The Christmas season is a time of relaxation (or trying to) and celebration. Most people use it as a time to wrap things up for the year and to spend time with friends and family. I used this Christmas season to look back and see if the international exposure in my clients’ portfolios was still academically sound…for me, that IS relaxing. When you have 6 kids under the age of 14 like we do, you find relaxation in weird places.
If you’ve been with me as a client for any amount of time you already know that I don’t believe in “gut hunches” or market timing when it comes to investing. All I know is data. I want to know what is academically provable. Once I know that, then I deliver that to my clients and add in a healthy dose of behavior (stay the course, don’t market time, no speculation, etc.)
However, for me to help clients behave prudently with their finances, I need to be certain that we are following the data and what history ha proven. If I can be certain that we are allocated in a manner consistent with what academia teaches us about security prices, then it makes my job easier to help teach my clients that data.
In the past 5-8 years or so I have seen many portfolios in my office that were almost 100% in the S&P 500 index. While I can’t say for sure, I at least believe in my heart that these people, their advisors, or the fund companies they were using were chasing the “hot hand”. It’s no secret that large US companies have had a great run relative to some other indices. But chasing the hot hand isn’t something that can be repeated with any level of certainty. If you are chasing returns, you need to be right twice every time (when do I get in and when do I get out). If I let my clients do this they would, at the very least, miss out on asymmetric returns in other asset classes over short periods of time. So, we don’t do that. Instead, we allocate client equity portfolios across at least 17 different markets around the globe and domestically.
That phrase, “around the globe” is what I focused on in my “down time” during Christmas. In a 95% equity portfolio, my clients will be almost evenly split between equities in the U.S. and equities internationally. We allocate to large, large value, small, small value, and emerging markets both large and small outside the U.S. In a conversation with another advisor around that weighting, he said “wow, that’s a lot of international”. He then proceeded to tell me how foolish this was. My immediate thought was, “is he right”??? As your advisor, one of my jobs is to constantly be learning, constantly be worrying for you so you don’t have to. Thus began my Christmas break excursion into reems of data to see if he was right.
I should start with this: I asked the other advisor why he said what he said. I was looking for data, of course. I thought maybe he had researched something I hadn’t. That wasn’t the case. He just said I was too heavy in international. When I pressed a little more, he also thought I was too heavy in small cap and value stocks as well. In other words…he thought we should put the vast majority of clients’ money into large cap U.S. stocks. At first, I just wrote it off as another case of “chasing the hot hand”. But then I thought it through a little and was curious enough to look deeper into the returns.
I began looking at every asset category over 10- and 20-yeartime frames. I was comparing them to the S&P as well as other indices. For simplicity’s sake in this article, I decided to focus on 2 main asset categories for this article: U.S Large Cap Value (USLCV) and International Large Cap Value (ILCV). The source is:
• Fama/French US Large Value Research Index (1926-Present) - The index portfolios include all NYSE, AMEX, and NASDAQ stocks for which Fama/French have market equity, and (positive) book-to-market equity data.
• Fama/French International Value Index (1975-Present) - Includes all firms with Book to Market Value data in EAFE and within the top 30% highest book-to-market value.
A very important note PLEASE READ:
Every time I write an article about return, I get this: “yeah but what if I am not invested over that long of a time frame” and the answer is always and will always be this: the shorter the periodyou are invested (if retirement is looming, for example) then the less exposure to equities you will have. The point of this article is to comment on the allocation of whatever equities you hold with me. For some of you only 20% of your portfolio is in equities and for some of you that number is 95%. Whatever percentage you have, we are allocating the equity portion equally between domestic and international.
Now for the findings: I am just distilling a month’s worth of reading and calculating into a few data points to show generally what is true over time. In this case I looked at several 20 year rolling time periods. For today we will look at only the two indices mentioned above.
Here are three 20-year periods I looked at:
1994-2013
1975-2004
2001-2020
For comparison I am investing $100,000 lump sum into each category and not accounting for taxes or fees. In all three-timeframes, ILCV beats USLCV. The largest difference was by $800,000 in the period 1975-2004. In the most recent (2001-2020) USLCV produced $290,000 vs. $367,000 in ILCV. And this is during a time when the U.S. equity market was on fire.
To be fair, the international portfolio does come with an increased risk (standard deviation). But that is why we allocate the way we do. We are looking to capture market returns (risk premiums) and offset that risk with non-correlated asset classes both in the equity and fixed income markets and outside (annuities and cash value life insurance).
The bottom line?
International my not be the “hot hand” now but it more than pulls its weight over long time periods and must be allocated to and rebalanced to over each quarter and year. At the end of the day, we aren’t comparing your portfolio to the S&P 500 or even to your friends’ portfolio. We are building a portfolio that will achieve, over time, the personal rate of return necessary to accomplish the plan that we have built together. And part of that plan will now, and forever be a healthy allocation to international stocks.
The bottom-line part 2?
This is what I do all day, every day and I do it so you don’t have to. However, that doesn’t mean you should just trust me. If you would like to go into a deeper dive on any of the numbers I looked at, I invite you to let me know so we can review. While I always want to be the one who “worries for you so you don’t have to” I never want you to think that I expect you to just believe anything I say. The data will always prove the truth!