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Three takeaways

  1. U.S. equities have been the strongest performing asset class for a long time, but that may be changing.
  2. It may be a good time to think internationally as global economic recovery is taking shape.
  3. iShares exchange traded funds (ETFs) can offer simple ways to access international equities.

Investors are leaning hard into U.S. equities just when they should be looking abroad.

A recent BlackRock analysis of over 20,000 financial professionals’ model portfolios found that the average advisor is significantly overweight U.S. stocks versus the MSCI All Country World Index (MSCI ACWI), a broad global equity benchmark.1

Figure 1: Average advisor U.S. equity weights up since 2018

Chart: Average advisor U.S. equity weights up since 2018

Source: BlackRock, in an annual BlackRock analysis of over 20,000 financial professionals’ model portfolios across the industry, we found that an average equity sleeve holds 70% U.S. equities as of June 2018, 75% of U.S. equities as of 9/30/20. The MSCI ACWI index holds 57% of U.S. equities as of 9/30/20. Weights are subject to change.

While this home-country preference shouldn’t be surprising, given that U.S. equities have been in the spotlight for most of the past decade, the unprecedented concentration in domestic stocks does ring alarm bells about the potential for extreme concentration since the U.S. equity market is increasingly top-heavy in large technology companies. For example, in 2020, Facebook, Apple, Amazon.com, Netflix, Google-parent Alphabet and Microsoft (commonly referred to as the FAANGM), drove 60% of the return of the S&P 500 index, while the other 494 companies drove 40% of the S&P 500 index return.2 Such concentration could present a large portfolio risk with U.S. equity indexes at historical highs and regulatory uncertainty looming.

Figure 2: U.S. equity market return composition

FAANGM vs. the rest of the U.S. equity market

Chart: U.S. equity market return composition

Source: Bloomberg, as of 12/31/20, based on market cap weighted S&P 500 index. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

Looking beyond U.S. borders

International investing could offer a potential solution to this problem. Investors often look to international markets to expand diversification and access new growth potential. The U.S. vs. international relative stock outperformance tends to come in waves with one leading performance over the other. Currently, valuations are indicating a shift may be forthcoming as the valuation gap between domestic and international equities could be changing.3

A global recovery takes shape

As the global economy rebounds from the Covid-19 pandemic and vaccinations rollout, we expect many regions to see steady recovery over the next 12 months. We expect to see more normalized manufacturing activity, stronger consumer confidence, and rising trade volumes. This increased economic growth will likely lead to higher revenue and valuations from international companies, particularly in emerging markets.

A few supportive forces are at play:

1. Synchronized fiscal stimulus and more predictable U.S. trade and foreign policy under the Biden administration are beneficial for global growth. The International Monetary Fund recently estimated that emerging markets will grow at 6.3% in 2021 compared to -2.4% in 2020. Emerging market countries in Asia, such as China and India, are leading the projections in 2021, especially India, which is projected to grow 11% this year.4

2. The ongoing trend of a weaker dollar amid easy monetary policy could serve as a potential driver for emerging market equities to outperform in the next few months.

3. While the U.S. remains a primary engine for the most cutting-edge research and innovation, many new business ideas and technological advancements are coming from international markets. For example, Europe owns the most advanced renewable energy technology, Asia saw the fastest growth in the business-to-consumer (B2C) space, enabled by technological solutions such as mobile payments and online retail.5

4. U.S. companies are capturing less of their sales growth from overseas markets. (Figure 3). The average international revenue growth of the companies within the S&P 500 has been decelerating in the past few years, as companies overseas started to take a larger share of the revenue pie. We expect this trend to continue into the next decade, powered by the strong economic growth and favorable demographic trends in developing countries.

Figure 3: U.S. companies are capturing less of international growth

Chart: U.S. companies are capturing less of international growth

*2020 data as of Jan 2020 to isolate the impact of Covid-19.
Source: Thomson Reuters DataStream, as of 12/31/20, based on the cap weighted average YoY foreign revenue growth of companies in the S&P 500 index.

In this fast-changing world, the belief that investors may gain the same global growth exposures through domestic companies that run business in foreign markets is no longer true. It is time to consider getting direct foreign revenue access via international ETFs.

ETFs offer simple access to international equities

The good news is that international investing is simpler than ever, thanks to more efficient investment options and more open overseas markets. iShares ETFs offer direct access to international economies at a low cost.

There are a few different ways to invest in international markets. For example, ETFs offer broad international market exposures through regional and country-specific markets, sustainable and factor-based products.

iShares has the industry's largest suite of country ETFs in the U.S which offer the potential to target growth while also seeking portfolio diversification.6

Additionally, driven by growing recognition that sustainability considerations can be financially material, investors are seeking sustainability in their international exposures. Investors rebalancing into international equities might look to add international ESG ETFs that provide access to companies with favorable environmental, social and governance characteristics.

Lastly, factor strategies offer investors another way to efficiently access international markets. Recently, we’ve seen increased investor interest in quality factor exposures with more than $6 billion into U.S. listed ETFs with a quality focus in the past 12 months.7 Quality factor ETF strategies seek to track above-average exposure to highly profitable companies with stable earnings and low indebtedness all while delivering diverse exposure.

Summing it up

The global economy is poised for recovery, giving investors reason to consider adding to international equities as part of their core portfolio strategy. A cost-effective and simple way to gain exposure to this asset class is by including international ETFs to help improve diversification.

Jeff Spiegel
Head of U.S. iShares Megatrend and International ETFs
Contributing authors: Jasmine Fan, Tanvi Pradhan, Elizabeth Turner
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