When we’re in our comfort zones, we’re more likely to feel safe and familiar—and this same psychological effect is at play when we’re choosing where to invest. In fact, it’s widely understood that investors tend to prefer investing in their home country instead of taking a more global perspective, a behavior known as home bias.
However, investors could consider expanding their geographic exposure. From Shanghai to London, 20 of the world’s stock exchanges have a market capitalization above $1 trillion.
This infographic from MSCI highlights the possibilities in international equity investing. Let’s dive into some of the key concepts covered in the visualization.
Consider Correlations
For starters, by looking abroad, investors may be able to include markets in their portfolio that have relatively low correlation with their home market. This means the market movements are not as closely aligned, and the markets may behave differently from one another.
For instance, the U.S. has varying degrees of correlation with international stock markets. A correlation of 0 indicates there is no relationship between the market movements, while a correlation of 1 indicates that they move the exact same percentage in the same direction.
| Country | Correlation With U.S. Market |
|---|---|
| Japan | 0.11 |
| Taiwan | 0.21 |
| Korea | 0.24 |
| China | 0.43 |
| UK | 0.58 |
| France | 0.59 |
Daily correlations based on data from December 31 2015-December 31 2020.
In the past, adding less correlated markets to a portfolio has helped to reduce overall volatility.
Manage Potential Concentration Risk
Technology companies have become more dominant in major U.S. stock indexes due to their strong performance. In the MSCI USA Index, for example, the weighting of FAANG stocks has doubled from about 8% in 2019 to more than 16% in 2021.
This increased concentration means that more of the performance and risk of each index can be driven by this small number of stocks. Branching out geographically can help to reduce that concentration risk.
Access Alternative Revenue Sources
Investors that focus in the U.S. may find their exposure to revenues and potential growth from other regions is limited. For example, only 31% of the MSCI USA Index’s revenue exposure comes from areas outside North America.
On the other hand, the MSCI All Country World Index derives about 70% of its revenue exposure from regions outside North America. As investors move towards a more global portfolio, they increase their exposure to revenue and potential growth from other regions.
Gain Exposure to Economic Growth From Other Regions
While GDP growth in developed economies has been more consistent, growth in emerging markets has been higher. For example, emerging markets typically experience higher GDP growth as they transition to industrial economies with higher standards of living.
Here is historical and projected data for various regions, based on average annual GDP growth.
Historical and Projected GDP Growth by Region
| 2001-2020 | 2021P-2025P | |
|---|---|---|
| Europe | 1.45% | 2.82% |
| North America | 1.63% | 2.84% |
| Pacific | 2.52% | 2.80% |
| World | 3.33% | 4.12% |
| Emerging Markets | 5.12% | 5.10% |
Note: Projections as of April 2021. The Pacific region represents Japan, Hong Kong, Singapore, Australia, and New Zealand.
Emerging markets had GDP growth that outpaced other regions in the past, and the International Monetary Fund projects that they will continue to experience above average growth.
Increase Exposure to Innovation
Thematic investing is one way to gain exposure to innovation, and international investing is another potential method.
Innovation goes far beyond Silicon Valley, and is heating up abroad. In fact, over 70% of total R&D spending in 2018 originated outside of North America. Israel, Korea, and Taiwan were the top spenders as a percentage of GDP. By taking part in international equity investing, investors can aim to capitalize on new developments.
Access Attractive Valuations
Emerging markets have an attractive price relative to their return on equity, a measure of a stock’s profitability.
| Price to Book Value | Return on Equity | |
|---|---|---|
| U.S. | 4.4 | 13.7 |
| Emerging Markets | 2.0 | 9.2 |
| Europe & Middle East | 1.9 | 8.5 |
| Pacific | 1.6 | 6.4 |
Data as of December 2020.
Emerging markets offer the second highest return of equity of the group, at a much lower price to book value than U.S. stocks. In other words, emerging market stocks offer strong investor returns in comparison to the price paid to obtain them.
Broadening Horizons With International Equity Investing
While many investors succumb to home bias, they could consider a wider set of investment options around the world. By engaging in international equity investing, investors can:
- Aim to increase diversification and manage risk
- Take advantage of growth opportunities
- Access emerging markets
Global markets are changing. As innovation and growth accelerate outside North America, investors may want to consider new possibilities.
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Source: https://www.visualcapitalist.com/rcep-explained-the-worlds-biggest-trading-bloc-will-soon-be-in-asia-pacific/
