How to Set the International Allocation in Your Portfolio

On this episode of The Long View, Peter Mallouk, author and president and CEO of Creative Planning, talks about global diversification, AI financial advice, bond portfolios, and more.

Here are a few excerpts from Mallouk’s conversation with Morningstar’s Christine Benz and Amy Arnott.

Do International Stocks Still Provide a Diversification Benefit?

Amy Arnott: Another thing that you wrote about in the book is the importance of global diversification and the fact that markets can go through these long cycles where US stocks may be outperforming for a number of years, but then international stocks may do better for a number of years. But at the same time, we’ve seen correlations for international stocks, especially for developed markets, steadily increase. So, you’re not necessarily getting the kind of diversification benefit that you used to. Do you have an opinion about that? And do you still advocate that investors should have a significant portion of their portfolios in non-US stocks?

Peter Mallouk: I still think we should have large stocks, small stocks, international stocks. But I do agree—well, it’s just a fact—that the correlation is more significant. I think a part of that is it’s become a global economy. If you’re Walmart, you’re getting a lot of your earnings overseas. If you’re Hershey’s, you’re getting a lot of your earnings overseas and you’re a US company. Nestlé is getting a lot of theirs outside of their country, and they’re an international company. And so, I think as we see these companies become global empires, where the only tie they have to their country for the most part is the stock exchange. We’re going to see more and more correlation. And we’re seeing that as we see corrections in bear markets and bull markets. We’re seeing it become more and more a global economy. But it’s not exactly parallel. And there can be pretty significant discrepancies for certain periods of time. And that’s to me why you stay diversified—no different than real estate and large stocks. They’re about 80% to 85% correlated. But you should still own a little bit of both to not have all your eggs in one basket and not have things to be perfectly correlated.

How to Set the Non-US Allocation in Your Portfolio

Christine Benz: What do you think is a sane way to set someone’s non-US allocation, assuming that they’re based in the US? What’s a good benchmark for thinking about that?

Mallouk: I don’t have a religion around this issue. If I’ve got a client that says, “I want to be all US,” I’m good with that because big US is still global. And if you want to be large-cap Euro Pacific, you’re largely global. And so, people feel high conviction around 20% international exposure to 50%, I don’t really feel very strongly about where that chip is laid. I think you’re going to get a very similar outcome across all of that. And the key to me is just to make sure that you’re diversified one way or another. I like to have more US than international, but that did not work out from 2000 to 2010, and it’s worked out from 2010 to now. But I don’t have conviction about how it works out going forward.

Emerging-Markets Outlook

Arnott: I think you’ve been pretty optimistic about the prospects for emerging markets outside of China. Is that still your outlook?

Mallouk: I still feel that way. I think you’ve got over a billion people coming out of poverty. I think you look at what’s happening in India and a lot of the emerging economies. I think there’s a lot of reasons to be optimistic. There’s a lot of instability. So, I think we would never get the same valuation level as the United States. But I think it eventually will have its run. And when it does, I think it will be very, very rapid, much the way we saw it with small-cap US in the fourth quarter, where you just make up years and years and years of ground in a short period of time.

How to Avoid ‘Backyard Bias’

Benz: One thing that caught my eye in the book was this idea of what you call backyard bias. I think we all are aware of home-country bias, like overallocating to the US, but can you talk about what backyard bias is and how people can try to avoid it?

Mallouk: If you look at people who live in Sweden, they’re overallocated to Swedish stocks. People who live in Canada are overallocated to Canadian stocks, and the same with the US. But it even gets more backyard than that. Like if you live in the South in the United States, they’re overweight in energy stocks as a group. People who live on the West Coast are overweight in tech. People who live in the Northeast are overweight in financials. People who live in the North are overweight in industrials. We tend to buy what’s in our backyard. And we wind up with a lot of excessive sector or industry risk because of it. People who live in Canada have way too much in energy and financial stocks because the biggest stocks are the bank stocks and the energy companies and commodity companies. So, those become the big industry biases that show up in their portfolios. And we have the same thing here. We tend to buy what we see in our backyard. And that’s not the right way to make investment decisions.