Why You Shouldn’t Give Up on International Investing

On this episode of The Long View, David Herro from Harris Associates, who has been a longtime portfolio manager at Oakmark International and Oakmark International Small Cap, and Rajiv Jain from GQG Partners, which he founded in 2016, join the podcast live from the Morningstar Investment Conference 2024 in Chicago to discuss the case for international investing.

Here are a few excerpts from Jain and Herro’s conversation with Morningstar’s Christine Benz and Dan Lefkovitz.

Why Investors Should Have a Globally Diversified Portfolio

Christine Benz: The session is called Should US Investors Renew Their Passports? And we want to dive right into that. I recently posed this question to some financial advisor friends. I gave them two choices and said, which of these discussions are the most difficult ones with your clients? And the first one was coaxing them out of cash and into bonds, which I think I’ve been hearing is a tough sell. And the other was keeping the faith in international investing. And to my surprise, more of them said that the international investing question was the difficult one, that their clients were feeling uneasy with international equity allocations, especially given the performance differential relative to their US equity portfolios.

So, Rajiv, let’s start with you and talk about when you’re making the elevator pitch for why people should have a globally diversified equity portfolio, what do you say? What are the main reasons to keep the faith?

Rajiv Jain: As you know, this has been an age-old question and usually happens after 10 years of underperformance of non-US. Our view is that at the end of the day, corporate earnings will drive returns and if you leave US, these cycles that happen from time to time in different markets, you actually get a reasonably diverse book of investments you can have outside the US. And over the very long run, the returns patterns are remarkably similar. So, if you’re sitting for 2000-10, you actually didn’t really make any money in the US, and then the US did very well. If you’re sitting in ‘90 to 2000, you did well in a lot of non-US. So, I think these cycles come and go, but that’s the whole point of diversification is not everything should go up and down together.

Are the Higher Valuations of Stocks in the US Justified?

Dan Lefkovitz: David, I remember talking to you 15 years ago during a very different time, when stocks outside the US were on top. Throughout this very long run of US outperformance we’ve seen recently, people have said valuations are better outside of the US and yet US continues to outperform. What do you think—are the higher valuations in the US justified? Why haven’t lower valuations been a catalyst for ex-US?

David Herro: As a value investor who bases my appeal and my appetite for investing in certain stocks based on the cash flow streams and the price I have to pay for that cash flow stream. And you’re exactly right. We go through these periods where cash flow streams are more expensive or less expensive. If you look at what’s happened in the last 10 years, as Rajiv said, there’s been huge valuation divergence between US and non-US stocks. It used to be the US trade at 14%, 15% premium. Today, that number is almost a 50% premium. Some of this is also driven by currency. Don’t forget the dollar bottomed in 2014. When we buy shares in a foreign company, we have to buy the local currencies. And when the currencies are expensive, as they were in 2013-14, foreign currencies were very expensive.

Now in the last 10 years, they’ve devalued. So, the owner of foreign stocks has not only faced devaluation versus the US, but currency devaluation. So, the underlying investment is now a lot less expensive than say a US counterpart. And you’re able to buy those investments using undervalued currencies. So, looking forward, you have a double positive: underpriced stocks using underpriced currencies. Unfortunately, to have gotten to this position, we’ve had to go through 10 years of pain—a headwind of share prices falling or valuations falling and currencies falling. I just personally don’t think it’s sustainable. We’re investing in financial assets. The financial assets value is based on the cash flow stream it generates. And all else equal, you want to pay a low price and not a high price for an equal cash flow stream.

So, I know it’s been tough, and it’s especially been tough if you’re a value investor. Because not only do we have the international versus US headwind that we faced, but we also have the growth versus value. So, it’s been a double headwind for us. But I say if it looks bad in the rearview mirror, the front windscreen looks really good. The last time, I think what you’re talking about was 2007. I told the crowd, you look back and you see all these double-digit returns. Don’t believe that. That’s unsustainable. Companies do not create value, generally speaking, double digits. Now when you look back and you see international, international value, you see low single digits. Don’t believe that either. That’s unreal as well. So, I actually feel really good. Though to get to this position, it hasn’t been pretty.