When it comes to our portfolios, many investors have biased positions in the United States. And that sort of makes sense. As the world’s largest single market and a bastion of capitalism, it stands to reason that the U.S. would have an overweight position. However, that position may not be the best idea for the long haul.
It turns out that exposure to international equities makes a ton of sense.
This is where model portfolios can help. By offering a dedicated sleeve to international stocks, investors can have the benefits of going global while eliminating those underweight positions. The static nature and stability of a model can truly achieve that framework.
Hometown Biases
It’s easy to see why the U.S. is the most prominent allocation in many portfolios and models. After all, it’s the single-largest world economy, and its financial markets are some of the most liquid. And as U.S.-based investors, we tend to be very familiar with our brands, companies, and stocks. Analysts are all too familiar as well, with the U.S. boasting the widest comprehensive analyst coverage of all global markets.
So, it’s easy to load up.
And load up we have. According to brokerage and retirement plan data, the average U.S. investor has only about 10% of their allocations in international equities. However, the numbers are skewed. Most investors have a 0% weighting.
Even when trying to go global, we may fail to miss the mark. That’s because the rise of technology stocks like Apple, Microsoft, and Google has influenced major indexes to make the U.S. a top-heavy position. According to MSCI, the U.S. has gone from just a 40% weighting in the MSCI All Country World Index at the end of the financial crisis to more than 62% today. 1
Why an International Allocation?
The trend of hometown bias and growing U.S. influence in global indexes is a real shame as having an international portfolio can provide plenty of benefits.
For one thing, diversification. While it is true the U.S. is the single largest market, it doesn’t hold all the world’s stocks. Heck, it doesn’t even hold a third of them. Globally, there are about 58,000 listed companies. Kicking out the U.S., we are still left with more than 46,000. That is a lot of potential stocks to pick from. And those stocks provide plenty of diversification benefits.
The individual nations that hold those stocks also provide plenty of diversification opportunities. After all, the economies of Germany and France may be influenced by similar factors, but how they respond with policies, taxes, etc., are all different. A recession in India doesn’t mean there is one in Canada. Interest rate differences and central bank policies, laws, etc., all serve to influence their regions and nations. That provides a vastly different return set than focusing on nations like the U.S. 82% of the time, the top 50 performing stocks in the world haven’t been from the U.S.
As for those returns as a whole, they have varied over time. It’s easy to see the current U.S. dominance, but that is not always the case. It’s flip-flopped over history. This chart from Hartford underscores how the U.S. isn’t always on top and the outperformance/underperformance tends to go in cycles.
Source: Hartford Funds
Investors solely focusing on the U.S. could miss out on these extra returns during these long cycles of underperformance.
Second, international stocks tend to be less volatile than U.S. ones. The reason comes down to dividends and a value tilt.
The different dividend culture—which bases dividends on a percentage of profits rather than a static payout—creates a less volatile and higher yielding set of stocks. The yield on the S&P 500 has continued to drop and is now about 1.2%. Looking at the MSCI ACWI, an ex-U.S. index represented by the iShares Core MSCI Total International Stock ETF (IXUS), international stocks have a trailing 12-month yield of 2.52%. That higher cash return provides lower volatility to international assets.
Additionally, international stocks tend to have more of a value tilt. Because of their lower starting valuations, international equities tend not to bounce around as much U.S. growth-oriented stocks. Investors already have a margin of safety built into shares. This combined with cash return of the larger dividends smooths out a portfolio.
A Model Can Help
The trend of hometown bias and growing U.S. influence in global indexes has made building a diversified international portfolio more challenging for equity investors. This is where model portfolios can truly help investors and financial advisors get international exposure to capture all the benefits.
By including a dedicated international ETF as a core portfolio position, investors can truly get the diversification and income, and rescue the volatility of their portfolios. Moreover, they can benefit when the U.S. outperformance cycle ends and the international one begins.
As for that percentage, asset manager Vanguard estimates about 20% of your equity portfolio will be in international equities. But some managers have suggested as high as 50% to represent the true makeup of the world’s economy.
Either way, a broad ETF makes a ton of sense to achieve this allocation. It can be quickly rebalanced to meet the target allocation of a model. Investors may also want to check out an active approach. Many of the inefficiencies and lack of coverage can benefit active managers with more than half of managers beating their benchmarks in the sector.
International Active ETFs
These funds were selected based on their low costs and sorted by YTD total return, which ranges from 7.8% to 12.2%. They have expenses between 0.18% to 0.55% and assets under management between $20M and $5.5B. They are currently yielding between 0.1% and 3.3%.
| Ticker | Name | AUM | YTD Total Ret (%) | Yield (%) | Exp Ratio | Security Type | Actively Managed? |
|---|---|---|---|---|---|---|---|
| JIRE | JPMorgan International Research Enhanced Equity ETF | $5.1B | 12.2% | 2.33% | 0.30% | ETF | Yes |
| OSEA | Harbor International Compounders ETF | $20.75M | 11.1% | 0.1% | 0.55% | ETF | Yes |
| AVEM | Avantis Emerging Markets Equity ETF | $3.9B | 10.3% | 2.66% | 0.33% | ETF | Yes |
| DFAI | Dimensional International Core Equity Market ETF | $4B | 9.5% | 2.69% | 0.18% | ETF | Yes |
| DFAX | Dimensional World ex U.S. Core Equity 2 ETF | $5.5B | 9.3% | 3.24% | 0.3% | ETF | Yes |
| DFIC | Dimensional International Core Equity 2 ETF | $4.1B | 9.3% | 2.75% | 0.23% | ETF | Yes |
| AVDE | Avantis International Equity ETF | $3.2B | 8.8% | 2.78% | 0.23% | ETF | Yes |
| CGXU | Capital Group International Focus Equity ETF | $1.5B | 8.4% | 1.16% | 0.54% | ETF | Yes |
| AVDV | Avantis International Small-Cap Value ETF | $3.8B | 7.8% | 3.31% | 0.36% | ETF | Yes |
Passive International ETFs
These funds were selected based on their exposure to international stocks via a passive management style. They are sorted by their YTD total return, which ranges from 3.1% to 5.1%. They have expenses between 0.03% and 0.32% and assets under management between $3.62B and $443B. They are currently yielding between 1.8% and 4.9%.
| Ticker | Name | AUM | YTD Total Ret (%) | Yield (%) | Exp Ratio | Security Type | Actively Managed? |
|---|---|---|---|---|---|---|---|
| ACWX | iShares MSCI ACWI ex US ETF | $4.56B | 5.1% | 2.9% | 0.32% | ETF | No |
| VXUS | Vanguard Total International Stock ETF | $443B | 4.9% | 1.8% | 0.08% | ETF | No |
| VEA | Vanguard FTSE Developed Markets ETF | $184B | 2.9% | 4.9% | 0.06% | ETF | No |
| IXUS | iShares Core MSCI Total International Stock ETF | $37.9B | 4.9% | 3% | 0.07% | ETF | No |
| GSIE | Goldman Sachs ActiveBeta International Equity ETF | $3.62B | 4.6% | 2.7% | 0.25% | ETF | No |
| EFA | iShares MSCI EAFE ETF | $55B | 3.1% | 2.8% | 0.32% | ETF | No |
| SPDW | SPDR Portfolio Developed World ex-US ETF | $21.1B | 3.1% | 3.5% | 0.03% | ETF | No |
In the end, international stocks have a lot to offer investors. And in this one case, a model portfolio could be best. A static allocation that is meaningful can provide all the benefits—including higher returns, lower volatility, and diversification—to a portfolio. By combining active and passive ETFs in the sleeve, model investors can potentially have slightly higher returns than simply using a passive fund.
Bottom Line
Investors are woefully underweight international stocks. That’s a shame as they can provide some serious portfolio benefits. But, thanks to the rise of model portfolios, investors and their advisors can truly unlock international potential via an allocation to these stocks.
1 MSCI (December 2024). ACWI IMI’s Complete Geographic Breakdown
