Paulo Whitaker/Reuters
Traders work on the main floor of the BM&F Bovespa stock exchange market in Sao Paulo.
- After an impressive post-recession run, US stocks have the lowest expected return over the next five years, according to Northern Trust Wealth Management.
The investment firm, which oversees $1.2 trillion in assets overall, is advising US clients that having a home-country bias could prove more costly than it has up until now.
- Katie Nixon, its wealth-management chief investment officer, told Business Insider of some pitfalls investors can avoid when investing outside the US.
Since Lehman Brothers collapsed in 2008, investors who kept most of their assets in US stocks have silenced the naysayers.
That's because the US has led the global recovery in equities and is now in its longest bull-market run ever.
But this overweight to the US is poised to become costly in the years to come, according to Northern Trust, which oversees $1.2 trillion in assets.
"Ultimately, valuation matters, and capital is going to flow where they [investors] see the best risk-adjusted return," Katie Nixon, the wealth-management chief investment officer, told Business Insider. Her division has about $287 billion in assets under management.
"Low valuation means a higher expected return, and that's certainly where we find ourselves related to a longer-term view on emerging markets."
The EM recommendation is one that's being made far and wide on Wall Street, from firms like Merrill Lynch to investing gurus like Jeremy Grantham.
One often-cited measure of just how expensive valuations in US markets have become is the price-to-earnings ratio of the S&P 500, which, according to JPMorgan, is at the second-highest level on record for this stage of the business cycle.
With valuations so high in the US, returns are likely to be muted on a five-year basis relative to history and what could be earned in emerging markets, Nixon said.
Of course, it's not the most comfortable time for any investor to be an emerging-market bull, given the sell-offs that have ravaged countries and currencies from Turkey to Argentina in 2018. Last month, MSCI's index of 24 emerging markets dived into a bear market - defined as a 20%+ drop from its late-January high - and it was down 13% year-to-date on Wednesday.
Even Nixon and her team at Northern Trust have reduced their exposure to EM stocks on a 12-month basis, in favor of US investment grade and high-yield bonds. They agreed last week to tweak their global tactical asset allocation model.
But they expect performance to be different on a longer timeline, potentially making it unwise for US investors to have a home-country bias.
"US equities have the lowest expected return on our five-year forecast, and I do think that you'll start to see capital and interest certainly flow back into other areas of the world once those areas start performing a little bit better," Nixon said.
Finding where exactly to invest in the EM universe is trickier than it seems. For one, many stock markets don't always move in sync with the goings on of their economies, so it's not as straightforward as identifying countries with the most robust growth.
Brazil, for instance, had the best-performing major stock market in 2016 even with the economy in its worst recession on record.
That's why Nixon recommends broad-based exposure. While declining to specify any names, she counseled using exchange-traded funds as a way to do this, noting that stock pickers in emerging markets sometimes have substantially higher fees than their developed-market counterparts.
The stocks of multinational, US-based companies do not provide the same broad exposure to emerging markets the way ETFs do, Nixon said. Even companies like Coca-Cola, which earn revenues in several countries, do not offer enough diversification.
"We kind of fool ourselves into thinking 'I own Apple, or I own Coke, so I own a global portfolio,'" she said.
Additionally, Nixon does not recommend hedging the currency risk in EM equity markets. Given the 51% crash in the Argentinian peso, or the 41% slump in the Turkish lira, it's a move that nervous investors would want to make.
"We don't agree with that at all," Nixon said of hedging out currency risk. "It's a small risk relative to the return over a long-term perspective, and it's very unrelated to the persistence of the equity risk premium that you get in EM."