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With U.S. corporations generating so much of their revenues overseas, there's been a growing debate about whether you need direct foreign exposure. The answer is yes—and here's why:
Jack Bogle, founder of the Vanguard Group, recently argued that investors get sufficient foreign exposure indirectly through U.S. multinationals. According to FactSet, about a third of aggregate revenues for the S&P 500 index of U.S. companies is generated abroad. That's true. But what you don't get by simply investing in the S&P 500 is the chance to generate higher returns from a broader array of companies. This year, for example, U.S. equities are up about 8%. But European stocks are up 15%. India is up 19%. Mexico is up 20%. China is up 23%. And the stocks in Poland have soared 36% year to date.
In periods of turmoil and crisis, stock markets around the world tend to fall in unison. That was certainly the case in the global financial panic of 2008. So holding foreign stocks doesn't always protect you. But over longer stretches, "owning a globally diversified portfolio opens you up for less risk of a really bad outcome," says Ben Inker, head of the asset allocation team at GMO. While global stocks are somewhat correlated with one another, individual markets tend to move in sync with the stock sectors that dominate their economies. For instance, "the U.S. market acts like a tech stock ETF," says Jeffrey Kleintop, chief global investment strategist for Charles Schwab. "Japan tracks the financial sector. Germany tracks autos. And Canada's stock market tracks energy stocks." Therefore, having broad global exposure helps diversify your sector bets too.
"One of the most underappreciated reasons for foreign exposure comes with currency. The foreign currency you get from owning foreign stocks provides investors with a hedge against inflation," says Brian Singer, a portfolio manager with the asset manager William Blair. If inflation were to climb, reducing the purchasing power of the dollar, "it would be nice to have some nondollar exposure in your portfolio," says Inker. With inflation growing at 2.2%, this may not seem like a priority now. But if the U.S. economy heats up, the case for going abroad will be that much stronger.