Higher returns from international markets?

Question

I've heard that part of your portfolio should be invested in international markets.

One argument for it is higher returns. However, browsing through some funds (FOSFX, FIEUX, FWWFX), all I can see is a lot of volatility for the same returns (most of the time even less) a U.S based fund would give. Not to mention the far higher expenses they come with.

Another argument for them is their low correlation to U.S stocks. Looking at history however, I don't see it. Most times U.S stocks have done badly, foreign stocks have also done badly.

So, are there any examples of funds with higher returns and low correlations to U.S funds, even if they have higher than usual volatility? I haven't been able to find them.

Answer 1

I went to Morningstar's "Performance" page for FUSEX (Fideltiy's S&P 500 index fund) and used the "compare" tool to compare it with FOSFX and FWWFX, as well as FEMKX (Fidelity Emerging Markets fund). According to the data there, FOSFX outperformed FUSEX in 2012, FEMKX outperformed FUSED in 2010, and FWWFX outperformed FUSEX in both 2010 and 2012. When looking at 10- and 15-year trailing returns, both FEMKX and FWWFX outperformed FUSEX.

What does this mean? It means it matters what time period you're looking at. US stocks have been on an almost unbroken increase since early 2009. It's not surprising that if you look at recent returns, international markets will not stack up well. If you go back further, though, you can find periods where international funds outperformed the US; and even within recent years, there have been individual years where international funds won.

As for correlation, I guess it depends what you mean by "low". According to this calculator, for instance, FOSFX and FUSEX had a correlation of about 0.84 over the last 15 years. That may seem high, but it's still lower than, say, the 0.91 correlation between FUSEX and FSLCX (Fideltiy Small Cap). It's difficult to find truly low correlations among equity funds, since the interconnectedness of the global economy means that bull and bear markets tend to spread from one country to another. To get lower correlations you need to look at different asset classes (e.g., bonds).

So the answer is basically that some of the funds you were already looking at may be the ones you were looking for. The trick is that no category will outperform any other over all periods. That's exactly what volatility means --- it means the same category that overperforms in some periods will underperform in others. If international funds always outperformed, no one would ever buy US funds. Ultimately, if you're trying to decide on investments for yourself, you need to take all this information into account and combine it with your own personal preferences, risk tolerance, etc.

Anecdotally, I recently did some simulation-based analyses of Vanguard funds using data from the past 15 years. Over this period, Vanguard's emerging markets fund (VEIEX) comes out far ahead of US funds, and is also the least-correlated with the S&P 500. But, again, this analysis is based only on a particular slice of time.

Answer 2

Tricky question, basically, you just want to first spread risk around, and then seek abnormal returns after you understand what portions of your portfolio are influenced by (and understand your own investment goals)

For a relevant timely example: the German stock exchange and it's equity prices are reaching all time highs, while the Greek asset prices are reaching all time lows. If you just invested in "Europe" your portfolio will experience only the mean, while suffering from exchange rate changes. You will likely lose because you arbitrarily invested internationally, for the sake of being international, instead of targeting a key country or sector.

Just boils down to more research for you, if you want to be a passive investor you will get passive investor returns. I'm not personally familiar with funds that are good at taking care of this part for you, in the international markets.

Answer 3

Here's the 2009-2014 return of the S&P 500 (SPY) vs. Vanguard FTSE ex-US (VEU) (higher returns bolded)

• 2009: SPY 26.37% vs. VEU 37.59%
• 2010: SPY 15.06% vs. VEU 11.81%
• 2011: SPY 1.89% vs. VEU -14.02%
• 2012: SPY 15.99% vs. VEU 18.90%
• 2013: SPY 32.31% vs. VEU 14.18%
• 2014: SPY 13.46% vs. VEU -4.54%
• 2015 YTD: SPY 2.49% vs. VEU 5.83%

Another argument for them is their low correlation to U.S stocks. Looking at history however, I don't see it. Most times U.S stocks have done badly, foreign stocks have also done badly.

Looking at the last 6 years (and current YTD), 1 in 3 years have international stocks doing better. I invest a portion of my investments in international because they aren't well correlated.

Answer 4

Foreign stocks tend to be more volatile -- higher risk trades off against higher return potential, always. The better reason for having some money in that area is that, as with bonds, it moves out-of-sync with the US markets and once you pick your preferred distribution, maintaining that balance semi-automatically takes advantage of that to improve your return-vs-risk position.

I have a few percent of my total investments in an international stock index fund, and a few percent in an international REIT, both being fairly low-fee. (Low fees mean more of the money reaches you, and seems to be one of the better reasons for preferring one fund over another following the same segment of the market.) They're there because the model my investment advisor uses -- and validated with monte-carlo simulation of my specific mix -- shows that keeping them in the mix at this low level is likely to result in a better long-term outcome than if i left them out. No guarantees, but probabilities lean toward this specfic mix doing what i need. I don't pretend to be able to justify that via theory or to explain why these specific ratios work... but I understand enough about the process to trust that they are on (perhaps of many) reasonable solutions to get the best odds given my specific risk tolerance, timeline, and distaste for actively managing my money more than a few times a year. If that.