In daily life, people are more likely to visit restaurants and stores close to home because they are familiar with the local area. But in doing so, they deprive themselves of all the great places in other neighborhoods. Similarly, in retirement portfolios, plan participants often over-allocate investments to companies domiciled in their own country, thereby potentially missing out on significant growth opportunities abroad, slowing their progress toward retirement readiness.
Participants generally tend to over-allocate assets to U.S.-based companies for three reasons:
- Habit: Since the U.S. has historically been the world’s financial epicenter, participants may be accustomed to investing in the U.S. and disinclined to responding to changes occurring across the globe;
- Knowledge: Participants may generally understand the laws, currency, and accounting requirements of their own country, but not those of a foreign country. Therefore, participants are more comfortable investing in U.S.-based firms; and
- History: The best brands in the world have been, historically, U.S. brands, and the familiarity participants have with these brands leads them to continue to invest in those companies.
Foreign Exposure May Increase Portfolio Diversification
Foreign equities get a bad rap for being overly volatile. However, the MSCI EAFE and the S&P 500 had comparable returns of 10.6% on an annualized basis over the last 43 years! Therefore, plan participants who invested solely in their home country would have been able to achieve a similar return with increased diversification by allocating to foreign markets.
Additionally, participants may unknowingly increase their risk by concentrating their investments into their home country. For example, U.S. employees who work for a U.S.-based company may own their employer’s stock in their retirement plans. If the stock’s value and the U.S. broad market both decline, the participants’ losses could be magnified. Increased diversification in a retirement portfolio may result in smoother returns over the long-term.Getting the Most Out of Foreign Exposure
There are several ways plan participants can increase their foreign exposure:
- U.S.-based multinationals offer some foreign exposure but not a lot. Since only 35% of revenue from companies in the S&P 500 Index, which includes the largest U.S. multinational companies, comes from overseas, participants are not maximizing their potential opportunities in the global marketplace. Additionally, investing in only U.S. multinationals limits exposure to some sectors such as oil and gas, commercial banking, and auto manufacturing, given that the majority of global market share in these sectors are based outside of the U.S.
- Foreign-based multinationals offer more foreign exposure since the majority of their sales, 55%, come from countries outside of their home country, based on sales of companies in the MSCI EAFE Index.
- Foreign local companies offer significant foreign exposure. These companies are often found in emerging market countries and sell almost exclusively within their own borders or neighboring countries. Only 28% of sales of companies in the MSCI Emerging Markets Index are to foreign countries, confirming the vast majority of their sales are done locally.
Boosting foreign exposure in retirement portfolios can be an excellent way for plan participants to increase diversification, take advantage of strong growth opportunities, and help them reach their retirement goals.
Pedro Marcal is a senior vice president, portfolio manager of the Alger International Growth Strategy, and portfolio manager of the Alger Global Growth Strategy, for which he manages the international developed portion of the portfolio. He joined Alger in February 2013 and has 24 years of investment experience. Prior to joining Alger, Pedro worked at Allianz Global Investors (formerly Nicholas-Applegate Capital Management), where he focused on international equities including developed and emerging markets products before moving on to manage global and developed international equity portfolios. Pedro earned his BA from the University of California at San Diego and his MBA from UCLA Anderson School of Management
NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.
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