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June 24, 2014 at 09:20 PM
Using foreign diversification in both equities and fixed income markets may not deliver higher returns—at least, not consistently—but it does drive down volatility, and thus risk in client portfolio, according to Louis Kokernak of Haven Financial Advisors. The rationale is that foreign stocks have a relatively low correlation with the U.S. market.
Even though that’s not always true, particularly as the global marketplace becomes ever more interrelated, Kokernak said that the European Central Bank is currently “considering quantitative easing, whereas we’re winding down ours. [They’re] two economic spheres going in two completely different directions.”
Kokernak has been using international investing to control for risk since he became an advisor, influenced by the likes of William Sharpe, Harry Moskowitz and Ibbotson Associates, who “all argue for international diversification.” As a result, “Generally our stock portfolios are two-thirds U.S. and one-third foreign. Clearly the U.S. is over-weighted relative to market capitalization, but the foreign component is heavy relative to other advisors.”
Among equity holdings Kokernak uses are DFA funds that emphasize value and smaller cap. Specifics include “VEA, for foreign developed market exposure; VWO, for emerging market exposure; DFIVX, for foreign large-cap value; DISVX, for foreign small-cap; and DFEVX, for emerging market value.”
Bonds are also globally diversified, although “the bond space is a bit more complicated,” said Kokernak. The positions the firm takes in foreign bond markets are in some cases hedged against currency risk and in some cases not. Foreign holdings make up a smaller portion of fixed income portfolios, at a fifth to a quarter, and include ETFs, PIMCO funds and DFA funds. Thanks to the “tremendous amount of innovation in this space in the last ten years,” he said, adding there are plenty of options to choose from, which was not the case in the past.
