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Q&A With Brandes: Why Look For Opportunities Overseas?

Matthew Johnson is the Director, Private Client Sales, at Brandes Investment Partners, L.P. His responsibilities include sales management, product distribution and business development, as well as developing the strategy and planning and executing the firm’s field sales efforts. He joined Brandes in 1993.

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Jeffrey Germain, CFA, is a Director, Investments Group, at Brandes Investment Partners, L.P. His responsibilities include serving as an analyst on the basic materials research team and as a member of the International Large-Cap Investment Committee. His experience began in 2001 when he joined Brandes Investment Partners.

I spoke with Matthew and Jeffrey on June 20, 2019

Let’s start with some background on Brandes and your overall view of the international markets.

Matthew Johnson: Brandes is a Graham & Dodd value manager. We were founded in 1974 in San Diego, California. As a firm, Brandes has been investing in international markets for about a half-century or so.

With the S&P 500 tripling over the last decade and significantly outperforming markets around the world, investors seem to have lost interest in international investing. Given this sentiment, we think it’s important to revisit the concept of diversification. The case for making an allocation to international markets today is particularly strong given the valuation discount in international markets we are seeing versus the U.S.1

With respect to diversification, are you trying to make the case that U.S. equity investors are not properly diversified regionally?

Jeffrey Germain: I think it’s important to first set the stage with where the U.S. based investor is allocated regionally. We should then explore the issues of whether such an allocation is prudent from a diversification standpoint and if it leaves room to grow the international allocation.

At the end of 2018, the equity allocation for a typical U.S. investor was 70% in the U.S. and only 30% in international markets.2 If you consider this allocation in the context of where most of the world’s gross domestic product (GDP) is being generated, it does not seem properly balanced. International markets actually represent 85% of global GDP, with the U.S. comprising the remaining 15%.3 The international equity markets also offer a fuller opportunity set as a significantly higher percentage of large-cap companies are domiciled in markets outside the U.S.4

So yes, more GDP is generated outside the U.S. and the opportunity set is larger, but, are the companies domiciled outside of the U.S. ones I want to invest in? Are these companies I would recognize? We believe the answer to both questions is yes. The international marketplace is home to many businesses with powerful brands that are well known. As an example, just under half of the 2018 Top 100 Most Valuable Brands are represented by non-U.S. companies. Also, of the brands that represented the 2018 Top 20 Risers, more than half are from non-U.S. companies.5

To sum it up, in our view and at a high level, a 70% allocation to U.S. equities does not appropriately consider the economic realities of today’s world and likely reflects a home country bias.

What has kept investors so heavily invested in the U.S.?

Jeffrey Germain: Well, there have been many factors at work here, but a key reason has been strong U.S. equity performance. In other words, part of the attraction and increasing allocation to the U.S. market has been the result of the U.S. market’s strong absolute and relative performance for an extended period of time. In fact, as of June 30, 2019 the U.S. market outperformed international equities for a record 139 months on a cumulative basis.6 So in part, the high U.S. equity allocation reflects a positive feedback loop: investors have increasingly allocated to the part of the market that has performed well. The key question is, will U.S. outperformance continue or will international equities eventually have their day in the sun? In our view, there are several factors that support a compelling positive outlook for international markets.

First, when reviewing the historical performance of the U.S. and international equity markets, it’s clear the relative performance pattern has been cyclical. In fact, since the 1970s, there have been a number of periods when international equities outperformed the U.S. over a long period.7 For us, it’s hard to believe that such cyclicality is no longer present. Second, and most importantly, we believe valuations favor international equities over the U.S.

What about investor concerns? The U.S. has been a safer place perception-wise than international markets, which have been dealing with a lot of macro and political issues.

Matthew Johnson: This notion of investor concerns never seems to go away, despite the fact that international markets keep on churning along. It’s been that way for a long time. What we have found from decades of investing is that when there is investment uncertainty, it’s a good time to hunt for opportunities.

Jeffrey Germain: Yes, there has been a lot for the market to digest and be fixated on with respect to international equities. Still a lot of uncertainty with Brexit, the European economic outlook has deteriorated and the ongoing trade war is on everyone’s mind. These issues are real and it’s important to study and account for them when considering an allocation to international markets. However, after carefully examining and accounting for these issues, our view is that the market is placing too much emphasis on them and this anxiety has led to unjustifiably low valuations for non-U.S. markets.

The market’s tendency to overemphasize broad risk factors and misprice equities in the process is not new. In fact, there are a lot of historical examples of dramatic macro-driven market sell-offs that were overdone and resulted in a very attractive opportunity set for bottom-up, fundamental investors. For example, performance following the 1994 Mexican Tequila Crisis, the 2002 Brazilian Real Crisis and the 2014 Russian Financial Crisis were all very strong.8 That’s not to say that there was no risks or issues present during these episodes. It just highlights that some of the best investment opportunities have emerged when the market’s focus on long-term company specific fundamentals morphed into a panic about the broader market contention.

Read the full article here by Robert Huebscher, Advisor Perspectives


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