International Asset Allocation
by Craig MacKinlay
Over the past several years, investments in the U.S. stock market have had a higher annualized return than investments in non-U.S. markets when viewed from the perspective of an U.S. investor. For the five-year time period ending on April 29, 2016, the S&P 500 index provided on average an annual return of 11.02%. In contrast, the MSCI ACWI ex USA, which captures approximately 85% of the global equity opportunity set outside the US, was basically flat with an average annual return of -.13% in U.S. dollars. As discussed in last May’s edition of Partner Talk, this large performance difference naturally leads to questions of the benefits of an international allocation in investment portfolios, a topic that is considered in this edition of Partner Talk.
One can ask the question – “What drives return differences across markets?” It is the case that, in a macroeconomic sense, the relative performance of markets does depend on economic activity and fiscal imbalances around the world as well as the actions of central banks. However, building a macroeconomic model to explicitly capture such effects is complicated and soon becomes intractable. A simpler way to think about the return differences is to recognize that because international returns are ultimately translated into U.S. dollars, the strength of the dollar plays a key role. Indeed, this has been the case in recent periods.