The Big Picture for the Week of November 7, 2010

James Picerno explored an idea put forth by research at MSCI Barra about what role global benchmarks should play in portfolio construction by money managers and the extent to which more and more US based managers are going global. This is of interest here because going more into foreign equity exposure has been one of the primary threads on this site.

A building block for the conclusion of the research was the extent to which US stocks comprise less of the world's total market cap; down to 40% from 50% ten years ago. As an active manager the nitty gritty of indexing is obviously not as important as any of the active decisions that might get made. One way to look at the US' market cap going from 50% to 40% during a ten year stretch where the US was down is that foreign outperformed during that time period. While I haven't looked under the hood of the research it is reasonable to conclude that foreign grew in the world's market cap at the expense of the US given that, again, the US was down for the period in question.

Part of the goal of active management of course would have been to look forward and see that foreign might be poised to outperform. From the point I started this phase of my career, early in the last decade, this seemed like a very obvious conclusion to draw; that is that specific foreign markets would outperform the US.

From an evolution standpoint, since inception in late 2001 the iShares MSCI EAFE Index Fund (EFA) is up 49% versus a 9.4% gain for the S&P 500 so EFA was the better hold. However almost all of that advantage occurred in the earlier part of the decade before the financial crisis. In the last five years EFA is up 5.4% versus a gain of 0.47% for the S&P 500--the 5.4% is overstated because the euro is up 20% versus the greenback in that five years and EFA obviously translates into dollars. Before you say that all correlations went to 1.00 I would point out that in the last five years Brazil and Chile are each up about 140%, Israel is up 70%, Shanghai is up 200% (despite being down 50% from its peak), Malaysia up 60% and so on.

James quotes the research as follows; "our research suggests that global equity mandates, together with dedicated emerging market mandates and small cap mandates, may be emerging as the 'new classic' structure for implementing equity allocation." Conceptually this is fine but I am not a fan of being overly rigid with these things, obviously as an individual you don't have to be overly rigid and if you are an advisor then you may or may not have flexibility with this sort of thing. We do have flexibility for the reason that if it makes more sense to simply avoid some segment of the capital market than to pick the thing that can go up while everything else is going down then that is what we'll do.

James opines that "a possible equity mix might be constructed with a 50% weight in a global equity fund with the remaining 50% allocated in regional, industry and/or style funds." Above a certain account size I am not a fan broad based like ACWI and VT which are specifically mentioned elsewhere in the article but from the standpoint of staying on your own mat this can be a suitable way to go.

From 30,000 feet I obviously agree with the article but I think the conclusion was obvious years ago. I do not really believe that most of the investment management industry is only now getting around to discovering foreign investing and doing so only with the broadest funds. Whether that is true or not hopefully my years of advocating narrower exposure has resonated with you and you are doing the research, making the decisions and taking advantage of the resources available.

On a related note I am seeing more and more articles on investing in Argentina. The country has a lousy history, was much more globally relevant many years ago, does have some positive attributes looking forward and a little recent political uncertainty mixed in. Per BNY Mellon ADR site I count 24 ADRs available between the NYSE and five letter stocks. The benchmark Merval Index has historically been more volatile than the US market. As a microcosm, during the last five years it fell a little more than the US during the meltdown and is up much much more than the US since the low.

Now, as markets are going up all sorts of favorable attention is being paid and it makes you feel like you've missed something but on the next meaningful downturn I would assume it will go down much more and any commentary will make you feel like you are crazy for ever having even thought about buying in. You can sort out whether Argentina specifically makes sense for you but the volatility characteristics of the country are not unique and do have a place in a diversified portfolio. While not a new destination, there was a closed end fund many years ago that appears to be gone now, it might be new to you and there will be other new destinations too.

As much as I like Chile, in theory if everyone buys in it won't go up anymore. While that is a ridiculous comment it makes the point mentioned above which is the themes and destinations do evolve and sometimes the evolution makes them a sell and if a country does need to be sold then it needs to be replaced.