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Breaking Down International Investing

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Advisor Debra Morrison of Empowered Retirement, Inc. likes to explain things by analogy, so that people are willing to talk about the process of investing —something she says doesn’t happen “unless you break it down.”

And she explains the international components in a portfolio that way, too—components that are necessary because “we are in a global environment. When we limit our horizon to that which we can perhaps physically touch or see,” she said, “we are potentially limiting the return.” And since the U.S. is only a part, and not the largest part, of that global environment, there’s plenty of room for investments in other countries.

Conjuring up the image of a chocolate cake, Morrison pointed out that the recipe calls for some flour and some baking soda. And, just as the cake will have more flour than baking soda, portfolios are over weighted in U.S. investments. But you “have to have some baking soda—frontier or emerging markets” or else you have no cake.

Having done international investing for 37 years “you went to Mark Mobius at Templeton and went to the Tweedy Brown Fund and Helen Young Hayes, who was investing in Pacific Rim countries—active money managers because you knew the managers and strategies,” Morrison said. It’s a lot easier now than then, when it wasn’t so easy to get information on possible investments, she said.

That’s not all that’s easier; these days her firm sticks to passive investments and indexes, and brings in “international investments via institutional no-load Dimensional Fund Advisors’ mutual funds, in a percentage that better reflects the GDP of individual countries relative to the world’s total.” The same goes for bonds, which she uses in the form of “global bond funds—and we keep our maturities very, very short. I did used to buy individual bonds,” she said, “yet most of them were U.S. I don’t know enough, and don’t know whether most people know enough [to buy individual countries’ bonds directly]. I prefer institutional and no-load.”

So how much of the portfolio actually goes into international? Around 40%, said Morrison, is the recommendation for most clients, although the client does have a choice and some are not comfortable with that much outside the U.S.—particularly since many among her clients are older and more conservative. However, Morrison pointed out that “the U.S. is less than half the world market cap and shrinking; 70% of world GDP is generated outside the U.S., and you’ve got to have money in those markets.” In fact, the U.S. finished 2014 as 22nd out of 44 countries, based on its 10-year performance.

“I always like to go back to historic statistics,” she said, “because Mark Twain said, ‘History may not repeat itself, but it will surely rhyme.’ Rather than prognosticate about the future, I always think it’s helpful to see where we’ve been.” And looking at past performance, her decision has been to overweight that 40% that’s in international investments into value.

“[B]ased upon the last 80 years of history,” she said, “there isn’t a significant enough correlation coefficient to warrant midcap investing, so we choose to invest in international large and then international microcap—both in the larger, developed countries as well as emerging markets.” Micro and emerging markets make up 6–18%, while 10–20% is in international large cap. Frontier is represented, she said, in DFA’s emerging markets fund; “a DFA offering will give you a frontier representation that grows into emerging markets; there’s such an affinity for micro.” The firm stays away, too, from investing in currencies.

In another analogy, Morrison said, “It’s so perverse how most people take advice to follow a [financial] plan.” While she counsels clients to “do their homework about what their goals are” by “mak[ing] a good course, then stay[ing] the course … and then we’ll see how current investments are poised to get you to your final goal,” she said that “most people don’t make the good course.”

Instead they pick up bits and pieces of advice from “various and sundry people they meet,” as if they were cruising the aisles of a supermarket—“cereal here, Taylor pork roll there, and [they have] no idea whether it will make a meal. You don’t want clients, and investors in general, buying stuff up—and on commission!—with no idea if it will get them to their goal on the timeline they want, and then acting helpless when it doesn’t work.”

But that’s how many people operate, she said, doing “rear-view mirror investing” by looking at magazines and choosing the latest five-star fund and buying that—and then dumping it if it doesn’t continue to deliver five-star returns. Instead, they need to be looking at three-star funds that have the potential to grow into five stars. “You can’t look to past performance, and certainly not to immediate past performance, and tweak the allocation.” Especially in frontier and emerging markets, their volatility will cause them to move between “fabulous” results and plunges, and many investors will take one look at the drop and sell—never sticking for the long term and the growth that can result.

Said Morrison, “Let’s map it out [the financial plan] like a hike, or a picnic or dinner, and then let’s follow it. If the recipe calls for 350 degrees for an hour, don’t open at 20 minutes and run your finger through it to see how it’s doing.”