Global Diversification

In the past United States citizens have often been somewhat narrow-minded when it came to investment opportunities. At least part of this is attitude has no doubt been due to the fact that the U.S. is fairly isolated geographically, along with the dominant position that America has enjoyed both politically and economically. Another reason for this myopia is that investors in the U.S. stock and bond markets have historically benefited from very strong returns and, as a result, have often seen little benefit of diversifying their portfolios internationally. However, in recent years, things have taken a dramatic swing away from such nationalistic viewpoints. The fact is that non-dollar markets have currently (and significantly) outperformed – and will likely continue to do so – the United States market. This turn of events can be attributed to a number of causes.
The first reason overseas markets often provide investors with a higher return potential is that many overseas economies are growing at a faster rate than the U.S. economy. Naturally, the faster the rate of local economic growth, the greater the growth potential is for the companies that operate in those markets. This faster growth rate can be attributed to several factor, including a faster rate of population growth relative to that of the United States, the transformation of these often less-than-technically-advanced economies into more modern and productive markets, and the widespread adoption of democracy, capitalism, and the rule of law among these nations. As long as these trends continue, the emerging markets will continue to enjoy a faster rate of economic growth than the U.S., which is a mature market by comparison.
Another reason for higher rates of growth abroad is that overseas companies are typically subject to less government regulation. U.S.-based businesses face a formidable amount of government regulation, which covers virtually every aspect of creating and operating a business. While no one would argue that many of these regulations are beneficial and even necessary, they do nevertheless often put United States businesses at a competitive disadvantage relative to their foreign competitors. Companies operating outside the United States often face far less government regulation and, as a result, lower operating costs.
One of the principal advantages that non-U.S. companies (as well as domestic companies that operate overseas facilities) enjoy is markedly lower labor costs. These lower costs include both wage and benefit expenses. In many emerging markets, there's no health, dental, disability or unemployment insurance, not to mention company-sponsored retirement plans. Additionally, laws such as the federal Family and Medical Leave Act – which guarantees that U.S. workers who take time off to care for newborn children or sick family members will not lose their jobs – are unheard of in many overseas markets. However, low labor costs alone will not build a viable economy unless the work force is also well educated and equipped with a strong work ethic. In many countries, the school year is longer and the curriculum more rigorous than that in the United States. And the work ethic among blue-collar workers in numerous foreign countries is either equal to or (more likely) greater than that of the average U.S. blue-collar worker.
Internationally, governments often take a very active role in promoting and protecting business – unlike the U.S. market, where the relationship between government and business can frequently be more antagonistic than cooperative. Additionally, one of the favorite tools of United States foreign policy-makers is the trade embargo. While the government considers these embargoes to be an effective tool to promote U.S. national interests, such tactics typically hurt United States companies. Since domestic entities are prohibited from doing business with or in nations that are embargoed, non-U.S. companies will naturally step in and fill the void.
But while non-dollar markets do have a number of advantages, they also have disadvantages that should not be overlooked. For instance, many foreign securities markets are considerably less well-regulated than their U.S. counterparts. And while that is not to suggest that the United States markets are completely free of illicit manipulation, it's certainly less of a problem than in many other markets, where market manipulation is sometimes rampant. Other disadvantages include:
Lower liquidity. In the U.S. market, daily trading volume is extremely high, resulting in excellent liquidity, especially for the smaller investor. In other markets, volume can sometimes drop to alarmingly low levels. Low liquidity can force investors to accept a lower price when they sell their securities or pay a premium when they buy.
Higher trading and transaction costs. The lower liquidity and the lack of automation in some overseas markets can dramatically raise trading costs. The cost of trading in the U.S. is only a few cents per share; in other markets the expense may be many times higher. This not only reduces investment profits but also works to limits investors' flexibility.
Less required financial disclosure. United States companies that issue publicly-traded stocks have rigorous reporting requirements. Overseas companies, on the other hand, often enjoy more flexible requirements. These may include, for example, the ability to maintain undisclosed reserve accounts. As such, investors who buy non-dollar stocks may run a greater risk of unpleasant financial revelations.
Stockholders are a lower priority. In the U.S., heads of public corporations know that their major (and sometimes only) priority is to enrich the shareholders to whom they report. In other markets, enriching shareholders is often only one of the business's priorities – and not necessarily one of the highest. As a matter of fact, some foreign governments have clearly stated that they expect corporate shareholder returns to take a back seat to social progress and wealth redistribution.
Higher short-term volatility. While non-dollar markets may offer a higher rate of return, they also tend to come with higher short-term volatility. Large short-term price swings, both up and down, can reasonably be expected. These swings are the result of both changes in the valuation of the stocks in their native currencies, as well as swings in the U.S. dollar-versus- the native currency foreign exchange rate. Investors not able to tolerate such high volatility should avoid such markets, even if it reduces their total return.