The expanded opportunity set foreign stocks offer investors
The historical risk profile of foreign versus domestic stocks
The valuation disparity between foreign and domestic stocks
"Past performance is no guarantee of future results." This may be the most ubiquitous disclaimer in the world of finance and investments. It appears, usually in tiny print, in every prospectus, website, and TV commercial offering financial products of any kind. We all know this, and yet, when it comes to international equities, investors seem convinced that a decade of underperformance relative to the surging U.S. market guarantees a future with nothing but more of the same. The MSCI EAFE Index of developed foreign stocks averaged a 4.80% annualized return in U.S. dollar terms for the 10-year period ending March 31, 2024, falling well short of the S&P 500’s stupendous 12.96% annual return over the same period.
Given this yawning discrepancy in past performance, why would anyone own foreign stocks?
Expanding Your Opportunity Set
The U.S., with its entrepreneurial culture, business-friendly government and legal framework, and sophisticated capital markets, is a long-term return dynamo. Even we would agree that a substantial allocation to our home market makes prudent sense within an investor’s overall portfolio. But this doesn’t mean the U.S. is the whole story.
Less than one quarter of the securities in the world public equity universe are listed in the U.S. Recognizing the advantages of a U.S. domicile, these American stocks are highly valued, accounting for almost two-thirds market weight of the All Country World Index, more than 10 times the weight of the next largest country.
Foreign equities represent the largest set of publicly traded companies
Source: FactSet (March 2024). It is not possible to invest directly in an index.
But America’s leading companies are by no means the only great opportunities around the world. Foreign markets are home to innovation leaders in technologies, like semiconductor capital equipment and healthcare, global giants offering entertainment, everyday consumables and elegant fashion and luxury goods, resource companies that bring to market the basic inputs for a greener global economy, sophisticated industrial equipment manufacturers, and scores of companies with superbly executed business models that give them sustainable home-field advantages. All investors should be well aware of these opportunities for long-term return.
Investors seeking to diversify industry group exposures may consider looking overseas
As of 3/31/24. Source: FactSet (May 2024). It is not possible to invest directly in an index.
Foreign Stocks? Sounds Risky …
The argument that foreign stocks are riskier is often cited as a reason to avoid international markets. Even the word “foreign” evokes mysterious social and political forces that promise to trigger unpleasant bouts of volatility. But our natural home-country bias obscures a less threatening truth.
As you can see in the chart below, non-U.S. developed market foreign stocks, as measured by the standard deviation of annual returns in local currency, are no more volatile than their U.S. counterparts. This is probably due to the smoothing effect exerted by investing across the world’s diverse economies. Nevertheless, the notion of “risky foreign stocks” is simply inaccurate.
Local currency stock price fluctuations have been less volatile among foreign domiciled companies
Source: FactSet (May 2024). * The local return represents the theoretical performance of an index without any impact from foreign exchange fluctuations. It is not possible to invest directly in an index. Past performance is not indicative of future results.
Patience Rewarded Through Income
Valuation also works in favor of investors in non-U.S. stocks. The American market’s advantages are no secret, and U.S. stocks trade at a premium to their foreign counterparts on nearly every measure of value. For example, the next chart compares the dividend yield of the MSCI EAFE Index to the S&P 500 over the past 20 years.
Dividend income is an important component of long-term return. The extra income collected over time may be a reason why foreign stocks as a group exhibit less volatility. The lower valuation of foreign stocks does not necessarily mean they are poised to immediately outperform the U.S. side, but investing at favorable valuation levels generally leads to good results for patient investors. Higher valuation levels may present the risk for sharper downturns.
Income seeking investors have enjoyed larger dividends from foreign companies
Source: FactSet (May 2024). It is not possible to invest directly in an index. Past performance is not indicative of future results.
To summarize, we recommend embracing the compounding power of "and." Investing is not an either/or strategy. Owning U.S. companies and a carefully constructed portfolio of international stocks provides a bigger opportunity set, potential to reduce overall portfolio volatility, and lower valuation — a winning combination in our opinion.
About The Author
Brandon Harrell is the Portfolio Manager for the Transamerica International Equity fund and Co-Portfolio Manager of the Transamerica International Small Cap Value fund. Prior to joining TSW in 1996, he worked as an Intelligence Officer at the Central Intelligence Agency. Previously he was a Securities Analyst at Growth Stock Outlook, Inc., and a High Net Worth and Mutual Fund Portfolio Manager for Capitoline Investment Service. Brandon graduated from Wake Forest University and received his MBA from George Mason University. He holds the Chartered Financial Analyst® designation.
The MSCI EAFE Index is an unmanaged index used as a general measure of market performance. It is not possible to invest directly into an index. Calculations assume dividends and capital gains are reinvested and do not include any managerial expenses.
The MSCI All Country World Index (ACWI) is a stock index designed to track broad global equity-market performance.
The S&P 500® Index is an unmanaged index of 500 common stocks primarily traded on the New York Stock Exchange, weighted by market capitalization.
Past performance is not indicative of future results. It is not possible to invest directly in an index, which also does not include the application of fees.
Important Information
All opinions, estimates, projections, and security selections contained herein are those of the sub-adviser. It does not constitute investment advice and should not be used as a basis for any investment decision.
Mutual funds are subject to market risk, including loss of principal. Past performance is not indicative of future results.
Mutual funds are sold by prospectus. Before investing, consider the funds' investment objectives, risks, charges, and expenses. This and other important information is contained in the prospectus. Please visit transamerica.com or contact your financial professional to obtain a prospectus or, if available, a summary prospectus containing this information. Please read it carefully before investing.
The price of equity securities fluctuates based on changes in a company’s financial condition and overall market and economic conditions. If the market prices of the equity securities owned by the fund fall, the value of the fund will decline. The prices of securities the sub-adviser believes are undervalued may not appreciate as anticipated or may go down. Investments in global/international markets involve risks not associated with U.S. markets, such as currency fluctuations, adverse social and political developments, and the relatively small size, lower market volumes and lesser liquidity of the markets. The fund will be exposed to additional risks as a result of its investments in the securities of small capitalization companies.
Transamerica Funds are advised by Transamerica Asset Management, Inc. (TAM) and distributed by Transamerica Capital, Inc. (TCI), member of FINRA.
Transamerica Companies and TSW are not affiliated companies.
