Talk Your Book: International Investing

Episode Summary

Executive Summary: The episode argues that short-term performance has made U.S. stocks look unbeatable and international diversification look flawed, but those conclusions are distorted by recent history and by using “growth of a dollar” as a misleading metric. Holly Framsted of iShares explains how multi-factor ETFs aim to improve outcomes beyond market-cap weighting while managing tracking error and portfolio construction. The discussion ends by framing international investing as a long-term risk-management tool, not a short-term return bet.

Main Topics: Why U.S. outperformance can mislead investors (Priority: 5/5): The hosts show that almost all of the U.S. market’s long-run advantage over international markets came after 2008, which makes recent history a poor basis for broad conclusions about home-country bias. Limits of using “growth of a dollar” in backtests (Priority: 5/5): They argue that cumulative dollar growth over multi-decade horizons can be a nearly meaningless statistic because small return differences and regime shifts dominate the outcome. Home-country bias and the case for global diversification (Priority: 5/5): Both hosts strongly reject the idea that domestic-only investing is rational, using Japan and other markets as examples of the risk of concentrating in one country. How iShares builds multi-factor ETFs (Priority: 5/5): Holly Framsted explains that INTF is designed to combine value, quality, momentum, and size exposures in one portfolio rather than in separate sleeves, with constraints to keep the fund market-like at the core. Tracking error, active share, and factor implementation (Priority: 4/5): The conversation covers why higher tracking error can be desirable in a factor product and why portfolio construction matters more than simply stacking factor funds together. Valuations abroad vs. the U.S. (Priority: 4/5): The hosts discuss cheaper international valuations, but note that sector composition—especially the U.S. tech weighting—may explain a lot of the valuation gap and complicate apples-to-apples comparisons. Long-term value of international diversification (Priority: 5/5): The episode closes by arguing that global diversification is primarily a defense against concentrated country risk and poor long-run economic outcomes, even if it disappoints over short periods.

Key Arguments: Recent U.S. outperformance is heavily concentrated in the post-2008 period, so long-run charts can overstate the case for U.S. superiority. Growth-of-a-dollar charts are a weak basis for investment decisions because they ignore regime changes and the path dependency of compounding. Owning overseas stocks is still necessary even if U.S.-listed multinationals get revenue abroad; business-specific exposure is not the same as true international equity exposure. Multi-factor funds can outperform by selecting stocks with multiple favorable traits at once, rather than combining separate single-factor sleeves that may cancel each other out. Higher tracking error can be acceptable or even desirable in a factor ETF if it creates a more meaningful change in portfolio exposures. International portfolios may offer better opportunities for factor investing because markets are less concentrated in a few mega-cap stocks than the U.S. Valuation differences between U.S. and international markets are partly driven by sector mix, especially the U.S. tilt toward technology. International diversification should be viewed as risk management, not a short-term forecast that foreign stocks will immediately beat the U.S.

Data Points: $1 invested in S&P 500 since 1970: $134 - Opening comparison of U.S. equity compounding versus international markets. $1 invested in MSCI World ex USA since 1970: $60 - Used to illustrate the appearance of long-term U.S. outperformance. S&P 500 return from 1970 to 2018: 10.4% annualized - Compared with MSCI Europe over the same period. MSCI Europe return from 1970 to 2018: 8.8% annualized - Shows a smaller but meaningful gap versus the S&P 500. S&P 500 total return from 1970 to 2018: 12,500% - Illustrates long-run compounding. MSCI Europe total return from 1970 to 2018: 6,000% - Illustrates long-run compounding. S&P 500 return from 1970 to 2007: 11.0% annualized - Before the post-crisis divergence. MSCI Europe return from 1970 to 2007: 11.3% annualized - Europe slightly beat the S&P before 2008. S&P 500 total return from 2008 to 2018: 132% - Post-financial-crisis period cited as the main source of U.S. outperformance. MSCI Europe total return from 2008 to 2018: 3% - Shows how weak Europe was after the crisis. S&P 500 growth of $1 since later 2007: $2.36 - Used in comparison with MSCI World ex U.S. to show recent U.S. dominance. MSCI World ex U.S. growth of $1 since later 2007: $1.11 - Shows near-flat performance relative to the S&P 500. Rolling three-year U.S. outperformance streak: Over 100 months - Cited as the longest such streak on record in the discussion. IFA five-year return: ~11% - iShares developed ex-U.S. stocks over the last five years in the transcript. U.S. stocks five-year return: ~70% - S&P 500 performance over the same period as IFA. INTF holdings: 235 holdings - Portfolio size of the iShares multi-factor fund. INTF active share: 89% - Indicates substantial deviation from the benchmark. INTF outperformance in rolling six-month periods: 62% of periods (23 of 37) - Since inception, used to support factor consistency. INTF outperformance in rolling one-year periods: 77% of periods (24 of 31) - Since inception, used to support factor consistency. INTF since-inception total return: 5.6% - Mentioned relative to ACWI ex-U.S. being slightly down. ACWI ex-U.S. since-inception total return: slightly negative - Compared against INTF since inception. S&P 500 top 10 weight: ~22% - Used to show U.S. market concentration. ACWI ex-U.S. top 10 weight: <10% - Used to show more diversified global concentration. S&P 500 sector weight in technology: ~20% - Part of the valuation and concentration discussion. ACWI ex-U.S. sector weight in financials: 24% - Shows different sector composition versus the S&P 500. ACWI ex-U.S. sector weight in industrials: 11% - Used to explain lower valuation multiples abroad. ACWI ex-U.S. sector weight in tech: <8% - Supports the sector-composition argument. Europe-focused ETF flows: Nine straight months of ad flows - Mentioned as evidence of performance-chasing out of international assets. MSCI IFA weighted average market cap: ~$38 billion - Benchmark reference for INTF portfolio size discussion. INTF weighted average market cap: just under $18 billion - Shows the fund’s tilt toward smaller companies. MSCI IFA small value outperformance: ~2.5% per year (1994-2017) - Used to argue factor/value worked well internationally. MSCI IFA small value return (2009-2017): 13.8% annualized - Compared against MSCI IFA’s 8.8% annualized. MSCI IFA return (2009-2017): 8.8% annualized - Benchmark for the small value comparison.

Pivotal Quotes: "I cannot be convinced that diversifying across the world is not a good idea." — Ben Carlson: Direct rejection of home-country bias and a defense of global diversification. "The problem is, it's kind of crazy... probably the most meaningless data point is growth of a dollar." — Michael Batnick: Critique of using cumulative dollar growth as a primary backtest statistic. "International diversification works in parentheses, it says eventually." — Michael Batnick: Summarizing the AQR paper’s view that diversification pays off over long horizons rather than short ones.

Implications: Listeners should treat U.S. dominance as a recent regime, not a permanent law. The episode suggests global diversification and factor exposure are long-term risk controls, with success depending on patience, portfolio construction, and realistic expectations.