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International Exposure in a Portfolio

March 4, 2022
By Tim Courtney, Chief Investment Officer

Within the first few days of the war on Ukraine, governments began closing off avenues of liquidity for Russia and its citizens. Since then, investors and companies have begun reconsidering their exposure to Russia’s economy for multiple reasons. Companies are closing stores, shutting down factories and looking to sell ownership stakes in local assets. Those asset values are falling rapidly as the ruble moves to a record low.1

Most investors who have assets in Russia have them through emerging market funds. Many of the stock funds have a typical exposure of 2% or less but, with local exchanges closed, index services such as MSCI have declared Russia an uninvestable market.2 Funds will now likely begin selling their exposure when they can to opportunistic buyers.

Even with the turmoil occurring in global markets, broad emerging market indexes are down between 5% and 6% YTD as of March 2, compared to broad U.S. and developed international indexes, which are down near 8%.3

This could change, but, as always, it is difficult to predict the path markets will take and even more challenging to predict developments that will alter that path. This is a major reason for diversification. We think there are several reasons why investors should hold assets outside of the U.S., where about 40% of the world’s stock capitalization resides.4

Market outperformance swings back and forth. International and U.S. markets have traditionally traded dominance, where one market will outperform for a number of years and then valuations and circumstances change and the other will take over. The level of U.S. outperformance in recent years is among the largest over periods going back into the early 1970s. The U.S. market trades at a premium as it should, with extremely successful and profitable companies operating in a relatively stable environment. There are successful and profitable companies abroad as well, and having a portion of a portfolio hold these companies helps diversify.

Different weights to sectors. While U.S. markets have skewed to the growth side in recent years caused in part by greater weights to technology and communication companies, international markets are skewed to the value side of the market, holding higher weights to financials, industrials and materials. Again, this helps further diversify portfolios.

Foreign currency exposure. The value of the U.S. dollar has remained strong, even after money supply rose from $4.6T in January 2000 to $18.38T in August 2020. It increased again to $21.84T by January 2022, an increase of 42% over the last two years.5 This supply has been met by investors demanding dollars. We’re not forecasting immediate risk to the U.S. dollar but other countries are always looking for alternatives, and holding some non-dollar denominated assets can help hedge against dollar decline.

Portfolios should continue to be weighted toward U.S. markets and dollar denominated assets. Even with the turmoil happening abroad, having exposure to assets outside the U.S. can still make sense.

If you have any questions please contact your Exencial advisor.

Sources:

  1. CNN Business (2/28/22) — Russia faces financial meltdown as sanctions slam its economy
  2. MarketWatch (3/3/22) — MSCI says Russian markets are ‘uninvestable’; indexes reclassified from ‘emerging’ to ‘standalone’
  3. Yahoo! Finance (data as of 3/3/22) — iShares MSCI Emerging Markets ETF (EEM) compared to SPDR S&P 500 ETF Trust (SPY)
  4. Dimensional.com (1/21/2022) – Global market breakdown
  5. St. Louis Fed (1/31/2022) – FRED economic data, M2 M2SL

 

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