Benefits of International Equity Investing
Currently, Canada makes up 3% of the global equity market capitalization. This means there is another 97% of opportunities outside of our borders. It was only back in the year 2000 that the Canadian government increased the foreign RRSP limit from 20% to 25%, raised it again to 30% in 2001 and removed any restriction in 2005.
In Figure 1 we can see which segments make up the global equity market. Canada is currently 3% of the global equity market, the USA is the largest market with 52% while the rest of the developed markets such as Europe and Japan contribute 37% and emerging markets are the remaining 8%. Naturally, after Canada, the next logical place for Canadians to invest has been in the USA, home to some of the biggest companies in the world just to the south of us. But what about the other 45%?
Figure 1 MSCI All Country World Index Composition
In this piece we address why international investing is appropriate for anyone’s investment portfolio. To start off, we would like you to think about how you make your consumer purchase decisions. What brand of car you drive? Is it a BMW (German), Toyota (Japanese) or Hyundai (Korean)? If you have any luxury handbags it could be a Louis Vuitton (France) or Gucci (Italy). When we buy things for ourselves (or others), we buy brands from all over the world to find the best fit. We do not limit ourselves to only Canadian or US made items. The same principle applies to investing in global equities. International investing provides more opportunities to choose the best companies anywhere and can provide exposure to market segments not well represented in North American markets. In this example, when it comes to automotive OEMs (original equipment manufacturer) there are great global brands available in Europe, Japan and Korea. While good brands exist in the US as well, they are not the best choice for everyone. In the luxury space, there are some public companies available in North America too but the vast majority of luxury brands come from Europe.
Global investing can also provide diversification, lower portfolio volatility and enhance returns. Table 1 looks at 10 year equity index returns in Canadian dollars for the TSX, the S&P 500 and the MSCI EAFE index which includes Europe, Australasia and the Far East. We can see during different periods we can get varying degrees of performance from each market. From 2005 to 2015 the US S&P 500 was the best place to be. From 1997-2007 it was the Canadian TSX that provided the highest returns. From 1984 to 1994 the greatest returns were found in the international markets. Having diversified global exposure allows investors to capture higher potential returns in other markets and lowers overall volatility over the long term.
A third benefit to global investing is the ability to take advantage of regional differences in the economic cycle, valuation, earnings growth and momentum. In Table 2 we have compared different regional indices to their projected price-to-earnings ratio for 2018 and 2019 along with earnings-per-share growth and dividend yield. We actually see a good case for all regions at the moment. Valuations overall are not very daunting in Canada, US or internationally and the EPS growth for each market also looks attractive. While the US is the most expensive market currently, it also has the highest earnings growth this year thanks to US tax reforms and a weaker US dollar which makes US company foreign earnings translate better in US dollars. Over 40% of the S&P 500 revenues are derived from outside of the US. Canada has significant exposure to late-cycle commodities and energy as well as financials which will benefit from increasing resource prices and rising interest rates.
If we look to the international markets, they look attractive too. The biggest markets in the international space are Europe and Japan both of which we like. In Europe, valuation is at a discount to the US; dividend yield is very high and earnings growth is good. Earnings growth in Europe is also less mature than in North America. Earnings in Europe are still more than 20% below peak levels from 2007 as the region only started to recover from its recession in 2013, several years after North America. Earnings really only started to show good growth in 2016. In Japan, monetary policy is the most accommodative of any developed market country. The valuation here is actually cheaper than it appears because Japanese companies on average have very little net debt; and often has a lot of net cash. Japanese firms run very conservative balance sheets. Japan is one of the few countries where valuation is well below its historical average.
Overall we feel that there are good reasons to have a globally diversified portfolio with the ability to hold assets from all regions. It provides greater choice in finding the best opportunities globally; provides diversification and lowers portfolio volatility, and offers an opportunity to enhance returns over the long term.
Kai Lam, CFA
Vice President & Portfolio Manager, International Equities
Jones Collombin Investment Counsel Inc.