FA Magazine July/August 2021 - Page 31

more broadly in equity portfolios increase the odds of hitting their expected return targets .
McDonald warns , however , that if foreign markets outperform America ’ s for several years , domestic investors complacent at home may start piling into foreign securities late in the game .
Big Outperformance Odds
Some asset management firms anticipate foreign markets will trounce America ’ s . Vanguard Group is projecting investors outside the U . S . could enjoy equity returns of 7.5 % to 8.0 % between now and 2030 , while U . S . -centric investors could realize only 4.5 % to 5.0 % over the same time period .
Roger Aliaga-Diaz , Ph . D ., a principal and senior strategist in Vanguard ’ s investment strategy group , calls this one of the “ more extreme gaps ever .” In his view , it ’ s very uncommon .
An April 2021 research paper by Vanguard takes a long look back at American and foreign markets and how relative weighting can shift over time . In 1970 , American stocks represented almost 65 % of all global equities . In the 1980s , with Japanese stocks soaring , the U . S . share had fallen to 29 %.
This trend reversed course in the late 1980s , and by September 30 , 2020 , the U . S . market accounted for 58.4 % of the total global market . It ’ s worth noting that the United States represents less than 25 % of global GDP .
Aliaga-Diaz also suggests that foreign equities might provide more efficient inflation protection than current inflation hedge favorites like cryptocurrencies and commodities . Most of the developed world offers even more paltry interest rates than the U . S ., and European stocks sport higher dividends .
Echoing Northern Trust ’ s McDonald , the Vanguard study found that global diversification smoothed out returns and reduced volatility . Specifically , the study found that an allocation of 35 % to 55 % to foreign equities was optimal when it came to reducing portfolio volatility .
Lower volatility isn ’ t the only factor advisors should consider . The last time long-duration U . S . tech stocks were shooting the lights out occurred in the late 1990s , when interest rates on 10- year Treasury bonds were in the 4 % to 5 % range .
Today those same bonds are yielding 1.5 % and their counterparts in Europe and Japan offer even less income . In contrast , equities in these foreign developed markets offer more robust dividends than pricey U . S . shares . If the
just a label ,” he says . “ These economies are truly emerging .”
Arnott acknowledges that the negative sentiment and fears of another Covid wave have dampened enthusiasm for developing markets . “ Five years from now , Covid will be a long-fading memory . Most narratives like [ that ] make attractive opportunities ,” he adds .
Viewed through a valuation lens , Arnott notes that the Shiller CAPE ratio for emerging markets stands at 17 , while
Nations like China , South Korea and Taiwan have become serious players in the technology industry . China has turned into “ a tech innovator ,” says Gabriela Santos , global market strategist at J . P . Morgan Asset Management .
search for retirement income remains a global challenge for the next decade , it could favor stocks in developed markets with generous payouts .
Emerging Markets Change
Back in the days when the developing world provided the best returns , from 2001 to 2010 , there essentially were two types of emerging markets — those with cheap labor like China and those with plentiful commodities like Russia and Brazil . A decade makes a “ humongous difference ,” notes Santos . In 2009 , cyclical stocks represented 65 % of emerging market indexes . Today , that figure has fallen to 45 %.
Nations like China , South Korea and Taiwan have become serious players in the technology industry . China has turned into “ a tech innovator ,” Santos says . Portfolio managers at American Funds said earlier this year in a webcast that they expect China to emerge as a major player in the bioscience and pharmaceutical industries over the next decade .
Longtime value investor and index designer Rob Arnott , co-founder of Research Affiliates , acknowledges this shift . “ Emerging markets are more than it ’ s only 20 for the EAFE index and 31 for the S & P 500 .
Conventional wisdom is embracing another narrative as the developed world emerges from the pandemic , namely that high-tech stocks are brilliantly positioned for yet another new paradigm . Even if true , Arnott believes this is fully reflected in investment prices and preferences .
But other asset managers are shifting their portfolios back toward the United States . Chris Mack , a portfolio manager at Harding Loevner , thinks that U . S . management teams generally adjusted to the disruption caused by the pandemic better than their foreign rivals .
It varies from industry to industry , however , and Harding Loevner finds excellent management teams outside the domestic market , Mack says . Taiwan Semiconductor , for example , is better positioned than Intel . But U . S . software concerns like Salesforce , Adobe and Microsoft are making the transition to cloud-based adoption more quickly than German giant SAP .
On balance , Harding Loevner is taking the contrarian stance and is positioning more portfolios toward the U . S . than it has over the last few years .
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