International stocks offer the benefits of diversification and can also yield high returns. Current valuation levels make the traditional case for global investing much stronger. The run-up in US stock prices means that foreign stocks are currently under-owned, relatively inexpensive, and likely to outperform. We believe that frontier markets offer unique opportunities to replicate the past successes of emerging markets.
Diversification
It is possible to produce higher returns with lower risk through global diversification. International investing improved performance when it mattered most. Between 2000 and 2010, US stocks had an average annual return of -1.82%. During that same decade, the emerging markets produced an average yearly gain of 9.78%.
Competitive Returns
International stocks also yield returns that are competitive with those of US stocks. Between 1970 and 2010, global stock markets generated an average annual return of 8.68% compared to 8.48% for domestic stocks. US stocks are on track to produce higher returns during this decade. Even with recent setbacks, international stocks still outperformed during three of the last five decades.
Increasing Home Bias
40% may be the optimal allocation to international stocks, but domestic investors are reducing their already low foreign holdings. According to Fidelity, investors under 35 lowered their international allocations from 21% to 13% between 2009 and 2017. Those between 35 and 50 reduced theirs from 18% to 15%. Increasing home bias is partly the result of uninformed return chasing.
Current stock valuations could make this the right time to increase international allocations.
Valuation
The run-up in US stock prices during the last decade led to high valuation levels, which often imply future underperformance. Stock market capitalization as a percentage of GDP is one of the most respected measurements of stock valuation. In the United States, it rose from 138% in 2007 to 166% in 2017. On the other hand, the world's stock market capitalization as a percentage of GDP fell slightly, from 114% to 112%. US stock valuation relative to the rest of the world is now even higher than it was in 1999.
A More Inclusive Future
New countries become part of international financial markets as the global economy expands, and they tend to outperform the market. Between 1987 and 2012, the emerging markets' share of the MSCI ACWI grew from less than 1% to more than 12%. China, India, and Russia were not even a part of the MSCI Emerging Markets Index at its inception. We also know that China is not going to be the next China. To reproduce those returns, international investors must look to the frontier markets.
Despite a difficult decade, frontier markets have still outperformed global stocks over the long term. Since May 2002, frontier markets have produced an average annual return of 7.80%, compared to 7.41% for international markets.
The Growing Case
International stocks are competitive with US stocks in the long run, and they are currently attractively priced. Frontier markets, such as Kenya and Bhutan, could become the emerging market success stories of the future; however, frontier markets and international private equity present unique challenges. Institutional clients are best served by a platform that provides them with access to a diverse range of these markets.
Ashton Global can help to identify fund managers with the right connections to private capital in emerging and frontier markets. Firms in developing countries often grow faster before the general public has the opportunity to become aware of them. Investing outside of existing stock markets is one of the few remaining ways to generate genuine alpha.
Please email investor@ashtonglobal.com to learn more.
