Global Investing "Bunk"
Ten years ago an opinion pieceappearing in The Wall Street Journalby a prominent financial writer claimed that the notion of broad-basedinternational diversification of equity investments for US investors had beenconvincingly revealed to be little more than faddish "nonwisdom." He described a strategy of acceptingmarket rates of return across a broad universe of countries as being littlemore than gambling since "speculators in 86 foreign markets apportion myfunds." He had resistedsuggestions from financial professionals to diversity globally, he said, smuglyconfiding that he had "no money in the former Yugoslavia, none in the presentArgentina, none in the future Republic of Antarctica, none in Zambia, Belgiumor Kazakstan." (Even if he had, itmight be hard to tell. Theaggregate weight of these countries would have represented about 1% of aglobally diversified capitalization-weighted portfolio.)
At the time, the case forinternational diversification appeared questionable based on recent performance. For the period ending November 1997,the S&P 500 Index had outperformed benchmarks of developed country andemerging country stock markets by a wide margin over one, three, five, andseven-year periods. For thethree-year period, annualized return was 31.05% for the S&P 500 Indexcompared to 6.19% for the MSCI EAFE Index (net dividends) and -7.24% for theMSCI Emerging Markets Index (gross dividends). Why bother investing in L'Oreal, Heineken, or Samsung whenGeneral Electric and Microsoft are showering shareholders with such impressivereturns? In the author's view,"the notion that the US offers insufficient opportunity to diversify isabsurd." A prominent mutual fundexecutive made a similar observation the following year, comparing investmentopportunities in the US market to a prospector standing in "acres ofdiamonds."
The article went on to cite aprominent fee-only financial advisor who applied a globally diversified passivestrategy for his clients, poking fun at his allocation strategy that "a robotcould figure." The thinly veiledsuggestion was that investors were ill-served by such advice.
The author cited poor disclosure,risky currencies, and weak legal protection of shareholders as reasons why USresidents "can lead a happy investment life without leaving home." Perhaps so, but he was silent on themerits of his advice for citizens of other countries. Should Dutch grandmothers or Hong Kong physicians boycotttheir local securities markets and limit their holdings to US securities? If they did so, would their decisioncause prices to fall in non-US equity markets, raising the cost of capital forlocal firms and hence investment returns for the remaining shareholders? It sure seems plausible to us.
Since the article appeared inDecember 1997, global markets have had their share of ups and downs, butresults suggest that excluding non-US securities from consideration may haveunappealing consequences. For theten-year period ending November 2007, annualized return for the S&P 500 was6.16% compared to 9.00% for the MSCI EAFE Index and 14.76% for the MSCIEmerging Markets Index. Amongnineteen major markets (EAFE constituents plus Canada), only one (Japan) hasunderperformed the S&P 500 in US dollar terms over the last ten years. And while US investors are currentlyfretting over losses related to the mortgage market fiasco, markets such asIndia roll on to record highs (the Bombay Sensex hit 20,290.89 on December 11,up from 3329.14 ten years earlier) and some observers are explaining thecontinued strong performance of emerging markets as a "flight to quality."
Can any of us predict with confidence what the next ten years will hold?