The asset allocation recommendations of the vast majority of investment advice providers include some meaningful exposure to international stocks. Yet, given the fact that U.S. stocks have outperformed international stocks for eight out of the last 10 years (and by a wide margin in many of those years) and the correlations between these markets have narrowed (providing a less compelling diversification value), it’s not unreasonable to question the value of investing overseas.¹

Moreover, for investors certain they want exposure to international markets, it can be argued that the S&P 500 provides more than enough. For instance, 40% of the revenues of the companies comprising the S&P 500 index are derived overseas, with some industry sectors—Info Technology (58%) and Materials (54%)—earning more overseas than domestically.²

However, many large money managers still see value in investing overseas. One such proponent is Cliff Asness, founder, managing principal and chief investment officer at AQR Capital Management.

Why International Diversification Still Works

In International Diversification Works (Eventually)³, co-authored by Asness, he argues that international diversification is still important, making several key points:

• Though international markets may crash or suffer bear markets in tandem with U.S. equity markets, this lack of diversification benefit is a short-term phenomenon. For investors with a longer-term investment horizon, the greater concern is wealth creation and preservation.
• Over longer-term periods, markets tend not to crash at the same time, which allows the diversification benefit of international investing to reveal itself.
• Short-term performance is dominated by multiple expansion, which accounts for 51% of the variation in quarterly returns.
• Over the longer-term, country-specific economic performance becomes the primary determinant of returns in individual markets, accounting for just 1% of quarterly returns, but 39% of 15-year returns (and rising over time).

The paper does add an important caveat, which is that the analysis is done on equal-weighted portfolios since historical capitalization data were unavailable. This contrasts with most available global investment options that are cap weighted. Asness warns that cap-weighted investment options are not particularly well diversified and that they have an unintended tilt against value stocks.

One reason to consider international not mentioned by Asness is that International versus U.S. performance tends to run in cycles that last an average of eight years, so now may be the time for international stocks to shine.⁴

Sources:

1. https://www.blackrock.com/us/financial-professionals/literature/investor-education/why-bother-with-international-stocks.pdf
2. https://insight.factset.com/sp-500-companies-with-more-international-exposure-reporting-revenue-decline-for-q1
3. https://www.aqr.com/Insights/Research/Journal-Article/International-Diversification-Works-Eventually
4. https://www.hartfordfunds.com/dam/en/docs/pub/whitepapers/CCWP014.pdf

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