“90% of what passes for brilliance or incompetence in investing is the ebb and flow of investment style.” – Jeremy Grantham, GMO

The U.S. equity markets have far outpaced the international markets over the last few years. There are several reasons to explain the drivers behind this divergence in performance. The main driver, in our opinion, has been the aggressive monetary policies of the Federal Reserve (Fed) which has helped the U.S. economy recover faster than those in other developed nations. The other global central banks led by the European Central Bank (ECB) and Bank of Japan (BoJ) have also started on this path of balance sheet expansion, but they have obviously lagged the U.S. Fed’s pace. In the table below, we summarize the annualized total returns for the S&P 500, MSCI EAFE, and MSCI Emerging Market (EM) indices since January 2009, and compared those returns for the previous 12 years prior to the credit crisis. The U.S. equity markets have led dramatically in the past 7 years. This divergence has been especially pronounced in the last two years. The annualized returns, however, were much closer in the previous 12 years, and the MSCI EM Index actually led all the indices, mainly due to the rapid growth in the Chinese economy.

Index Jan. ’09-Feb. ’15 Jan. ’96-Dec. ’07
S&P 500 +16.7% +9.4%
MSCI EAFE +10.4% +8.5%
MSCI EM +12.0% +11.2%

Source: Bloomberg

Given the lackluster performance in the last few years, many investors are questioning whether geographic diversification adds any value to a portfolio anymore. Furthermore, some of our domestic equity managers also invest in international companies, which have contributed to their performance lagging the domestic indices. We would take a contrarian view in answering the above question. As we pointed out in our year-end Client Letter, we view the valuations in the U.S. equity markets to be stretched relative to history. We also believe, regardless of the recent underperformance, the case for investing in international and emerging market equities remains a compelling one. Therefore, we have favored managers with global mandates who can source opportunities regardless of where a company is domiciled. Furthermore, the run up in the U.S. markets over the last few years has resulted in much higher valuations relative to the international markets. In the table below, we compare the relative valuations of the global equity indices.

Index Price/Earning Price/Book Dividend Yield
SPX 18.6x 2.9x 1.9%
MSCI EAFE 17.7x 1.7x 3.3%
MSCI EM 12.4x 1.5x 2.7%

Source: Bloomberg

Many of the leading global companies in technology, healthcare, industrial, media and other sectors are domiciled in the U.S. Also, the U.S. companies have been very fast to adapt to a changing macro environment following the credit crisis. Nevertheless, we believe there are excellent companies overseas as well. Our job as fiduciaries is to hire managers with deep research teams and expertise whom we believe can best uncover those hidden values over time.

Sasan Faiz
Co-Chief Investment Officer