If you ask Frank Armstrong how long he’s used foreign investments in client portfolios, he’ll say “since inception.” He’ll go on to say that of the firm’s $650 million under management, 50% of equity assets are in foreign holdings—a strategy that in 1993, when he launched Investor Solutions, was considered both “highly risky” and “quite aggressive.” However, Armstrong has found such an approach a good one for his clients that has paid off over the long haul. “Additionally, we like the almost perfect dollar hedge that a 50% foreign equity position provides,” he points out.
How did Armstrong get started along the foreign investing path? By looking for asset classes with low correlations to one another, he says, in accordance with modern portfolio theory (MPT). “At the time [foreign investing] was considered quite aggressive,” he says, “but the data was compelling that it would in fact both lower risk and increase returns, and that’s been the story since then.” While most people, if they considered foreign investing, he explains, would “consider maybe 10–15%, … data pointed to a much higher exposure.” So that’s what Armstrong used.
“If you put yourself back in 1993, foreign investing was not at the top of most people’s mind,” Armstrong said. In spite of the fact that it actually lowered portfolio risk, people thought of it as a chancy move. Still, asked if it was hard to find clients to go along with such a radical (for the time) strategy, he says not.
“Clients sought me out because they identified with that kind of strategy,” Armstrong said, “People who thought that [MPT] was nuts probably didn’t call me, but people who identified with it did. If I had gone into a bar and said, ‘Hey, guys, we really need to increase to 50% foreign,’ I wouldn’t have gotten much of a reception,” he said.
Armstrong’s approach doesn’t include focusing on specific countries or regions. Instead, he and his firm use index funds and ETFs that offer access to ex-U.S. investments. Initially, the firm used the MSCI EAFE (Europe, Australasia and theFar East). However, now its approach is broader, including now-available emerging markets and the most recent addition: foreign real estate.
“Index funds typically won’t invest where there’s not a rule of law,” he says, explaining the firm’s choice of investments, “where Americans would have to pay higher taxes than locals, where they would have to buy a different set of shares than local residents. For a long time, we avoidedIndiabecause there were problems between payment and delivery; it could be months and months.” However, “Indiacleaned up its exchanges, and now we use funds that invest there. We wanted the widest possible diversification in the global cap rating.”
He clarifies: “We use ETFs or index funds, depending. You can’t get a foreign or emerging market small company fund in ETFs, because the market doesn’t provide enough liquidity. So there we would use index funds. But in EAFA, we would use ETFs, for advantages such as cost and liquidity.” The firm also favors passive investments, “because there’s simply no credible data that active management adds value over time.”
However no strategy “works every second, day, month or year,” but over the long haul foreign holdings “have added a great deal of value.” During the “lost decade” of stock in the 2000s, “the S&P 500, which everybody thought was ‘the’ market, lost nine-tenths of a percent per year,” he said In contrast, “We did about 7.5% [per year].”
The firm’s 2012 portfolio results for the year to date at interview time, Armstrong says, are up about 13%, “and probably a little better than the S&P.” However, he adds, performance “doesn’t rest on one particular time frame, because you can win or lose on a particular time frame. We expect to win cumulatively more than we lose, and at lower risk … If [clients] want excitement, they can go to Vegas, but not here.”