- Index fund legend Jack Bogle has long considered international equity investing to be unnecessary.
- But some of the Vanguard Group founder's most recent comments on the subject show a less-than-dogmatic Bogle, though he is clearly still a U.S. stock market–first kind of guy.
When investors go looking for a reason not to follow the market crowd, they've always been able to rely on Vanguard Group founder Jack Bogle. The benefits of international investing is one of those contrarian-Bogle areas. Even though Bogle first made his U.S.-centric stock market views known more than two decades ago, there are no shortage of articles reiterating his belief in any given year. The press keeps asking Bogle about it, cribbing notes from his latest responses on the subject.
It's a good time to take a look at Bogle versus the go-international crowd. International investing has had a great year, and more investors have embraced the concept through exchange-traded funds: Five of the top 10 ETF inflows this year are developed markets (ex-U.S.) and emerging markets portfolios, taking in roughly $62 billion from fund investors.
Bogle took some questions from financial advisors and investors at the summer Morningstar Investment Conference, a private session to which Morningstar provided CNBC with an exclusive link for review purposes. During the session Bogle again provided an answer to the international investing question, when asked specifically whether the run-up in U.S. stocks led him to at all change his view. Bogle's response neatly summed up his view, but also showed that he is far from dogmatic, even open to the opposing, go-international camp.
Here are three things Bogle said about taking stock portfolios overseas and why they shouldn't represent a hard "no" for investors.
1. When Bogle first outlined this approach, it was in a book he published in 1993. Bogle acknowledged it at the Morningstar conference — in fact, it was the first thing he said.
"I wrote that as far back as 1993, when I was thinking about currency risk, and financial and institutional risks in other countries."
Obviously, a lot has changed in close to 25 years.
Alex Bryan, director of passive strategies research at Morningstar, said there's another way to poke holes in this talking point, especially over a long period of time.
"Even if the U.S. has a more favorable regulatory environment, stronger property rights, better innovation than in other countries, etc., market prices should already reflect those things," Bryan said.
2. The U.S. has done much better than the rest of the world. But that only makes Bogle right about the past, not the future.
"Since then , the S&P 500 is up 700 percent and non-U.S. up 300 percent, a huge difference. I've been right, but maybe I'm wrong now, after all those years lagging around the world. Maybe now is the time to step up international."
There is no reason to expect that relative outperformance to continue.
"U.S.-focused investors have been fortunate in the past, but there is no reason to believe that the U.S. stock market is priced to offer better returns over the long run than stocks listed outside the U.S.," Bryan said.
He added, "What matters is how things unfold relative to consensus expectations. In order for U.S. stocks to outperform over the long term, they need to do better, relative to investors' expectations than non-U.S. stocks. It is almost impossible to predict whether they will."
This month the International Monetary Fund lifted its growth outlook for the United States, the euro area, Japan and China from its last forecast, in July. The fund projects the global economy will grow 3.6 percent this year and 3.7 percent next year, in both cases an increase of 0.1 percentage point from its previous estimate. It also would represent the fastest growth rate since 2011.
Christine Lagarde, the head of the IMF, said in Oct. 5 remarks that "the long-awaited global recovery is taking root" and that three-quarters of the globe is enjoying an economic upswing in "the broadest-based acceleration since the start of the decade."
The S&P 500 has returned 7.5 percent on an annualized basis over the past decade, whereas the MSCI EAFE index has gained less than 2 percent over that same stretch.
But cherry-picking data can make either argument look better: Fran Kinniry, a principal in Vanguard's investment strategy group, said at the Morningstar ETF Conference last month that while the preceding 10 years have favored U.S. stocks at the expense of non-U.S., the 10-year period from 1997–2007 saw foreign stocks trouncing domestic names. WisdomTree Investments, which runs some of the bigger international stock ETFs, notes that 10-year rolling returns for the MSCI EAFE Index produce an average return of 5.5 percent. The 1.7 percent return over the last decade ranked it in the bottom decile of EAFE's 10-year returns, meaning 90 percent of the other periods generated higher returns.
Still, over a period of decades, from January 1970 through March 2017, foreign stocks lagged their U.S. counterparts, with greater volatility, Bryan noted in a recent commentary. But with less-than-perfect correlation between assets, a globally diversified portfolio does lower overall risk.
Bogle said himself at the summer event, "I do think investors can make a legitimate choice; if they want to do non-U.S., they should do it." He added that if an investor is determined to go overseas, he would recommend no more than a 20 percent allocation.
3. There is a lot more to invest in now than just the EAFE, which was a primary part of Bogle's criticism.
"The three largest countries in the international index [EAFE] are Great Britain, Japan and France, and to bet those countries will do better than the U.S. in the long run is a bad bet."
That's still true today. Those three countries still comprise a little over half of the overseas developed markets index. But Bogle's argument didn't take into account the rise of emerging markets.
Bogle said recently that if he were to invest internationally, it would be in emerging markets, but not more than 5 percent.
Bogle has other reasons for remaining an America-first guy when it comes to investing. He has noted that so many of the large U.S.-based multinationals derive a significant portion of revenue from foreign markets, the international exposure is effectively handled through an S&P 500 index fund.
Others have pointed out that correlations between the United States and foreign markets are rising, diminishing the benefits of risk diversification. Recently as high as 0.8, they're still not at 1. A correlation of 1.0 is considered "perfect" lockstep movement for assets; anything lower can reduce overall portfolio risk.
According to Morningstar Direct, the correlation between the MSCI EAFE Index and S&P 500 over the past 40-year period (1976–2017) is 0.71. The correlation between the MSCI Emerging Markets Index and U.S. equities (over the shorter period of 2001–2017) is 0.75.
"The best course of action is to own a globally diversified portfolio," Morningstar's Bryan said.
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Bogle provides one more compelling reason for his argument, and though it lacks market data, it has billions of dollars backing it:
"Maybe they should abandon this idea, but I stick with it myself, and there is a certain individual who lives in Omaha who is leaving his trust for his wife to be invested 90 percent in the S&P 500. I would hope if Bogle and Buffett agree, the world would say, 'For so long you've been all right.' But that's not the case. We can both be wrong very easily."
There is one group of Bogle disciples who often depart from the master on this topic: the Bogleheads, an online community of Vanguard Group diehards that works with the John C. Bogle Center for Financial Literacy.
They don't view Bogle as being dogmatic about any issues other than keeping costs low and ignoring the daily noise in the markets. And they see a simple way to gain exposure to international markets that stays true to the Bogle ethos of low-cost index funds. It's called the three-fund portfolio. The Bogleheads thread about the three-fund portfolio is one of its most popular investing threads ever, with more than 25,000 posts.
The three-fund portfolio is typically a domestic stock "total market" index fund, an international stock "total market" index fund and a bond "total market" index fund. With the rise of low-cost and broadly available index funds and exchange-traded funds, there are plenty of options available to investors to create this simple asset-allocation plan and match the advice of most investing experts — except Bogle and Buffett.
Alex Frakt, an administrator of the Bogleheads site, said the group recommends international holdings. He stressed he does not speak as a "chief" of Bogleheads, and the online forum comes closest to its community "ideal" when answering investing questions. But he said via email that based on the posts by members, a 20 percent to 40 percent international equity allocation is the typical recommendation. He also noted that Bogleheads who hold to a zero percent — or 50 percent and above — view about international exposure tend to be the outliers, who speak up when their view is "highly correlated with the previous five years of relative returns of the two asset classes."
Frakt said he interprets Bogle's negative views on international investing through Bogle's underlying philosophy: Bogle's goal in answering basic investing questions is to serve the majority of investors. "Generally, he feels that investors should keep it simple, because the more active they are, the more likely they are to start doing really detrimental things, like betting on particular stocks or sectors or timing. This is the same reason he initially opposed ETFs and believes in total market investing, rather than asset class slicing and dicing."