May 2015 - International Equities Diversified Portfolios Update

The largest US companies have led the market higher over the past few years, and fortunately that’s where about 60% of the portfolio has been invested. However, we think it’s time to reassess that strategy. It’s never a good idea to have all your eggs on one basket, especially if it looks like the eggs might have gotten a bit expensive.

The largest US companies have led the market higher over the past few years, and fortunately that’s where about 60% of the portfolio has been invested. However, we think it’s time to reassess that strategy. It’s never a good idea to have all your eggs on one basket, especially if it looks like the eggs might have gotten a bit expensive.

One of the really difficult things about markets is that you have to worry not only about whether a company or economy is going to do well but whether too many other people think the same thing. If you end up investing in a winning economy but at ruinously short odds, you still lose money.

The chart below shows InvestSense’s expectation of long-term returns after inflation for different stock markets. Even if nothing much changes in the short to medium term we expect the US market to deliver sub-par returns.

Note that these are just our estimates, but we think they are based in sound logic and we are happy to share that with any investors who are interested. Simple metrics such as the price/earnings ratios of major regional indices, which you might see in the papers, tell a similar story.


This is what market professionals call being ‘priced for perfection’, and since nothing is perfect in investment markets it is a situation that often leads to disappointment.

The following graph shows Cash Flow Return on Investment for these countries and regions. This is very similar to the Return on Equity often quoted in the press, being the return an underlying company can generate per dollar of invested capital.

Clearly the US has been the top-performer and US companies will probably continue to be the most well run in the world for some time to come.

But everyone knows that, and that’s why the odds are already relatively short.

What really matters is what happens next.

If moribund Europe does a bit better than expected or a change of regime in India leads to better use of capital then investors in those markets will do well. Equally, there is no guarantee that corporate America can continue to deliver to the extent that it has in recent years. Earnings are linked to the business cycle and that means they go up and down as a company battles competitors and suffers overinvestment or underinvestment.

Portfolio Implications

In a diversified investment portfolio we don’t just have to bet on the winner, and it makes sense to back a few different economies.

As we can invest cheaply in thousands of companies it now makes sense to broaden the International Portfolio’s exposure to different regions. The changes shown below reflect that.

     

28th April 2015

New Allocation

VEU

International Equities

VANGUARD FTSE ALLW EX-US-CDI

14.8%

29.0%

IVV

International Equities

ISHARES CORE S&P 500 ETF

50.6%

30.0%

IJH

International Equities

ISHARES CORE S&P MID-CAP ETF

10.2%

15.0%

IEU

International Equities

ISHARES EUROPE -CDI

8.7%

14.0%

IEM

International Equities

ISHARES MSCI EMERGING MK-CDI

13.1%

10.0%

AAA

Cash

BETASHARES AUS HIGH INTEREST

2.7%

2.0%

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