For the past three years our insistence on maintaining a globally diversified portfolio has not been especially helpful in outperforming our blended benchmark on a consistent basis. If we use the EAFE Index (the MSCI Europe Australasia Far East Index) as a proxy for international markets, the returns versus the S&P 500 Index (the stock index in our benchmark) look unattractive:
|Year||EAFE||S&P 500||Difference||Cost at 5% Min. Allocation|
Our required minimum allocation to international securities is 5% of the total portfolio, so if we owned 5 % of the EAFE Index in every portfolio (which we emphatically do not), then the relative cost of being internationally diversified was 0.37% in 2010, 0.72% in 2011, and 0.17% so far in 2012. Or, if you prefer to think in terms of absolute return, if you had avoided investing in the EAFE index using the theory that the S&P 500 companies are themselves globally diversified in terms of their sales and their earnings, then the S&P 500 return from January 1, 2010 to last Friday’s close on October 26, 2012 was +34.07% versus the EAFE return of only +5.20%. While it’s true that we have owned international mutual funds that have generally outperformed the EAFE Index over the past three years, it’s also fair to say that the general under performance of the international allocation of the portfolio has been an ongoing frustration for us.
Again using EAFE as a proxy, a closer look at the EAFE performance versus the S&P 500 reveals that when EAFE has outperformed, it has generally done so over shorter periods of time and the extra returns have been significant. The following are the dates that EAFE has outperformed on a relative basis since 2010 and the returns for each Index for the period:
|Date Range||S&P 500||EAFE Index||EAFE Excess Return %|
|5/26/2010 – 10/14/2010||+10.77%||+25.96%||141%|
|3/16/2011 – 6/7/2011||+2.68%||+9.77%||264%|
|9/19/2011 – 10/27/2011||+6.97%||+12.26%||76%|
|1/13/2012 – 2/24/2012||+6.2||+11.19%||80%|
|5/30/2012 – 10/26/2012||+8.5%||+15.44%||82%|
Over the five periods that EAFE has outperformed, it has done so with an average return premium of 129%, which, knowing the extent that EAFE has actually underperformed over the entire period, clearly illustrates how damaging EAFE has been for its owners during the many periods it trailed the S&P 500. In fact, two of the periods shown were only one month long, one was three months, and two were five months. Which brings me to the point of today’s column: For the first time since 2010, we seem to be getting an extended period of outperformance from our international holdings, and that is very good news for those investors who prefer to analyze relative returns.
We currently own three different international positions in our managed accounts. The first, Matthews Asian Growth and Income, has been a long-time Pinnacle holding. The other two positions have been recently added to the portfolio; the MSCI European Monetary Union ETF (iShares, EZU), and the MSCI Italy Index ETF (iShares, EWI). All three positions have been significantly outperforming the S&P 500 Index over a period long enough to catch our attention:
|Date Range||Security||% Return|
|5/29/2012 – Present||Matthews Asian G&I Fund||+15.97%|
|5/29/2012 – Present||S&P 500 Index||+6.96%|
|7/24/2012 – Present||Europe ex-UK (EZU)||+23.05%|
|7/24/2012 – Present**||MSCI Italy (EWI)||+34.81%|
|7/24/2012 – Present**||S&P 500 Index||6.11%|
** Note: EZU and EWI were first purchased in Pinnacle’s managed accounts on 8/17/2012
It remains to be seen if the international allocation of our portfolio will continue to outperform. The May to October 2010 experience is the most recent example of a five month run of international equity outperformance that reversed itself, once again creating a headwind for globally diversified investors. However, at the moment it feels like a luxury to have the international allocation provide a tailwind for portfolio performance.
The Pinnacle Investment Team will continue to keep you apprised of any new developments in our international positions.