Do You Really Need International Diversification? 10 Top Investors Debate

[00:00:00] Welcome to Excess Returns, where we focus on what works over the long term in the markets. Join us as we talk about the strategies and tactics that can help you become a better long term investor.

[00:00:09] Jack Forehand is a principal at Validia Capital Management. Justin Carbonneau is a managing director at Life and Liberty Indexes. No information on this podcast should be construed as investment advice. Securities discussed in the podcast may be holdings of clients of Validia Capital.

[00:00:22] Hey guys, this is Jack. In this episode of Excess Returns, we're featuring an episode from our separate podcast, Two Quants and a Financial Planner.

[00:00:28] One of the topics we've discussed the most on Excess Returns is whether international diversification still makes sense for U.S. investors.

[00:00:33] We received some great insights on both sides of the issue from our guests.

[00:00:36] In this episode, we feature those insights along with our analysis of what they mean for investors.

[00:00:40] You'll hear from Larry Suedro, Corey Hofstein, Meb Faber, Andy Constan, Mike Green and many others.

[00:00:47] If you want to subscribe to Two Quants and a Financial Planner, you can find it on all the major podcast platforms.

[00:00:51] Thank you for listening and we hope you enjoy the episode.

[00:00:53] So Matt, today we're going to talk about a topic that might be one of the topics we've talked about the most on the podcast.

[00:00:57] Because this has been top of mind for a lot of people because for a very long time, U.S. stocks have been killing international stocks.

[00:01:03] But there's a lot of theory and a lot of data to suggest that international diversification works.

[00:01:08] And so we've asked a lot of people we had in the podcast what they think about this.

[00:01:12] And we're going to go through all the clips today.

[00:01:13] We've got 10 different people's opinions on this.

[00:01:15] There's a lot of academics, especially, and practitioners who don't want us to throw the international baby out with the investment bathwater.

[00:01:23] And it's just, it's such an interesting topic to dive through all these clips.

[00:01:27] Get all this perspective on how really smart people think about something that has kind of been a sucker bet for a while.

[00:01:33] And that's been really frigging hard for us allocators.

[00:01:36] And as a benefit to the YouTube commenters who have been commenting, I want to see less of you and I want to see more of the clips.

[00:01:41] That's going to happen this time because we've got a lot of clips.

[00:01:43] We've got 10 clips.

[00:01:44] We've got long clips.

[00:01:45] So people will be seeing less of our opinions and then more of the clips from the investors we've had in the podcast.

[00:01:49] All right.

[00:01:49] Well, I still packed all my hot takes, which is not really, but yeah, let's jump into it.

[00:01:54] Let's jump into it.

[00:01:54] So the first one is Corey Hofstein.

[00:01:56] We had him on our Show Us Your Portfolio series where people tell us how they manage their personal portfolios.

[00:02:01] And we asked him how he thinks about international exposure in his own portfolio, but he started by kind of asking us a question, which is what is international exposure in the first place?

[00:02:09] The rhetorical question I'm going to ask is what is international exposure?

[00:02:13] I don't need you.

[00:02:14] I don't want to put the hosts on the spot.

[00:02:16] Well, that'll be the last question of the podcast.

[00:02:18] Yeah.

[00:02:19] What does it even mean to be international exposure?

[00:02:22] If you are a U.S. company that does 100% of its revenue abroad, are you a U.S. company or are you an international company?

[00:02:30] If you're a U.S. company that's domiciled in Ireland for tax dodging reasons, are you a U.S. company or are you an international company?

[00:02:40] If you're a French company that does 100% of its expenses and 100% of its revenue in the U.S., are you a domestic company or an international company?

[00:02:47] Like, I'm not sure just because a company is listed abroad, it makes sense to call them an international company.

[00:02:56] We sort of have this, like, ridiculous line in the sand of if it's listed on a foreign exchange, it's an international company.

[00:03:02] That's not how the world works, right?

[00:03:05] We don't care about where someone's listed.

[00:03:08] All we care about is where their revenue and expenses are.

[00:03:12] So you look at the S&P 500 and you look at all these multinational companies, right?

[00:03:18] And you look at the breakdown of their revenue and you say, am I not buying a portfolio tied to the global economy if I just buy the S&P 500?

[00:03:27] Like, why do I need to go invest in France or Germany or the U.K. to say I'm internationally invested?

[00:03:36] It does.

[00:03:37] So that whole, like, I take a bit of, what's the word I want to use?

[00:03:43] Like, there's a bit of conflict for me as to, like, does this whole line in the sand even make sense?

[00:03:50] That doesn't even then begin to address the currency issue, right?

[00:03:54] Because if I buy, if I'm a U.S. investor and I earn money in dollars and I predominantly spend in dollars and I buy international equities, well, I now have a currency issue.

[00:04:05] Because local currency in Germany and France might be the euro.

[00:04:11] But I'm converting that back to dollars.

[00:04:13] So a perfect example is this year.

[00:04:15] Everyone's saying international stocks are doing phenomenally well.

[00:04:18] They're not doing any better than U.S. stocks.

[00:04:20] It's just that the U.S. dollar is down versus international currencies.

[00:04:26] Do I want a huge currency overlay on my portfolio?

[00:04:31] I don't know.

[00:04:32] Maybe.

[00:04:33] But no one talks about that, right?

[00:04:35] I don't think these are trivial items.

[00:04:38] So I will say where I have come down is that I think if you buy large cap, globally revenue diversified companies in the U.S., you are investing internationally.

[00:04:56] And I will say I have a heavy U.S. tilt.

[00:05:01] I think the risks there, right, where you're sort of taking risks is, again, there's geopolitical risks.

[00:05:10] If you are a U.S. investor and all your money is tied to the dollar, you are taking certain monetary risk, right?

[00:05:17] We don't sort of expect hyperinflation in the U.S. dollar, and we hope it doesn't happen.

[00:05:21] But there's plenty of countries that if you only invested in your local currency, that would be an issue.

[00:05:27] That's where I try to get the trend following to offset that risk.

[00:05:31] But I have come down on the side again.

[00:05:33] I think you can go way down the rabbit hole on this concept of what does it even mean to invest internationally?

[00:05:38] I would argue you can invest in U.S. large cap and you are investing internationally in a diversified way.

[00:05:42] I think this gets at the heart of what we're going to talk about here because there are some people who think international exposure is investing in international companies.

[00:05:51] And there's some people who think there's so much international exposure in U.S. companies that I don't need to invest internationally.

[00:05:56] So I think that's a good question to start with, which is what is international exposure in the first place?

[00:06:01] You got to hate a person who can make a statement like this and immediately you have seven more questions than you even thought you had in the first place.

[00:06:08] Also, shout out Fluffy Pillow and Corey Hopstein's backdrop.

[00:06:12] Big fan.

[00:06:14] Continuing that apparently.

[00:06:15] Apparently, yeah, if I have to look at this.

[00:06:17] We're going to consistently do, I guess.

[00:06:19] Judge Fields backdrops.

[00:06:21] No, but this is really interesting.

[00:06:22] And it also gets to the heart of this thing of, and we're going to see this over and over again too.

[00:06:27] You start playing with it from all the variables.

[00:06:29] If I just take my same U.S. exposure and I move to another country, all of a sudden I'm internationally diversified with U.S. stocks.

[00:06:35] So everything is available.

[00:06:38] Everything is fair game.

[00:06:39] This is that Corey Hopstein quant brain at work.

[00:06:42] But yeah, yeah, it's all just building blocks.

[00:06:44] You got to ask these questions.

[00:06:46] Yeah.

[00:06:46] And Corey kind of came down on the side of you do get international exposure in the U.S.

[00:06:49] and he made some points with respect to that.

[00:06:51] And I think there's definitely a case to be made there.

[00:06:53] I mean, U.S. companies have become more global, you know, especially if you own something like the S&P 500 where you're owning the biggest companies.

[00:07:00] I mean, a lot of those companies are doing a ton of business internationally.

[00:07:03] So you certainly are at least getting business diversification internationally if you invest in U.S. companies.

[00:07:09] You know that the money's coming from somewhere.

[00:07:11] And in many cases, that's part of how that's been the scale strategy.

[00:07:14] We've been beat to death with scaling and pivot for all these years.

[00:07:17] All these companies did it.

[00:07:19] They're in all these corners of the world running these businesses now.

[00:07:22] And you can't take that piece of exposure away.

[00:07:24] When we talk about the foreign exchange or the foreign currency effects, we talk about all this stuff.

[00:07:33] Any of these multinational companies, it's baked in there.

[00:07:36] So you got to see it.

[00:07:37] So the next clip takes the other side.

[00:07:39] And so it's good to present the second side of the argument.

[00:07:41] And this is Meb Faber, again, from our show here, Portfolio, where we talked about how he manages his personal money.

[00:07:46] Here's him talking about how he thinks about international exposure.

[00:07:48] You can look at a lot of industries and the top companies not in the U.S.

[00:07:52] And if you look historically, stocks by decade, it's super fun.

[00:07:56] You can find other decades where the list is dominated by other countries.

[00:07:59] The favorite example, of course, is Japan in the 80s, right?

[00:08:02] Top 10 market cap was mostly Japanese companies at that point.

[00:08:05] Biggest stock market in the world in the 1980s.

[00:08:09] But look, I was joking on Twitter the other day.

[00:08:11] I say, I'm so bullish on U.S. stocks.

[00:08:14] I'm going to put double the amount of any other stock market around the world.

[00:08:18] I say, screw that.

[00:08:19] You know what?

[00:08:19] I'm so bullish on U.S. stocks.

[00:08:21] I'm going to put five times as much in U.S. stocks as any other country in the world.

[00:08:26] I say, actually, you know what?

[00:08:28] Forget it.

[00:08:28] I've just been watching CNBC, AI Special.

[00:08:31] I'm going to put 10 times as much in the U.S. as any other country in the world.

[00:08:36] I go, wait, congrats.

[00:08:37] You've just gotten to the market cap weight.

[00:08:40] All right?

[00:08:40] So like right there, two-thirds in the U.S., one-third in four.

[00:08:44] And that's the market cap weight.

[00:08:45] That's the starting point, right?

[00:08:47] You have 10 times as much in the U.S. as any other country.

[00:08:50] And, you know, my example to all of my friends talking about tech and whatnot, I mean, I was

[00:08:54] seeing, looking at Ozempic and Novo and all these other countries, I said, I don't know

[00:09:00] why you would assume that big AI developments are guaranteed to be U.S. companies.

[00:09:05] You know, to me, it seems like, you know, these discoveries, if you said this is coming

[00:09:10] out of China or India or Singapore or Brazil, Argentina, Africa, who knows?

[00:09:17] Anyway.

[00:09:18] But people would love to give me crap and say, Matt, this proves, last 15 years proves international

[00:09:24] investing doesn't work.

[00:09:25] I said, it absolutely proves international investing does work.

[00:09:29] Because if you were located in 49 of the 50 countries in the world, God bless you.

[00:09:35] You put two-thirds of your money in U.S. stocks.

[00:09:37] International investing has been a screamer.

[00:09:39] There's only been one country that international diversification didn't help.

[00:09:43] And so I'll take that hit rate.

[00:09:45] 49 out of 50, to me, seems like a pretty good batting average.

[00:09:49] So international investing has worked particularly good the past 15 years.

[00:09:54] I think this one has probably three or four major important things we could talk about.

[00:09:59] You know, one is this idea that we don't know which countries are going to dominate in advance.

[00:10:04] I mean, the U.S. has dominated for a long period of time, but that doesn't necessarily mean

[00:10:08] that's been the case historically all the time.

[00:10:10] And so we don't really know the U.S. is going to dominate in the future, just because

[00:10:14] it seems like in the near term, at least, because of how well these companies are doing,

[00:10:17] like in the near term, it seems pretty obvious it's going to, but that doesn't mean it's

[00:10:19] necessarily going to forever.

[00:10:21] Different strokes for different folks in different domestic regions or something.

[00:10:26] This idea that if you go back by decade, you find these different winners.

[00:10:31] And in many cases, you couldn't predict them.

[00:10:33] Like you couldn't predict when Japan exactly was topping out or when Japan was exactly the

[00:10:37] perfect opportunity to jump in there.

[00:10:40] And just that historical perspective, it's really eye-opening to look back.

[00:10:44] Yeah.

[00:10:45] Just like those charts of seeing what sector was in the lead on any given calendar year.

[00:10:48] This part's hard and valuation and things like that aren't going to be your only clue.

[00:10:52] I like the other idea how he flipped it too, to say, all right, you're a U.S. investor.

[00:10:56] You really believe strongly you should have most of your money in the U.S.

[00:10:59] Well, guess what?

[00:11:00] You have 10 times your money in the U.S. than you have in any other country.

[00:11:03] So maybe you already have that, even if you own the global market portfolio.

[00:11:08] Yeah.

[00:11:09] Great point.

[00:11:10] And again, ties back to Corey Offsteen's thing of just look at these in terms of building

[00:11:14] blocks.

[00:11:14] These are all variables you can swap.

[00:11:16] And that includes imagining yourself in a different locale or dividing this up however

[00:11:20] you want.

[00:11:21] Really fascinating stuff.

[00:11:22] And then the last one is, I think one of the most important points was the most eye-opening

[00:11:27] for me, which is this idea of those of us sitting in the U.S. are sitting here thinking

[00:11:31] about what a disaster international diversification is.

[00:11:34] Anybody sitting in any other country is like, international diversification is the greatest

[00:11:39] thing of all time because I own this huge portion of the U.S. which has outperformed my own country

[00:11:44] by a lot.

[00:11:45] Somewhere right now, there's a, what, a Chinese podcast and they're thanking the gods for

[00:11:52] NVIDIA and that concentration and their international exposure.

[00:11:56] It exists.

[00:11:57] Foreign Jack and Foreign Matt are out there podcasting right now.

[00:12:01] So our next clip is actually from an interview we just did with Dan Rasmus of River Dodd.

[00:12:05] And this was one of their most viewed pieces of the year where they talked about this idea.

[00:12:09] They called it the Great Rotation.

[00:12:10] And they talked about this idea that the U.S. has dominated for so long and looked at

[00:12:14] the data to say whether that might continue in the future.

[00:12:16] So Dan talks about that idea, but he also talks about this idea that people like me have

[00:12:20] kind of been saying this for a long time.

[00:12:21] Before this piece a few years back, I wrote one of our best read pieces of a few years

[00:12:25] back was called Investing in a Bubble.

[00:12:28] And one of the points I made is I went back and I read all the great investors, people we

[00:12:33] think of as great investors today.

[00:12:34] And I read their old investor letters and I asked, when did they first know that the technology

[00:12:41] stock bubble, the late 90s, was in fact a bubble?

[00:12:44] Right?

[00:12:45] When did they identify it?

[00:12:47] Did they identify it?

[00:12:48] Right?

[00:12:48] Because, you know, if you're living through a bubble, can you identify it?

[00:12:51] Do people know?

[00:12:51] And what I found is that I think it was Ray Dalio called the tech bubble in 1995.

[00:12:58] I think, and I'm going to misquote the years, but you're going to get it roughly right.

[00:13:02] I think, you know, Howard Marks called the tech bubble in 96, Seth Klarman in 97.

[00:13:08] Okay.

[00:13:08] So, you know, everybody knew it was a bubble.

[00:13:11] The problem was they figured it out that it was a bubble too early.

[00:13:16] And so if you come out in 95 or 96 or 97 and you say the U.S. equity market's a bubble,

[00:13:22] the technology stock market is a bubble, and then the market goes up 25% in 95 or 96, and

[00:13:28] it goes another 25% in 97, so the bubble just keeps inflating, and then it goes up another

[00:13:33] 25% in 98.

[00:13:34] And you say, well, it's a crazy bubble.

[00:13:36] You know, we've got to keep our money out of this.

[00:13:39] You know, don't do it.

[00:13:39] And then it goes up another 20.

[00:13:40] You know, the NASDAQ is up another 25%.

[00:13:42] Well, what you've done is you've lost all credibility, right?

[00:13:45] You were the boy who cried wolf.

[00:13:47] You said it was too risky, and look at how much people made, right?

[00:13:50] You told them don't invest in fart coin, and look at how much money they made.

[00:13:54] You're just a Cassandra.

[00:13:56] You don't understand the new economy.

[00:13:58] And in fact, the stuff that you're telling me to invest in, you know, you want me to invest

[00:14:02] in French equities.

[00:14:04] You want me to invest in oil companies.

[00:14:06] You know, whatever boring, you know, value investor idea people are coming up with.

[00:14:11] When it just doesn't do as well, people said, well, I wasn't going to do well.

[00:14:14] If I wanted to make money, I would have put it in tech stocks.

[00:14:17] The only reason I put it in this is maybe it's diversification that didn't work.

[00:14:20] But the interesting thing is that by 2003 or 2004, actually, if you bought the value index,

[00:14:27] you came out way ahead of if you bought the NASDAQ because the up was so high, yes.

[00:14:33] And by 99, you looked like a complete idiot for not buying the NASDAQ, for owning anything

[00:14:37] else, for owning international stocks, for owning value stocks.

[00:14:40] You were the worst investor in the world by 1999 or 2000.

[00:14:44] But the bubble deflated so quickly and so dramatically.

[00:14:49] And then the market, the money flowed into these other sectors so rapidly that you came

[00:14:54] out ahead only two or three years later.

[00:14:56] And that's what sort of made the record of some of these people we think of as great investors

[00:15:00] today.

[00:15:00] They endured a period of underperformance where what they were doing was wildly out of

[00:15:04] favor.

[00:15:05] They were patient.

[00:15:06] And then it worked and they were vindicated.

[00:15:08] And now I would argue that we're in a similar phase here where U.S. equities are reaching

[00:15:12] valuation levels that we haven't seen since the 90s.

[00:15:16] It feels like most recently, it feels like 2021 in terms of mania around memes.

[00:15:24] And conversely, you go internationally.

[00:15:27] And the minute you step outside the U.S. border, the minute you step off a U.S. listed

[00:15:32] exchange, valuations plummet about 50 percent.

[00:15:35] And actually, some of the quality of these companies is very high.

[00:15:38] Now, they don't have tech stocks.

[00:15:40] OK, so we're at least not as many or not as good.

[00:15:42] OK, so so so set that aside.

[00:15:44] Everyone's sold in.

[00:15:45] You're not sector adjusting.

[00:15:46] Sector adjust all you want.

[00:15:47] Every sector international is cheaper.

[00:15:50] And it's not just, you know, yes, there's other than health care.

[00:15:54] OK, yeah.

[00:15:55] Europe has some good health care stocks, Nova Nordisk, et cetera.

[00:15:58] So that's fine.

[00:15:59] But but every sector is cheaper.

[00:16:01] Every market is cheaper.

[00:16:03] If you control for all of these factors, it's still dramatically cheaper.

[00:16:07] And what you're left with is this flow dynamic where people just keep dumping money into U.S. equities.

[00:16:12] It keeps working.

[00:16:13] People that advocate international equities keep losing.

[00:16:17] And so what I argue is that at some point, the divergence with the fundamentals between the fundamentals and where the flows are driving valuations becomes so fast.

[00:16:25] And I think we're clearly there today that that that the great rotation is coming.

[00:16:31] It's it's it almost has to be.

[00:16:33] And when you look at the challenge with this thesis, the fundamental challenge with this thesis is that the people that have been saying it today, me, for example, have been wrong on this point.

[00:16:45] I was wrong last year.

[00:16:47] I was wrong the year before.

[00:16:48] I was wrong the year before that.

[00:16:50] In fact, I've been wrong about international equities basically as long as I can remember.

[00:16:55] And that's the challenge.

[00:16:57] So you're going to believe me or believe that those arguing in favor of international equities.

[00:17:02] You're believing someone who's been routinely wrong, whose logic has led to losing money relative to owning the U.S. index.

[00:17:10] And that's the challenge.

[00:17:11] Right.

[00:17:11] Do you believe that I should buy something that yields, you know, basically the universe of things are yielding dividend yields of four or five percent or one or two percent?

[00:17:18] Things that trade at twenty five times P.

[00:17:20] Or 15 times P.

[00:17:22] You know, which all, by the way, have roughly equivalent forecast growth rates going forward.

[00:17:28] And I think that these price dynamics competing with the valuation or quantitative metrics is the sort of fundamental dilemma that investors face today.

[00:17:38] Yeah.

[00:17:38] And this is what this is what makes it hard about it.

[00:17:40] I mean, I'm just like Dan.

[00:17:41] I mean, Dan's like I said it last year.

[00:17:42] I said it the year before.

[00:17:43] I said it the year before that.

[00:17:45] And so did I.

[00:17:46] And, you know, this is one of the challenges with these things that work over the long term is you don't know they can not work for very long periods of time.

[00:17:53] And if you're somebody who's emphasizing that long term thing, you're going to have periods of time where it is wrong and wrong and wrong.

[00:18:00] And at a certain point, nobody's going to listen to you anymore.

[00:18:03] And so I think it's important because it's such a balance between thinking about what works in the long term, but understanding that investors timeframes is a lot shorter than that.

[00:18:11] And I can feel Dan's comments pulling at your value investor heartstrings, Jack.

[00:18:17] It's like, don't worry.

[00:18:19] Have a nice nap in this cemetery.

[00:18:22] A nice nap, a little cuddle.

[00:18:23] You're in good company.

[00:18:25] Howard Marks is over there.

[00:18:26] You know, whatever else.

[00:18:28] It's good company.

[00:18:29] But yeah, you could be early.

[00:18:30] And this ties back to both of those prior points, too, where it's just even if you have this thing, if you have this observation, you have this view, what you just said.

[00:18:38] Do you have the time horizon to back it up?

[00:18:41] Because you might have to be wrong for a period of time.

[00:18:44] And hey, I'm in that camp, too.

[00:18:45] I've been saying you have to have that international allocation still.

[00:18:48] And it's diversification.

[00:18:51] If it means you own something you hate, I can relate.

[00:18:54] I can very much relate.

[00:18:56] So this next one for Larry Suedra addresses one of the concerns with the other comment that, you know, you get your international exposure because U.S. companies have their business, you know, have a lot of business internationally.

[00:19:06] Larry talked about whether he thinks that makes sense.

[00:19:08] Well, yeah.

[00:19:09] So the argument about U.S. multinationals own a lot of international assets, let's for argument's sake, say Ford Motor has 50% of their sales overseas.

[00:19:23] Well, so does Daimler-Benz.

[00:19:24] And maybe more, right?

[00:19:27] And the evidence shows that U.S. stocks that are multinationals tend to trade more like U.S. stocks.

[00:19:34] In German and Japanese, multinationals tend to trade like their stocks.

[00:19:39] So I don't buy that argument.

[00:19:41] The other argument is, again, this recency bias.

[00:19:45] International emerging markets far outperformed U.S. in the 70s and 80s.

[00:19:50] 90s, it went the other way.

[00:19:52] The aughts went the other way.

[00:19:54] And now for the last 15 years, it's been reversed.

[00:19:56] There's no argument that anyone can make that says the U.S. can't be the next Japan.

[00:20:03] In 1990, everyone thought Japan was the only place you should invest.

[00:20:07] They had far outperformed.

[00:20:09] They were buying up Pebble Beach and Rockefeller Center.

[00:20:13] There was almost no semiconductor plants even left in the U.S.

[00:20:18] The head of Sony was on the cover, I think, of Fortune.

[00:20:22] You know, they're going to take over the world.

[00:20:24] And their returns to Japanese stocks have been zeroed virtually for 34 years.

[00:20:30] And the same thing could happen to the U.S.

[00:20:34] It's possible.

[00:20:35] So the only right strategy, unless you have a clear crystal ball, is to diversify.

[00:20:40] Now, having said that, I believe that you should diversify because we don't have clear crystal

[00:20:47] balls.

[00:20:48] But you must recognize that the world is getting smaller or flatter, to use Thomas Friedman's words.

[00:20:56] So the correlations of U.S. and international emerging market have risen.

[00:21:03] So instead of, say, the correlation between emerging and U.S. might have been 0.6 40 years

[00:21:10] ago, now maybe it's 0.8.

[00:21:12] And the correlation of international might have been 0.7.

[00:21:16] And now it's 0.9 or something.

[00:21:18] So you still want to diversify because it's just logical.

[00:21:23] But you now need other sources of risk that add to the portfolio because international is

[00:21:31] not as effective as diversify.

[00:21:33] It's still effective.

[00:21:34] It still adds value, just not as much as it is.

[00:21:38] Yeah.

[00:21:39] So he's right about this.

[00:21:40] I mean, one of the things that's important to understand is, yes, U.S.

[00:21:42] companies do have a lot of their businesses internationally.

[00:21:45] But also the data will tell you that companies typically trade with their home country.

[00:21:51] So even though U.S.

[00:21:52] businesses have a lot of international diversification, they're more correlated to the U.S.

[00:21:56] market, obviously, than they are to anything else internationally.

[00:21:58] I'm getting notes in Larry's backdrop of lima beans, of maybe like some Peruvian-like

[00:22:06] psych acid rock, you know, 70s thing going on.

[00:22:11] I'm into it, though.

[00:22:12] I'm really into it.

[00:22:12] I really love it.

[00:22:13] You see those curtains occasionally, those curtains people have behind them, like Toby

[00:22:16] Carlisle has one a lot of the time.

[00:22:18] So they'll just have that standard backdrop and then there'll be some sort of room behind,

[00:22:22] which Matt would have been able to evaluate.

[00:22:23] But unfortunately, you can't see it.

[00:22:25] You know, but I appreciate the color because it's not a green screen.

[00:22:28] He's not going to go Marvel superhero on me.

[00:22:31] Although him and Professor Xavier suddenly have a lot in common now that I think about this.

[00:22:36] I love, number one, Larry's points on just understanding that the world is

[00:22:43] getting flatter.

[00:22:44] That's something that I do think has a very strong place in this entire conversation.

[00:22:48] We are at whether or not we're at the end of a we're post globalization.

[00:22:53] This globalizing swing that we've been on since post World War Two really means the world

[00:22:58] has gotten flatter.

[00:22:59] And you have to accept that as part of the reality for driving these outcomes.

[00:23:03] But then if the correlations are up because everything's flatter, it does shift the conversation

[00:23:08] back towards stuff that he writes about elsewhere.

[00:23:10] You got to be focused on where's the earnings growth?

[00:23:13] Where's the money coming from?

[00:23:14] What's the multiple expansion potential?

[00:23:17] All the ways I've learned so many ways about how to think about capital market assumptions

[00:23:20] from Larry Suedro that you take what he says very, very seriously.

[00:23:25] And it's a good balanced take because he's in favor of international exposure.

[00:23:28] But this correlation thing, like as a quant, that resonates with me because if I think about

[00:23:32] it, like if correlations are rising and I want to put it in my formula, like how much

[00:23:37] benefit am I getting from international investing?

[00:23:39] I'm getting less than I used to.

[00:23:40] So although it makes sense to invest internationally, like Larry argues, and he probably is right

[00:23:45] about this, you know, you might need other diversifiers besides that because they're

[00:23:48] not giving you the benefit they once did.

[00:23:50] Yeah.

[00:23:50] Sometimes you don't want to show the room.

[00:23:51] You just want the lima bean curtain to just, you know, protect you from the things on the

[00:23:55] other side.

[00:23:56] I can get behind that.

[00:23:57] So this next tip is from Cullen Roche.

[00:23:59] And although he disagrees with Jack Bogle and agrees with Larry, he also made an important

[00:24:04] point about Kearns.

[00:24:04] It's one of the one of the few things I think that Bogle got really wrong across his life

[00:24:09] was that, yes, there is a large contribution, especially from a revenue perspective, if you

[00:24:15] just own something like the S&P 500.

[00:24:17] But the real, I'd argue the real benefit of owning international stocks is that, well, you're

[00:24:22] not only reducing your domestic stock exposure risk, you're also giving yourself a currency

[00:24:27] hedge.

[00:24:28] And that's one of the biggest, I think, contributing positives of owning international

[00:24:32] stocks is that you're really dampening the effect of the potential currency risk that

[00:24:35] you have in your domestic equity portfolio by owning some of these foreign entities.

[00:24:40] And so, you know, is it necessary?

[00:24:43] And, you know, what's the right size?

[00:24:44] You know, that's a much trickier debate.

[00:24:47] But I would argue that from a basic, you know, position of sort of reducing home bias and reducing

[00:24:52] currency risk, you should own, everyone, I think, should own some international stocks

[00:24:57] just to avoid that position.

[00:24:58] I mean, you can look at, there's a lot of historical evidence to support, you know, these arguments

[00:25:03] against home bias.

[00:25:04] I mean, the classic one is looking at, you know, like the Japanese stock market in the

[00:25:09] early 1990s, really, though, that whole 20 year period, that the Japanese equity investor

[00:25:15] who owned, say, US stocks, you know, diversified massively outside of the topics or the, you

[00:25:22] know, the any of the large Japanese indices, they insulated themselves from a lot of domestic

[00:25:27] risk.

[00:25:28] And yeah, you know, I think it's easy to look at the United States and say, oh, well, our

[00:25:32] economy is so big and so strong.

[00:25:33] Like, we're not going to turn into Japan or we're not going to turn into, you know, we're

[00:25:37] not a failing empire like the UK was back in the early 1900s, like, you know, or the

[00:25:41] early 1800s, whatever it was, you know, but I think that's really, that's like poor risk

[00:25:46] management in essence, in the sense that we, especially coming out of COVID, I think one

[00:25:50] of the big lessons from COVID is anything can happen.

[00:25:53] I mean, nobody predicted global pandemic that was going to like shut down the global economy

[00:25:57] for a year.

[00:25:58] And you just never know what's going to happen.

[00:26:00] And I think that diversification is essentially, you know, the process of spreading risk around

[00:26:05] and having a lot of home bias results in a lot of domestic equity and domestic currency

[00:26:11] risk that can easily be hedged away.

[00:26:13] Yeah.

[00:26:13] This just plays into the fact there's a lot of nuance to this.

[00:26:16] I mean, there's a lot of things to think about.

[00:26:17] And, you know, one thing a lot of people will not think about when they invest internationally

[00:26:20] is that there is some currency benefit, you know, assuming you're not currency hedging

[00:26:23] there, that's an additional benefit to an international diversification.

[00:26:27] Just this idea of if you're looking for diversification, you're looking for things that

[00:26:33] differentiate between other things you own.

[00:26:36] So diversification is choosing differentiation with ideally some type of thoughtful rebalancing

[00:26:43] exercise behind it.

[00:26:44] This is another theme that comes up over and over again as we listen to these clips, because

[00:26:48] at the end of the day, even if it's a tiny, tiny piece of this puzzle, Cullen saying, you

[00:26:54] know, we're not a failing empire hubris risk or however he explained it, like that's still

[00:26:58] there.

[00:26:58] It might be a teeny, teeny, tiny bit of it.

[00:27:00] But if you can just avoid that, avoid riding Japan off the top of that cliff decades ago,

[00:27:06] it makes a really big difference.

[00:27:08] And a big part of it gets expressed in some of these currency differentials on the more

[00:27:12] day to day, regular calendar year experiences of owning this stuff.

[00:27:16] One of the firms that's done some of the best work here is AQR.

[00:27:19] They've done tons of work.

[00:27:21] They've written great papers looking at, you know, one of the things they do a good job

[00:27:24] of is anytime anything's failing, whether it's value or international stocks, they'll

[00:27:28] say, let's look at every explanation that could potentially exist and let's test every

[00:27:32] explanation that could potentially exist to make sure that this still makes sense to

[00:27:36] invest in.

[00:27:36] And so they did that with value.

[00:27:37] They did that with international.

[00:27:38] But here's Dan talking about how he analyzes the situation.

[00:27:41] We're never going to know an answer.

[00:27:43] And when I say we, I mean, globally, we are never going to know if this time is different.

[00:27:49] To some extent, this time is kind of always different.

[00:27:52] But is it going to be so different that history becomes irrelevant?

[00:27:56] So a couple of things you can do.

[00:27:58] One is, you know, if the past decade kind of went against what you think it should have

[00:28:04] done, well, then maybe look a little bit longer and say, OK, with longer context, was

[00:28:08] the past decade an aberration?

[00:28:10] Or was it actually more consistent than you would have expected just based on the past?

[00:28:16] So take international diversification as an example.

[00:28:19] Yeah, since 1990, it seems like a pretty atrocious idea.

[00:28:23] I think the US outperformed per year IFA by like 4.6%, something crazy like that.

[00:28:31] But if you go back beyond 1990, from 1970 to present, that edge really goes down.

[00:28:41] It's actually less than 1%.

[00:28:42] So there's still an edge.

[00:28:44] But it's a lot more modest than I think a lot of people think when they think about sort

[00:28:49] of like the inherent superiority of US markets.

[00:28:53] The second thing you can do is try to decompose the past.

[00:28:58] You know, what was the driver of that outperformance?

[00:29:02] And so what we did in this paper was we said, OK, well, there's kind of two ways for an equity

[00:29:08] market to outperform or to win.

[00:29:10] The first is based on fundamentals.

[00:29:12] So was that market able to outgrow?

[00:29:15] You know, were earnings, did they compound?

[00:29:18] Did they grow faster than other markets?

[00:29:21] The second, so one is you went on fundamentals.

[00:29:23] The second is you just get more expensive.

[00:29:25] You just went on prices.

[00:29:26] Are people willing, has the market willing to pay more per dollar of earnings from one

[00:29:32] country versus another?

[00:29:34] And I think this is an important exercise to do because, yeah, you know, if a country is

[00:29:39] sort of inherently fundamentally stronger, maybe that'll persist.

[00:29:45] But if a country won, if it outperformed just because it got richer, just because people

[00:29:50] were willing to pay more for it, that's probably not a great case or premise for investing in

[00:29:57] it going forward.

[00:29:59] OK, so for the U.S. versus IFA, we can do this since since 1990 to present.

[00:30:05] So the period in which the U.S. really trounced other developed markets, take that 4.6 percent

[00:30:12] return I mentioned, split it into fundamentals versus just valuations versus just prices.

[00:30:18] What do we find?

[00:30:20] Prices, valuations explains the vast majority of it in our sort of we've got, you know, regression

[00:30:26] models and we do it all kind of statistically.

[00:30:28] We find something like 3.6 percent can be explained just by U.S. markets getting richer.

[00:30:34] You're not really as much from fundamentals, just 1.2 percent.

[00:30:37] And for the T-stat nerds out there, it's a statistically insignificant number.

[00:30:42] You know, I'm not saying it is not an economically meaningful one, but statistically, there's a

[00:30:46] lot of noise around it.

[00:30:47] And so that's another way of just sort of, I don't know, maybe calibrating one's enthusiasm

[00:30:53] for an U.S. investor's enthusiasm for having a massive home bias going forward.

[00:31:00] IFA just tripled in relative expensiveness to U.S. over that period.

[00:31:04] And that's something we're thinking about for the next 10 years.

[00:31:07] Yeah, this whole this time is different thing, I think, is so important to think about because

[00:31:11] sometimes this time is different.

[00:31:14] But most of the time, this time is not different, at least when you're backed with like long

[00:31:17] term historical data.

[00:31:19] So I like that part at the beginning where he's saying you can never know for sure.

[00:31:23] This time is not different, but you have to be able to analyze it and make your best

[00:31:28] judgment as to as to what's going on.

[00:31:31] Taking it back over and over again, and I love their work on this stuff for this reason,

[00:31:34] taking it back over and over again.

[00:31:36] Was it earnings?

[00:31:37] Was it market multiple expansion?

[00:31:41] Understanding is it the fundamentals or is it the flows?

[00:31:43] What's driving this thing?

[00:31:44] And then how do we unpack that?

[00:31:46] How do we decompose these things to understand what's actually going on here?

[00:31:50] If you know it's those two realities, you're still going to look out forward into the world

[00:31:54] that we have to go out and invest in and ask ourselves that question.

[00:31:58] What do I think the fundamentals are going to do and why?

[00:32:00] And what do I think the flows could look like and why?

[00:32:03] And do they agree with each other?

[00:32:04] Are they competing?

[00:32:05] And if they're competing, which one has the advantage?

[00:32:08] And I think there's two important points for people to consider on the fundamentals.

[00:32:11] One is the country issue, because this is something you hear all the time, which is

[00:32:14] the U.S. has way more exposure to technology.

[00:32:17] Technology is growing faster.

[00:32:18] The U.S. has the best companies.

[00:32:20] So if we're going to evaluate, obviously, emerging markets with a bunch of miners or whatever

[00:32:25] types of companies they have should trade at a discount to that.

[00:32:28] So we need to adjust for that and then say, after we've adjusted, is the discount still

[00:32:33] there?

[00:32:33] And so what they do at AQR is they've adjusted for all of this stuff and said, there is no,

[00:32:38] yes, fundamentals are better in the U.S., but even after you adjust for all of that,

[00:32:42] there's still these international stocks are still, you know, I don't know what it is now,

[00:32:46] but at the time it was like the cheapest 1% they've ever been.

[00:32:48] Like these stocks are still very, very cheap relative to the U.S.

[00:32:52] even after you adjust for that.

[00:32:54] And so that should give me more confidence going forward that I probably should be able

[00:32:57] to be successful investing internationally.

[00:32:59] Somewhere out there, there's a shady mining company who just wants to change their name

[00:33:03] to, you know, crypto mining company, even though they're like out there mining for

[00:33:07] copper or something just to get that share price to move because of their weird local

[00:33:11] currency exposure.

[00:33:14] Yeah.

[00:33:14] So whenever I want to get too complicated in life, my first place I always go is Rick

[00:33:18] Ferry.

[00:33:18] Like I can always go back to clips from Rick Ferry from the podcast and say, all right,

[00:33:21] Jack, you're overanalyzing this crazy situation.

[00:33:24] Do I really need to think about it that in depth or can I just do the simple thing?

[00:33:27] So here's Rick's take on international investing.

[00:33:29] Well, a lot of international companies sell to us.

[00:33:33] So yeah, I mean, look at all our stuff, all the stuff that is around me right now.

[00:33:37] I'm going to guarantee you half of it came from China, at least.

[00:33:42] My iPhone, probably this case that I carry around, it's all made in China, right?

[00:33:48] And so China's a big manufacturing area.

[00:33:52] Obviously, we buy a lot of stuff from China, which by the way, has really helped keep our

[00:33:55] inflation rate low.

[00:33:59] And we'll continue to do that as well.

[00:34:01] So the bottom line is, I just want to own everything.

[00:34:07] And yes, US companies sell internationally.

[00:34:13] International companies sell to us.

[00:34:16] So if I'm buying this stuff, why wouldn't we want to own those companies if we can't?

[00:34:23] I'm trying to capture, make this as clear as I can.

[00:34:27] With my equity portfolio, I'm trying to capture global growth, real global economic growth.

[00:34:39] And with that, GDP, call it global GDP.

[00:34:44] If you can capture real GDP growth, you get maybe a 2% there.

[00:34:49] You have inflation nominal GDP, which is made up of inflation plus real GDP, call it 4.5%.

[00:34:56] You get dividend yield of about 2%.

[00:34:59] So you add all that up, I'm going to say it comes out to about 7%.

[00:35:03] So I can get 7% from a global equity portfolio trying to capture this worldwide global growth.

[00:35:15] That's all I'm trying to do.

[00:35:17] And if it happens in the US for a while, which it has, that's great.

[00:35:21] There are times when it doesn't happen here.

[00:35:24] It happens in Europe.

[00:35:26] There are times it happens in the Far East.

[00:35:30] I don't know where it's going to happen.

[00:35:31] Right now it might be happening in India.

[00:35:33] Fine.

[00:35:33] I want to own it all, all of it.

[00:35:36] I just want to capture this global growth component.

[00:35:40] I will outperform inflation.

[00:35:42] I will outperform taxes.

[00:35:44] And I'll get an excess return of maybe 3%.

[00:35:48] Above all of that, a real after-tax, after-inflation return of 3%.

[00:35:53] And that's about what I should expect from an equity portfolio.

[00:35:56] And I believe I will get that just from a global equity index fund that has very low costs and low taxes.

[00:36:03] That's what I'm trying to do.

[00:36:04] And this is obviously the take most people would think Rick would have.

[00:36:06] But we don't know for sure which countries are going to outperform.

[00:36:10] We don't know what the future is going to look like.

[00:36:12] So maybe just buying a globally diversified portfolio.

[00:36:16] And that way you're going to own whatever the great country is of the future.

[00:36:19] You're going to own it.

[00:36:20] So some people might think you could predict those things.

[00:36:22] Some people might think we know for sure the US is going to be dominant in the future.

[00:36:26] But if you want to hedge your bets, you're still going to own a lot of US in a global portfolio.

[00:36:30] But just own the global portfolio and call it a day.

[00:36:33] There's a lot of wisdom in that.

[00:36:35] There's a lot of wisdom to just sitting on the passive global financial asset portfolio as best you can construct it and letting it ride.

[00:36:41] And I got to think about this too.

[00:36:43] I mean, Rick Ferry, we got to draw the clear analog to Rick Ferrari.

[00:36:46] I think I've made this joke publicly with him in the past.

[00:36:49] But, you know, if you think about it like this raises the question, what's the, and do you know, trivia for you, Jack?

[00:36:55] I did not know this until I looked it up.

[00:36:57] Do you know what the Chinese Ferrari is called?

[00:36:59] The Chinese Ferrari equivalent?

[00:37:01] I do not.

[00:37:02] I would have no guess on it.

[00:37:03] And I say this because it's like, you don't know what will succeed.

[00:37:06] You got the Ferraris, then you got the Teslas, then what comes next?

[00:37:09] Who knows?

[00:37:10] I don't watch Formula One.

[00:37:11] You can say that and point that out in the comments if you like.

[00:37:13] The BYD Yang Wang U9.

[00:37:16] I challenge you.

[00:37:18] So if you haven't driven that BYD Yang Wang U9, Jack, I'm telling you, if Tesla told Ferrari to move over,

[00:37:25] it's the BYD Yang Wang U9.

[00:37:27] That's not telling Tesla.

[00:37:28] I assume you're not getting that thing in the U.S.

[00:37:29] And given the change of presidency we have, I assume you're definitely not getting it in the U.S. going forward.

[00:37:34] Well, we can point out that proposed strategy of where expats set up to pay taxes,

[00:37:39] in which case you and your spouse can stay married.

[00:37:42] You can go to another country and move your assets there.

[00:37:45] And don't ask me how that math works out in the long term.

[00:37:47] But it sounds like a pretty clever tax dodge to get that BYD Yang Wang U9.

[00:37:52] Can we get a sponsorship?

[00:37:53] Will that get us in trouble?

[00:37:54] If they want to call us and they got the money, we'll put it in there.

[00:37:57] All right.

[00:37:58] Rick Ferry, you're going to be driving home.

[00:38:00] Driving around his neighborhood, basically.

[00:38:02] On a little video.

[00:38:05] You remember that guy that was on, there was that guy that was on CNBC that time.

[00:38:08] I think I've brought this up in the podcast before, but like who looked bad because he was a technician

[00:38:12] and he didn't know what the company did.

[00:38:13] And then like to get back at people, he like had his wife like film him like slow rolling his Lamborghini or his Ferrari or something like that.

[00:38:20] Down the road.

[00:38:21] So we can do that.

[00:38:21] That could be our commercial event.

[00:38:22] We can do that.

[00:38:22] For the BYD, whatever he said.

[00:38:25] All right.

[00:38:25] My Subaru Outback will get a major upgrade in short order.

[00:38:30] I can't wait.

[00:38:30] Exactly.

[00:38:31] But the other advantage of the Rick Ferry approach is, you know, you could just go have a margarita.

[00:38:35] And there is a lot of an advantage to that.

[00:38:37] Like if you own the global portfolio, I really don't have to worry about this debate about, you know,

[00:38:42] whether I should have international exposure, I shouldn't have international exposure.

[00:38:45] I could just own everything and I can just go about my day.

[00:38:48] Get global growth.

[00:38:49] That's your job.

[00:38:50] That's the beautiful thing about what Rick is saying.

[00:38:52] Get global growth.

[00:38:53] That's your job.

[00:38:55] If you do that, your chances of those assets keeping up with your future liabilities, whether

[00:38:59] they be at gift or consumption, stand a great chance.

[00:39:03] There's a lot of nobility in just making that very simple point.

[00:39:06] And the next one is our good friend, Jason Buck.

[00:39:08] And as many who follow Jason would guess, Jason's answer had something to do with your inability

[00:39:13] to predict the future.

[00:39:14] Yeah.

[00:39:14] What I think you're going to find is me backpedaling into agnostic, you know, stances on this.

[00:39:20] Like, so I actually agree with Bogle, agree with Corey and agree with Meb when, you know,

[00:39:24] he prefers international as well.

[00:39:26] But like Corey said, I think that a lot of S&P 500 companies, you know, have tremendous,

[00:39:30] you know, international exposure.

[00:39:31] And it's really hard to parse that out.

[00:39:33] And more importantly, you know, people that invest in ETFs, almost nobody does due diligence

[00:39:38] is the way I think about life.

[00:39:39] And they don't really even dig into their ETF portfolios to even know what they have.

[00:39:43] So I don't think anybody really has a clue.

[00:39:45] The other thing is like, even on the individual companies, you know, whenever we have people

[00:39:49] that go, well, I don't understand what you guys do in volatility.

[00:39:51] I go, tell me what you do understand.

[00:39:52] They're like, I understand stocks.

[00:39:54] And I send them a paper that my partner, Taylor Pearson did called Reality Has a Surprising

[00:39:58] Amount of Detail.

[00:39:59] And in that, he asks you to draw a can opener.

[00:40:01] And, you know, that's like the most simple mechanical tool there is.

[00:40:04] And almost nobody can draw a can opener.

[00:40:06] And the thesis he gets to is Reality Has a Surprising Amount of Detail.

[00:40:09] When people tell me about stocks, I go, tell me about your favorite.

[00:40:11] They're like, oh, Amazon's my favorite.

[00:40:12] I go, okay, tell me more about like AWS side.

[00:40:15] They're like, oh, no, I'm more on the e-com side.

[00:40:16] And I'm like, well, that doesn't count.

[00:40:18] And then I go, tell me who their CFO is.

[00:40:20] And nobody, you know, crickets.

[00:40:21] Nobody has an idea.

[00:40:22] So one, sorry, that diatribe was, you know, if you're buying ETFs or you're buying stocks,

[00:40:26] I'm not sure anybody really knows or spends the time to really dig into what they're actually

[00:40:30] buying.

[00:40:31] But the way we look at the stock portfolio is we replicate using the stock index futures,

[00:40:36] basically MSCI ACQUI.

[00:40:37] So we're using a global portfolio.

[00:40:39] Right now it's about 60% U.S., 20% foreign and 20% emerging markets.

[00:40:46] And now is that giving you that broad exposure that you couldn't get on the U.S. side?

[00:40:51] That's debatable.

[00:40:52] The other side that Corey brought up on your guys' podcast is you're also getting a currency

[00:40:56] play.

[00:40:56] So in effect, and not only am I trying to hold, you know, all the world's stock indices, I'm

[00:41:01] also getting a kind of buy and hold currency play that I'm rebalancing as well.

[00:41:05] And we were rebalancing between those on a monthly basis.

[00:41:07] And I'm sure we can get into rebalancing more.

[00:41:09] But the same thing that Matt Faber has historically said as well is like, we're just trying to

[00:41:14] hold all the world's liquid asset classes and rebalance.

[00:41:17] So that's part of why we believe in maybe just, you know, venturing beyond the S&P 500

[00:41:22] into the foreign and emerging.

[00:41:23] So he's also right about this.

[00:41:25] I mean, you know, Jason is really trying to build a portfolio, a mutiny fund that, you

[00:41:29] know, doesn't have to predict the future.

[00:41:31] Just, you know, there's all kinds of things that, you know, they always say, like, there's

[00:41:34] way more things that can happen that do happen.

[00:41:36] So there's just a million different potential outcomes in the future.

[00:41:38] And if you think about it that way, then you want to have international exposure because

[00:41:43] some of those outcomes would benefit from having a global portfolio or from investing in

[00:41:48] international companies.

[00:41:49] So it fits very well with Jason's approach.

[00:41:52] You know, Jason talked about the costs, you know, the costs and benefits of this whole

[00:41:54] thing.

[00:41:55] But in the end, to come down on that conclusion, I think fits really well with the way Jason

[00:41:58] invests.

[00:41:59] The note that I wrote down for this one was that Jason Buck is the Tony Danza of agnostic

[00:42:04] stanzas.

[00:42:05] You're welcome, Jason.

[00:42:06] And just this, who is the boss?

[00:42:09] Reality has a surprising amount of details.

[00:42:11] I think that's so important.

[00:42:13] Who's the boss?

[00:42:13] Who's the CFO at Amazon?

[00:42:15] These are really important things.

[00:42:16] People don't do the due diligence.

[00:42:17] People don't think deeply about this stuff.

[00:42:20] It's important to step back and say, what's really going to matter is how I rebalance across

[00:42:24] all these different risks.

[00:42:26] And that's one of my favorite things that Jason talks about is thinking about risks that all

[00:42:30] these variable levels, all these subcomponents, and whether it's just rebalancing in and

[00:42:34] around currency stuff.

[00:42:36] There's advantages to be had from that rebalancing strategy, from the risks that you're taking

[00:42:40] on.

[00:42:41] That's an achievable outcome.

[00:42:42] And they invest internationally too.

[00:42:45] It's not like they're hiding from this stuff.

[00:42:47] They're going, what's the opportunity that we actually think we can have some control

[00:42:50] over harvesting something from?

[00:42:52] And if you like the Tony Danza thing, then you've definitely got to watch the Intentional

[00:42:55] Investor episode on Epsilon Theory, where with Matt and Jason, where Matt went into about

[00:42:59] 20 of those type of things in his introduction for Jason.

[00:43:02] Well, yeah.

[00:43:03] What are friends for if not making, yeah, dated and obscure references like, yeah, Beck Satan

[00:43:09] gave me a taco.

[00:43:10] So that's what we're getting for.

[00:43:11] I don't know if people...

[00:43:14] I don't even imagine what you would do, but I don't want to know.

[00:43:18] So anyway, moving on to the next one.

[00:43:20] This is another one that kind of fits with what we've talked to them about.

[00:43:22] But here's Mike Green talking about how he thinks about international investing.

[00:43:26] So first, I'm always in favor of diversification.

[00:43:29] I think that there are very clear benefits associated with putting a claim against assets that are earning income,

[00:43:36] both not in your native currency and not in your native, you know, I would describe

[00:43:41] as, you know, meatspace legislative, you know, capture, right?

[00:43:47] So if you're in Syria, for example, we wouldn't even be having this conversation and be like,

[00:43:51] okay, how do you access the S&P 500?

[00:43:53] How do you get out of your country, right?

[00:43:54] It's just a ridiculous luxury that we sit in the United States and say, you know,

[00:43:58] what do you think about international exposure?

[00:43:59] And we can debate it, right?

[00:44:03] So the obvious answer is that you should invest.

[00:44:06] But just like the value factor, the idea behind the value factor,

[00:44:10] the idea of accumulating claims on future cash flows,

[00:44:14] there's unfortunately a wrinkle to it that's created by the underlying characteristics of markets today.

[00:44:20] If I look going back to those same dynamics, you know, 90 plus percent of the marginal capital is now coming in through vehicles

[00:44:29] that attempt to buy equities both domestically and internationally,

[00:44:34] not based on their underlying characteristics of cash flows, or are they growing more rapidly,

[00:44:39] or do they offer excess return in the form of dividend yields or stock buybacks, et cetera.

[00:44:45] Instead, it's simply a function of, you know, well, based on some historical return profile and correlation characteristics,

[00:44:53] we're going to put 15% of the portfolio into those, right?

[00:44:57] So what that means is, is that within the U.S. framework, if I'm thinking about this,

[00:45:02] of each incremental dollar that goes into equities,

[00:45:06] most of these target date funds and structures will put something like 80% into U.S. assets

[00:45:11] and 20% into international assets and take down the international assets more rapidly.

[00:45:17] U.S. equities only make about 50% of global market cap.

[00:45:20] That's after significant appreciation.

[00:45:22] And on the flip side of it, you know, you have this relatively low allocation

[00:45:28] that's going out to the international assets.

[00:45:30] The international assets, to go back to the quality junk framework we were talking about,

[00:45:34] they're huge capital issuers.

[00:45:36] Why? Because it's growing more rapidly.

[00:45:37] They need more capital.

[00:45:38] They need U.S. dollars to put to work, et cetera.

[00:45:40] You see this in terms of share issuance.

[00:45:42] So there's dilution, the opposite of what David's looking for, for example.

[00:45:46] At the same time, less money relative to market cap is flowing into those spaces

[00:45:50] by virtue of these fixed investment structures.

[00:45:53] And so we end up with this perpetual underperformance that, from my perspective,

[00:45:57] is going to be very hard to break under the structural and systematic frameworks

[00:46:01] that we're currently operating under.

[00:46:03] And I just want to be really clear.

[00:46:04] I don't think it has anything to do with fundamentals, right?

[00:46:07] I don't think it has anything to do with diversification benefits.

[00:46:09] I just think it has to do, if I mechanically say, put 20% of my money into international

[00:46:14] and 80% of it into the U.S., and the U.S. companies are largely shrinking their capital

[00:46:20] while the international companies are tapping the capital markets, it's like an extreme version

[00:46:24] of my quality junk.

[00:46:25] And it's been one of the highest sharp ratio trades of the past 15 years is to bet against

[00:46:30] emerging markets, right?

[00:46:31] Or rest the world.

[00:46:32] So this fits with what Mike believes about the world, but it's also a really, really important

[00:46:36] point, which is if everybody's indexing, then you probably need to think about like, what

[00:46:41] is the international exposure in the index?

[00:46:43] How much are people investing in an international relative to the index?

[00:46:47] And how would international underperformance change in the future if this is going to continue

[00:46:51] going on?

[00:46:52] If this is going to continue being a dominant phenomenon, is that going to be a weight on

[00:46:56] international exposure where international companies are going to continue to underperform because

[00:47:00] of this passive indexing thing?

[00:47:01] The new not my president is apparently not my currency, not my political regime.

[00:47:05] I'm just saying.

[00:47:06] This is a really big point.

[00:47:08] It's this idea of you got to think about flows, not just on the national scene, but

[00:47:12] on the international scene for where money comes from and what that bid is that's behind

[00:47:16] this stuff.

[00:47:17] It falls back a line, I think, with some of Meb's prior point.

[00:47:21] Heavier passive flows around the world just means the U.S. is going to continue to get heavier

[00:47:25] and heavier flows with the size of the market capitalization of U.S. stocks.

[00:47:30] You have to take that into consideration.

[00:47:31] And that's a big deal.

[00:47:36] So our last one is Andy Constant.

[00:47:38] This is another.

[00:47:38] It's interesting how when you talk to people, you think you're just going to get the pro and

[00:47:42] con argument.

[00:47:43] But every time there's a nuance to these, like every person has a little bit of a nuance

[00:47:47] they introduce that the other people didn't.

[00:47:48] So here's Andy talking about balance.

[00:47:50] Yes.

[00:47:52] But I think you have to also be very conscious.

[00:47:55] For the U.S., it's less of an issue.

[00:47:57] For international investors investing in smaller markets that are their home country, I think

[00:48:03] it's essential.

[00:48:03] But for the U.S. investor, the U.S. investor does get both a deeply liquid local market and

[00:48:10] that is consistent with their future life liabilities.

[00:48:15] And so, you know, the diversification is a benefit, but it comes at a cost of convenience,

[00:48:21] of complexity, et cetera.

[00:48:26] Now, let me step back a little bit and say that one of the important factors for investing

[00:48:33] internationally is that your market has what I would call balance, meaning the U.S.

[00:48:42] has treasury bonds that if interest rates fall because growth falls, you'll make some capital

[00:48:50] return.

[00:48:51] And so they diversify against stocks, which are likely to be falling in that case.

[00:48:56] And so there's a nice balance between stocks and bonds that exists in the U.S.

[00:49:02] Until very recently, well, in Japan, it doesn't exist.

[00:49:07] So if you're going to invest in Japan as a diversifier, all you're doing is buying Japanese

[00:49:12] equities because you can't buy Japanese bonds.

[00:49:15] They're just, you know, they won't provide anything for you in the case of a falling Japanese

[00:49:20] economy where your long stock position is.

[00:49:23] So I consider Japan to have no balance.

[00:49:26] And so any allocation I would give to Japan would be very, very small.

[00:49:31] And I think that's what's happening to some extent regarding the yen because international

[00:49:35] investors can't get balance there.

[00:49:38] Um, Europe is better, but it's still not obvious that there is strong balance.

[00:49:45] Interest rates have risen a lot, but they came from zero and now they're still quite

[00:49:50] a bit lower than the U.S.

[00:49:52] And so I think you can get some balance in Europe.

[00:49:56] Emerging markets, that's like buying a tech stock or buying anything else.

[00:50:02] You're just, I'd prefer to lever an S and P position than buy a levered beta investment

[00:50:09] that comes prepackaged in the form of an emerging market equity or a, um, single or a NASDAQ

[00:50:18] stock or, uh, you know, any particular high flyer just for me in terms of the way it responds.

[00:50:24] Um, but I would say one thing is that when you're getting to our emerging market diversification,

[00:50:30] I think you're doing some of the same things that you're doing.

[00:50:33] Um, when you choose high beta U S stocks as a diversifier, um, I'm just not sure you're

[00:50:41] getting much value there versus doing that.

[00:50:44] So I guess the high level thing is I still want diversification, low cost, low complexity,

[00:50:52] uh, low fee, and it's available internationally, but I, you know, I would caution that there are

[00:51:00] places where it would make sense at places where it's just a different bet.

[00:51:04] Yeah.

[00:51:04] And I thought that was a really important point because, you know, we take for granted as U S

[00:51:07] investors.

[00:51:08] I mean, we've got, you know, we can have a good diversified portfolio of stocks and bonds

[00:51:13] and invest only in the U S and also invest in, and invest in some of the biggest companies

[00:51:17] in the world.

[00:51:18] If we're in a different country, we're in a different situation than that.

[00:51:21] I think a lot, and he makes a lot of great points as Andy always does with this stuff.

[00:51:25] He, he said this, this one statement about deep local markets consistent with future

[00:51:30] liabilities.

[00:51:31] And I might've gotten that quote just a little bit wrong, but it's close enough.

[00:51:33] Deep local markets consistent with future liabilities.

[00:51:36] If you were a person living in the U S you have the great advantage of having a stock and a

[00:51:40] bond market.

[00:51:41] That's deep.

[00:51:42] That's liquid.

[00:51:43] That's accessible where the bonds don't yield zero anymore, but we're not in a Japan type

[00:51:48] situation.

[00:51:49] And likewise, the stock market has growth across a diversified amalgamation of sectors that we

[00:51:55] can invest in where there's actual growth.

[00:51:57] So that means if you're saving for your kid's education, for retirement, for whatever, you're,

[00:52:03] you're a, you're a business and you're just trying to do asset liability matching inside

[00:52:07] of your pension for future retirees.

[00:52:09] You can actually solve all that inside of the U S markets.

[00:52:12] The minute you start to step outside of the U S or into other countries, these problems enter

[00:52:18] the fray.

[00:52:18] You have to start solving for what is the depth of the local market and how consistent are

[00:52:23] they in my assumptions to get me to my future liabilities.

[00:52:27] As soon as you globalize that thing, it's a, it's a very complicated problem.

[00:52:31] And it puts a lot of points back on advantages that the U S has, not just for people who live

[00:52:36] here, but for, for people around the world with dollars to invest.

[00:52:40] So where do we come down on this?

[00:52:41] I mean, this is an interesting debate and it's one, you know, sometimes when we have these

[00:52:44] debate, I feel like I have a pretty clear answer at the end.

[00:52:46] And in this one, I don't think so.

[00:52:48] I mean, I'm a believer in international investing.

[00:52:50] I think Larry Sledrow's point's really important that, you know, companies do trend to trade

[00:52:54] with their home countries.

[00:52:55] And I'm not a believer that the U S I think in the near term, it looks pretty promising

[00:52:59] for the U S.

[00:52:59] I mean, if you look at what's going on with AI and you look at the dominant firms in

[00:53:02] AI and you look at just the dominant firms in the economy in general, like I think it's

[00:53:05] pretty positive for the U S.

[00:53:07] But I also think international exposure makes sense for most people.

[00:53:10] And so again, it can be a matter of how much, but, but I do think like some level of

[00:53:15] international exposure makes sense in most cases.

[00:53:17] I think you got to have some, I don't think it can be zero.

[00:53:20] Does it have to be 50% or should it be 25% that's up to you?

[00:53:24] And that's asking those big questions in your capital market assumptions, because at least

[00:53:29] in the professional work I do, we're looking at what are the capital market assumptions

[00:53:33] for building these portfolios.

[00:53:35] And then we're asking, where is their growth, be it earnings or whatever else, where is there

[00:53:40] the room for multiple expansion or contraction based on flows and how we think of them.

[00:53:46] You got to put all that together and then have a rebalancing strategy around it.

[00:53:50] I think you need some international exposure.

[00:53:52] You have to decide where you straw that line as it relates back to the global financial

[00:53:56] assets portfolio.

[00:53:57] And then let's face it, all of us out there are just trying to get that BYD Yang Wang U9.

[00:54:02] So, you know, however you're going to do it, you just got to get there.

[00:54:06] Yeah.

[00:54:06] And I think the percentage thing is such an important point because it really, it really lies inside

[00:54:10] of yourself.

[00:54:11] Like how much international exposure you should have to some degree, because if you're a person,

[00:54:14] you know, who owns the global market portfolio and is going to be looking at the line item

[00:54:18] of my international stocks every year and is going to say, yeah, I just can't deal with

[00:54:21] this.

[00:54:21] Like I need to panic.

[00:54:22] I need to abandon them.

[00:54:23] You're probably going to abandon them at the wrong time.

[00:54:25] And so for a person like that, less international exposure makes sense.

[00:54:28] I mean, I remember when we had Rob Arnott and show us your portfolio, he has like almost

[00:54:31] his whole portfolio in emerging markets right now.

[00:54:33] But Rob Arnott can do that because Rob Arnott understands the long term and Rob Arnott probably

[00:54:38] is not going to abandon that no matter what, unless he saw compelling evidence on the

[00:54:41] other side.

[00:54:41] So a lot of this probably lies inside each individual person.

[00:54:45] Yeah, I think you have to make sure this is just another matter of alignment.

[00:54:48] If you're Rick Ferry and you can just go have a margarita about it, you can have that level

[00:54:53] of exposure.

[00:54:54] But if you're somebody who's going to get really upset by the vagrancies of emerging

[00:54:58] markets or you got into Russia at the wrong time right before the Ukrainian invasion or

[00:55:02] something and lost a bunch there, there are risks to doing this.

[00:55:05] But if you're comfortable with the risks and the time horizon required to see them out,

[00:55:10] by all means, you're aligned with it.

[00:55:12] Go do it.

[00:55:12] If you're not, don't make yourself your own worst enemy.

[00:55:15] Talk to somebody and just thoughtfully put together your plan to do it.

[00:55:19] And the final point I make as we wrap up is I don't think you can go wrong either way

[00:55:22] here.

[00:55:22] I mean, I think there's some of these where it's like a clear answer.

[00:55:25] Like in this case, you can make the case like if you're somebody who doesn't believe in any

[00:55:28] of this and you just invest in the S&P 500 and you get your international exposure that

[00:55:31] way, you're probably going to be fine long term.

[00:55:34] I mean, this is not something that's going to like completely derail your portfolio because

[00:55:37] you don't have international exposure.

[00:55:38] We're probably talking about stuff around the edges because people like the points Corey

[00:55:42] made are good.

[00:55:42] I mean, you are getting some exposure to international stocks in your U.S.

[00:55:46] portfolio.

[00:55:47] We can argue about the degree, but you're getting it.

[00:55:49] So you're probably not going to go wrong if that's what you believe in and that's what you

[00:55:52] decide to do.

[00:55:53] Couldn't agree with that more.

[00:55:53] Well said, Jack.

[00:55:55] So on that note, I guess I don't know if we've answered the question for everybody,

[00:55:59] but we will wrap up.

[00:56:00] Thank you, everybody, for joining us and we'll see you next time.

[00:56:02] Hi, guys.

[00:56:03] This is Justin again.

[00:56:04] Thanks so much for tuning into this episode.

[00:56:07] You can follow Jack on Twitter at Practical Quant.

[00:56:10] You can follow me on Twitter at JJ Carbono and follow Matt on Twitter at Cultish Creative.

[00:56:16] If you found this discussion interesting and valuable, please subscribe in either iTunes or

[00:56:21] or leave a review or a comment.

[00:56:23] Also, if you have any ideas for topics you'd like us to cover in the future, please email

[00:56:27] us at accessreturnspod at gmail.com.

[00:56:30] We would like this to be a listener-driven podcast and would appreciate any suggestions.

[00:56:34] Thank you.

[00:56:35] Thank you.