About the author: Alexander Torrens is the head of Walter Scott North America, a global equity portfolio manager and an investment firm of BNY Mellon Investment Management.
With the clock ticking down on 2023, U.S. equities look set to further extend the decade-long period of dominance they have enjoyed over their international peers. Mix in considerable geopolitical uncertainty in various parts of the globe and U.S. investors could be forgiven for leaving their passports at home and sticking exclusively with their home market. I think this could be a missed opportunity.
The case for investing globally is often framed in terms of “why now?” Proponents point to shifting macro conditions or other cyclical reasons to look beyond U.S. shores at a given point in time. Today, the argument might focus on the likely persistence of many of the drivers of U.S. outperformance over the past decade, whether valuation expansion, the epic run of the “magnificent seven” group of tech stocks, or the strength of the dollar. Advocates of mean reversion, meanwhile, tell us that the stark outperformance of U.S. equities is unlikely to last.
But while these are all legitimate, interesting, and important questions to ask, relative calls between markets are notoriously difficult to get right on a consistent basis, let alone time well consistently too. In our view, investors should consider exposure to both the U.S. and international equity markets at all times for two separate, but closely connected, reasons.
The first of these, diversification, is well-understood. Or at least it should be. In the 70 years since Harry Markowitz introduced the world to modern portfolio theory, diversification has with good reason become a bedrock of investor thinking. Done correctly, diversification can potentially allow investors to increase the expected return of a portfolio for the same level of risk.
Of course, when Markowitz labelled diversification “the only free lunch in finance,” he was speaking to the risk/return benefits that accrue from buying uncorrelated assets. Today, the correlation between the U.S. and other developed equity markets is relatively high, so the benefits of diversification are certainly not what they were prior to our globalized era. Only when investors venture into emerging and more esoteric geographies do we see a more material benefit emerge. That said, there is a residual diversification benefit to investing globally that allocators should want to harness: The serving might not be as big, but you’re still getting your sides for free.
The second and most compelling argument for investing globally is the freedom to pursue the very best investment opportunities regardless of where they happen to be listed. Put bluntly, why would you not want access to the broadest possible opportunity set? To be solely exposed to the U.S. is to leave some outstanding opportunities on the table. No country has a monopoly on corporate excellence.
Many of the most interesting companies identified by our fundamental company analysis don’t have U.S. peers, or if they do, they are a rather pale imitation. Just as there are no international equivalents of the Silicon Valley behemoths, there are no U.S. analogues of the storied French and Italian luxury houses. Asian savings and protection? Industrial automation? Fashion and beauty? All long-term opportunities with market-leading exponents domiciled outside the U.S.
Nor are these businesses narrow plays on domestic economies. Overwhelmingly, they are global multinationals deriving a significant proportion of their sales and earnings from countries other than where they are listed. You’re unlikely to be investing in a Japanese automation business for exposure to the Japanese economy or a Danish pharmaceutical firm solely for the domestic healthcare opportunities.
It goes without saying that this bottom-up approach to global equity investing demands rigorous analysis of all stock-specific opportunities and risks. This includes paying due consideration to the impact of geopolitics, an issue very much front of mind for U.S. skeptics of global investing.
At a portfolio level, rather than look at events such as Ukraine or the Middle East through the prism of geography or sector, we think it more relevant to consider risk exposure by the potential for value impairment across stocks, and then aggregate this up. To think of China-Taiwan risk, for example, only as an Asian phenomenon is to overlook the severe ramifications for those U.S. tech companies entirely dependent on Taiwanese chip manufacturers. Better to understand how risk is expressed across real-world businesses, then stocks, then the portfolio. Globalization may be in retreat, but the world is still incredibly interconnected.
The myriad links and chains in the global economy are an inconvenient truth for those who question the wisdom of straying from U.S. shores in an uncertain and volatile world. Ultimately, no amount of U.S. exposure can offer immunity from geopolitical risk. What it can guarantee you, however, is a sizable chunk of country-specific risk, whether you’re 100% invested, overweight or even just at “market” weight. Risk, just like opportunity, can be found anywhere.
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