Nearly a decade into an economic recovery marked by low yields and stock market volatility, wary investors are still struggling with where to allocate portfolio assets for stable, long-term returns. The data suggest that portfolios with exposure to international equities have the potential to produce superior risk-adjusted returns, yet there is still reluctance among some U.S. investors to go beyond their borders in search of returns.
Investor apprehension toward international markets may be understandable. Foreign markets are different; the trading costs are higher; there are currency risks; unfamiliar accounting standards; and in many parts of the world there is political instability.
Why Invest in International Stocks
However, investors who limit themselves to US stocks ignore that nearly half of the world’s market capitalization exists outside of the US. Therefore, in context of proper diversification, their portfolios are under-diversified, which can increase their volatility. At any given time, foreign markets, including their subsets of developing economies, emerging economies and regional markets may not perform in unison with US equity markets.1 As for the long-term, the correlation between the MSCI EAFE Index and S&P 500 over the 40-years ended September 2017 was 0.71, according to Morningstar Direct.
Adding foreign equities may reduce portfolio volatility due to the lower correlation of international and US risk factors. Global diversification may increase return opportunities by better managing the risk/return tradeoff. There is also an argument that foreign equities may be more attractively valued than U.S. equities at this time in light of the significant run up in the US stock market.
Dividend Yield: The Key to Stable Returns
Beyond looking at price/earnings and a variety of valuation metrics, dividend yield and future income growth are key indications of a company’s financial stability and potential to deliver favorable risk-adjusted returns over the long-term.
Many investors are unaware that dividend income has accounted for approximately 75 percent of long-term stock returns. When reinvested, dividends have accounted for as much as 95% of annual returns.2 The purpose of constructing a value-oriented international equity portfolio around high-quality dividend-paying companies is to be able to capture similar returns.
While high-quality dividend stocks are not likely to generate market-leading returns in any given year, the portfolio may likely lose less money on the downside, which is a key to growing portfolio value over the long-term.3
Undervalued international companies can offer the potential advantage of higher dividend yields than their US counterparts, along with greater exposure to fast-growing developing and emerging markets. Between current dividend yields and future real growth, a portfolio of international dividend-paying stocks can offer the benefits of growing income and capital appreciation, but with less volatility than the broader stock market.
Investing for Stable Long-term Returns in International Value
When investing for stable, long-term returns, investing internationally is essentially no different than investing in the US. The key is to buy stocks in mis-valued companies with growing, diversified revenue streams selling at a discount to their fundamentals. Additionally, finding value in international markets may be easier than in US markets because they are less efficient and more susceptible to short-term fluctuations in reaction to negative developments and macro-events.
In our view, owning long-term positions with well-diversified exposure across individual companies, countries, industries, and underlying currencies can provide access to far more growth opportunities than are presently available in US markets, greater protection from headline and macro risks, and greater portfolio diversification benefits than are available from an all-US equities portfolio.
Mondrian Investment Partners Limited www.mondrian.com is an independent, employee-owned, international value-oriented investment manager with offices in London and Philadelphia.
Mondrian, founded in 1990, managed more than $60 billion (US) in assets, including over $16 billion in international equity assets as of September 30, 2017. We have a diverse, global client base, investing for corporations, public and private pension plans, endowments, foundations, and individual investors in a broad range of strategies and vehicles.
 Don’t Forget Diversification. CFA Institute. November 4, 2014 – https://blogs.cfainstitute.org/investor/2014/04/11/diversification/
 The Importance of Investment Income. ETF.com. March 24, 2008. – http://www.etf.com/publications/journalofindexes/joi-articles/3869-the-importance-of-investment-income.html?nopaging=1
 The Paradox of Low-Risk Stocks, Gaining More By Losing Less. Alliance Bernstein LLC. May 2015 – https://www.abglobal.com/Research-Publications/CMA-created-content/Institutional/Instrumentation/INS-6730.pdf
For more information on why international value stocks should be apart of your client’s portfolio allocation, please contact the following: