Two years ago, Ben Johnson, director of global ETF research for Morningstar, humorously noted that if diversification is the only free lunch in investing, investors around the world might be leaving a lot on the lunch table.
Diversification is measured across numerous dimensions: asset class, individual stocks, types of investments, industry, sector, and strategy. And investors are fairly obliging when it comes to accommodating these parameters.
However, when it comes to investing overseas (diversifying across countries), many decide to ditch it at the border. And here’s why that is a big mistake.
#1. The intangibles rest on misplaced conclusions.
Investors tend to have a home bias because it is a preference for the familiar. They feel--either rightly or wrongly--that they know their local markets and local firms better than those overseas. It could also be a reflection of their pride in their nation and its champions of industry.
Familiarity or pride may be legitimate reasons to shirk global investing, but flimsy. Asymmetries in knowledge and information are not insurmountable. The world is increasingly flat, and barriers to the movement of information and capital continue to come down.
Shankar Sharma of First Global tackled this head on at the Morningstar Investment Conference a few years ago. “Never mix nationalism and investing. Be detached. Be objective. Question your motives.” He was quick to add that the problem arises when investors view it as an “either-or” strategy. “Why can’t both coexist in a portfolio? Don’t invest in global stocks to the elimination of Indian equity. But neither should you put blinkers on when it comes to looking overseas.”
According to Business Journal, for Americans, domestic stocks represent only 55% of the global stock market. For Australians, their market represents only 2% of the global stock market. The article never mentioned India, which corners just 2.5% of global stock markets.
Clearly, by limiting your investments only to India, you are denying your portfolio access to a lot of growth potential.
#2. In the search for alpha, the world should be your hunting ground.
If you cannot knock down the pillars of home bias (the term used to describe investors' tendency to tilt their portfolios in favour of domestic stocks), then look at the compelling arguments to increase global exposure.
- Indian stocks and global stocks have not and will not ever move in perfect unison.
- Pairing assets that zig and zag at different times in response to different fundamental drivers (changes in rates, inflation, differences in fiscal and monetary policies, and so on) is a good way to reduce portfolio risk.
- There will be times when valuations across global markets are out of sync. It is at these moments when taking from your leaders to add to your laggards can make the most meaningful contributions to your long-term returns.
- Indian investors may want to invest in FAANG stocks and Tesla, for example. Or stocks where there are no listed Indian entities – such as mining companies or electric vehicle batteries. Or, even debt instruments of other countries.
Rupal Bhansali of Ariel Investments, explained once that if she wanted to own a tyre company and restricted herself to the U.S., she would be forced to own Goodyear. Yet, she did not believe its manufacturing process was well evolved, it was not sufficiently invested in technology and R&D and training of workers, was struggling to ramp to the more prevalent higher rim-size models of tires, and was extremely leveraged. But once she viewed global listed companies to scout from, she could bet on the best tyre companies in the world: Michelin (France) and Bridgestone (Japan).
#3. No country is destined or entitled to outperform.
No country or market is immune from a shock.
The Mexican Peso Crisis and the Asian Financial Crisis are worth mentioning.
A devaluation on December 20, 1994, triggered a crisis of confidence that led to the subsequent collapse of the peso. As a result of the “tequila” effect, events in Mexico led to serious pressures and increased volatility in financial and exchange markets in a number of Latin American countries.
The Asian Financial Crisis of 1997-98 dealt a severe blow to Indonesia, South Korea and Thailand. In varying degrees, Malaysia, Singapore, Taiwan, Hong Kong and the Philippines also felt the heat. Some of these were the Asian Tigers – they were the aspirational nations for the rest of the emerging countries.
Expecting one market to do well every single year is naïve at best, but completely foolish.
In 2017, the stock markets in Argentina, Turkey and Nigeria had a banner year. In 2018, Ukraine and Macedonia put up a spectacular performance, followed by Qatar. In 2019, Greece was not only the top performer in Europe, but across the globe. Russia, Italy and Brazil also stood out that calendar year. In 2020, Vietnam, South Korea, Taiwan and Denmark delivered admirably.
#4. Bull and bear markets simultaneously coexist.
Devina Mehra of First Global explained this so well in a recent webinar, that I shall just reproduce what she narrated.
As with the markets, it is the similar case with asset classes. No one asset class or market will consistently outperform. But when one is beaten down, another will be rallying.
Look at India. In 2019, government treasury instruments and gold did exceptionally well, much better than the Nifty 500. In 2020, Indian IT and pharma stocks had a massive bull market, while banking and finance stocks had a bear market.
Look globally. Even as Asian stock markets were getting decimated during the Asian Financial Crisis, European stock markets and risk-free U.S. Treasuries were doing well.
Between March 2000 and October 2002, as U.S. equities put up a dismal performance, gold, U.S. Treasuries and oil did well.
(The 2000 Dotcom Bust: On March 10, 2000, the combined values of stocks on the NASDAQ stood at $6.71 trillion. On April 6, 2000, it was $5.78 trillion. In less than a month, nearly a trillion dollars worth of stock value had completely evaporated.)
Between 2003-07, U.S. stock market returns paled in comparison to those of Emerging Markets, not to forget the 2000s commodities supercycle. Over the past decade, the reverse has taken place. The U.S. stock market and the USD has fared much better when compared to emerging markets – their stock markets and currencies. And the commodity bull run too abated.
Evidence has made it clear that it is futile and self-defeating to expose your portfolio to just one asset, one country, one region, and one currency. Japanese investors, Latin American investors, Asian investors, and European investors would testify to this.
I rest my case.
Larissa Fernand is Senior Editor at Morningstar India. You can follow her on Twitter.
