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May 7, 2013

Granite Hill’s Tanner Looks Long Term With International Investing

Paul TannerFor Paul Tanner, founder of Granite Hill Capital Management in Ridgefield, CT, there’s little debate about global diversification in an investment portfolio. He believes in allocating a healthy 40% to 50% of his clients’ holding to international markets with a view to a longer-term return, because although many international markets appear risky in the short-term, history has shown that taking on more risk in the short-term does actually pay off in the future, and international diversification is the best way to do this.

Tanner (left) doesn’t claim any particular expertise in international economics and finance. As a matter of fact, he doesn’t follow the daily, or even weekly or monthly, machinations of different countries and markets. He bases his conviction of the benefits of global diversification—in particular in the international and emerging markets small cap space—on the simple rationale that investors need to think long-term. They need to prepare for a future that’s different from the past, and he believes that the best defense to global volatility is a prudent but sizeable allocation to foreign holdings that reflect an investor’s personal risk tolerance and that is designed to pay off in the long-term.

“Technically, we are looking for assets that are not correlated to the US stock market, because when one market zigs that other zags, the returns are smoother,” Tanner said. “This produces a diversification benefit through rebalancing and rebalancing forces you to maintain a static allocation and buy the relatively weak asset class, selling the relatively strong asset class.”

Tanner also juxtaposes valuations and risk. Right now the US is at twice book value, which suggests a richer valuation and lower prospective returns relative to other parts of the world, he said. At 13.9, the US earnings multiple is also higher than everywhere else but the Pacific region and US stock prices, at seven times cashflow, are higher than elsewhere, he added.

“To the extent Europe and the emerging markets appear more risky than the US, I think rational investors are demanding a premium for the greater investment riskiness and they will likely be rewarded over time,” Tanner said. “These expected higher returns are by no means guaranteed, of course, and in 2026 when we examine returns, my expectation is that international/EM small and value will surpass US large caps, but by not as much as the past 13 year period.”

As such, Tanner believes it’s very important to convince investors to look beyond the short-term and focus on the longer-term, because he believes there’s ample evidence to prove that taking on more risk in the present makes for greater reward in the future.

Of course, there’s always an argument that in times of crisis, markets all over the world tend to become heavily correlated, which means that global diversification becomes a moot endeavor. However, it is the long-term, measured in years, and a  portfolio-wide outlook that count because history has shown that globally diversified portfolios tend to fall less and recover much quicker, Tanner said.

Case in point: In the worst five-year holding periods, globally diversified stock portfolios beat portfolios invested only in the home market by 18%. While they lost 39%, home market portfolios fell on average 57%, he said.

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