International stocks provide the benefits of diversification, and they also produce 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 provide unique opportunities to reproduce the past successes of the 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 return of -1.82% per year. During that same decade, the emerging markets produced an average annual gain of 9.78%.
Competitive Returns
International stocks also produce returns that are competitive with US stocks. Between 1970 and 2010, global stock markets generated an average gain of 8.68% per year 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, world 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. Between 1987 and 2012, the emerging markets grew from less than 1% of the MSCI ACWI 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 still outperformed global stocks over the long-term. Since May 2002, the frontier markets produced an average annual return of 7.80% compared to 7.41% for global markets.
The Growing Case
International stocks are competitive with US stocks in the long-run, and they are currently attractively priced. Frontier markets like Kenya and Bhutan could be the emerging market success stories of the future. However, frontier markets and international private equity present unique challenges. We believe that institutional clients are best served by a platform that gives them access to a variety 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 involved. Investing outside of existing stock markets is one of the few remaining ways to generate genuine alpha.
Please contact us at +1 212 514 8953 or email investor@ashtonglobal.com to learn more.
