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Portfolio > Economy & Markets

Returns and Diversification Value Outweigh Volatility

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If you ask Larry Luxenberg of Lexington Avenue Capital Management how long he’s been doing international investing in his clients’ portfolios, he’ll tell you it’s “been decades.” Back in those days, he used ADRs and mutual funds that participated in foreign investments; now he primarily sticks to open-end mutual funds and some ETFs.

“Foreign investments should be a significant part of most investors’ portfolios,” Luxenberg said. “Foreign stock markets represent more than 50 percent of world stock market capitalization and foreign markets have been growing faster than the U.S. in recent decades. While foreign markets have been more volatile than the U.S., their greater returns over time and value as a diversification outweigh this disadvantage.”

While he doesn’t favor particular regions, countries or industries, he does aim for global diversification—something that he strongly believes in. “I often come across clients who have specific investments before they start working with me,” he said, “but I try to get them to take a more diversified approach.”

As a rule it works well, although he said sometimes clients do push back on emerging markets. But diversifying doesn’t mean a scattergun approach, either. “I had one client in particular who had ETFs in a dozen or more countries, but the net effect of that is not as diversified as some open-end mutual funds. And that kind of investing leads to a hodgepodge portfolio and doesn’t let you achieve [the results you’d get from a more focused approach],” he said.

The rest of the world may take up more than half of global stock market capitalization, but Luxenberg said for the past five years he’s aimed at keeping about a third of the portfolio in foreign markets, in a combination of developed countries and emerging markets.

While the exact proportion of markets made up of countries other than the U.S. has seen “some fluctuation over that period,” he said, with the U.S. weighting moving between 45–50%, the changes have not been “significant enough for me to change” the ratio in the portfolio.

He also uses international bonds, but “in this environment, fixed income yields have been so low that the differential between global and domestic hasn’t been that significant. I haven’t felt that the risk justified it for the most part. I do use a little global fixed income, but not as much as on the equity side.”

One caveat to international investing, he said, is that international has been more volatile than domestic. “And I think a secondary drawback comes under the heading of tracking error. When people turn on the news and see that the Dow has gone up a lot, and look at their portfolio and see it hasn’t, because international has performed poorly, they’re upset,” he said.

“You have to look at your overall portfolio—where you’re invested, and what you’re trying to achieve over long term—and make sure the client understands the potential for this temporary tracking error. And you also don’t want to weight a portfolio too much, so that this kind of effect will be too pronounced.”

People get fearful, Luxenberg said, when they hear the term emerging markets. “When you start talking about the companies they represent, and the opportunities, most people don’t intuitively connect that with commodities. But by definition, emerging markets are very heavily commodity oriented. People want to participate in commodities, but they don’t necessarily connect that with emerging markets.”

But it’s definitely worth educating clients. “Over time, over the last two to three decades, international equities have appreciated faster than U.S. equities, [so if they’re not invested in them] they’re missing out. For the last five years, the U.S. was stronger than international, but if you go back 10, 15, 25 years, international has outperformed the U.S. The most dramatic example is that, in 1990, emerging markets were three quarters of one percent of equity markets. But as of the end of August, they represented 11 percent. Over that time, if you weren’t doing emerging markets, you lost a huge opportunity.”


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