By DAVID MOON, Moon Capital Management
If you’ve ever had anyone evaluate an appropriate asset allocation for you,
chances are they recommended putting a portion of your assets into foreign
funds. It is common for advisors to suggest investing anywhere from five
to twenty percent of your assets into international equity investments.
Given that the average international fund increased 34 percent last year
(compared to a 28.7 percent increase for the S&P 500,) this suggested
diversification seems to make sense.
Seeming to make sense is not the same thing as making sense.
Investing in international equity funds increases the number of things that
can go wrong, provides diminished diversification benefit and is mostly a bet
against the US dollar.
Years ago, researchers noted that the returns of non-US stock markets showed
little correlation with stocks in the U.S. As a result, these researchers
concluded that adding some international investments to a portfolio would lower
the overall volatility of an otherwise purely domestic stock portfolio. If
you could reduce volatility without decreasing your overall long-term return,
this would be a good thing. Consultants, advisors and other assorted
experts immediately latched onto this notion, impressing their institutional
clients with their multinational recommendations.
This discovery became popular with individual investors about the same time
instantaneous worldwide information flow increased the likelihood that most
world stock markets move somewhat in tandem. In other words, the
non-correlation diversification benefit began to disappear. Stocks around
the world tend to move in the same direction – especially compared to 40 years
If the world’s stock markets move in relative concert, a broad investment in
foreign stocks, denominated in foreign currency, is little more than an
expensive method of betting on a decline in the value of the US dollar.
Although the average international fund increased 34 percent in 2003, the
value of the dollar declined 21 percent against the euro. If a European
stock fund increased 34 percent last year, almost two-thirds of the return was
simply the result of a decline in the value of the dollar. The return had
little to do with emerging markets or geographic diversification. The
international stock exposure provided only 13 percentage points of the return –
significantly less than the return of the S&P 500.
There are legitimate reasons to invest in foreign companies. Most of
those reasons are specific to the individual companies. Yet too many
people consider “international investing” as a sort of broad panacea for risk
It’s hard to argue with an advisor who has all sorts of graphs and pictures
to convince you to diversify into other stock markets. It sounds
sophisticated, if not downright safe, to “reallocate some of your stock holdings
to non-correlated, non domestic equity markets.”
How differently might you react if asked to “short the US
David Moon is president of Moon Capital Management, a
Knoxville-based investment management firm. This article
originally appeared in the News Sentinel (Knoxville, TN).