance of both developed and emerging stock markets, excluding the US.
MSCI Emerging Markets Index is a free float-adjusted market capitalization-weighted index that is designed to measure equity market performance in the global emerging markets.
MSCI World ex USA Index is a free float-adjusted market capitalization index that captures large- and mid-cap representation across developed markets countries excluding the United States.
Russell 1000 Index measures the performance of the large-cap segment of the U.S. equity universe. It is a subset of the Russell 3000 Index and includes approximately 1000 of the largest securities based on a combination of their market cap and current index membership.
Important Risks: Investing involves risk, including the possible loss of principal. • Foreign investments may be more volatile and less liquid than US investments and are subject to the risk of currency fluctuations and adverse political, economic, and regulatory developments. These risks may be greater, and include additional risks, for investments in emerging markets or if a fund focuses in a particular geographic region or country. Diversification and asset allocation do not ensure a profit or guarantee against loss.
Diversification and asset allocation do not ensure a profit or guarantee against loss.
Neither MSCI nor any other party involved in or related to compiling, computing or creating the MSCI data makes any express or implied warranties or representations with respect to such data (or the results to be obtained by the use thereof), and all such parties hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any of such data. Without limiting any of the foregoing, in no event shall MSCI, any of its affiliates or any third party involved in or related to compiling, computing or creating the data have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of the possibility of such damages. No further distribution or dissemination of the MSCI data is permitted without MSCI’s express written consent.
The views expressed here are those of the author. They should not be construed as investment advice. They are based on available information and are subject to change without notice. Portfolio positioning is at the discretion of the individual portfolio management teams; individual portfolio management teams, and different fund sub-advisers, may hold different views and may make different investment decisions for different clients or portfolios. This material and/or its contents are current as of the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of Hartford Funds.
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