The Case for Broadening One’s Investment Horizon

by: , Managing Director and Senior Portfolio Manager, MainStay Investments

Renowned stock picker Peter Lynch was known for his mantra: invest in “what you know.” While it certainly worked for Mr. Lynch, nearly three decades later the investment world looks a lot different. As a result, a more prudent strategy is to pursue a broader investment approach. A broader investment approach can expand one’s opportunity set and also lead to enhanced portfolio diversification.

Comfort in the Familiar

It’s human nature to find comfort in the familiar. Behavioral research shows that the human brain is not wired for the arduous task of choice. For example, when given too many choices, decision making becomes paralyzing. The same holds true in the financial world, where the brain must sort through a dizzying array of investment options. As a result, it’s not surprising that many investors stick with what they know—such as a specific segment of the marketplace.

The Benefits of a Broader Approach

On one hand, confining one’s scope to familiar and comfortable investments lessens the probability of imprudent risk-taking. On the other hand, it can limit the ability to pursue attractive opportunities and lead to inadequate portfolio diversification. Consider the following:

A World of Opportunities

Geographically speaking, approximately half of today’s global equity market capitalization resides outside the U.S. This includes some of the world’s most famous—and most profitable—brands. Non-U.S. juggernauts can be found in a variety of industries, including pharmaceuticals, semiconductors, telecommunications, automobiles, oil and gas, food and beverage products, and retail.

MSCI All Country World Index Market Cap Weights

Source: Factset As of 4/17/18

Boosting Return Potential

Broadening a portfolio to include non-U.S. companies has led to improved investment performance. As shown in the chart below, over the last 15 years, adding a 20% allocation to international developed stocks matched (or at times exceeded) the performance of investing only in the S&P 500 index.

Source: Bloomberg 4/18/18. Domestic investment is based on S&P 500 total return index. The International index is based on MSCI EAFE Index daily total returns. Past performance is not indicative of future results. An investment cannot be made directly in an index.

Enhanced Diversification/Less Risk

The adage about not putting all your eggs in one basket is as stale as a three-week-old loaf of bread. Still, the implications in the investment world are as important as ever. That’s because market and economic cycles around the world are in a constant state of flux. For example, whereas the current economic expansion in the U.S. is likely in the late innings, many European economies are in the early stage of their recoveries. As such, a portfolio with both U.S. and non-U.S. stocks can not only lead to better return potential, this type of diversification can help reduce a portfolio’s overall risk exposure.

Value At Risk

Source: Bloomberg 4/18/18. Domestic investment is based on S&P 500 total return index. The International index is based on MSCI EAFE Index daily total returns. Value at risk (VaR) is a measure of the risk of loss for investments. It estimates how much a set of investments might lose (with a given probability), given normal market conditions, in any given day. Conditional value at risk (CVaR) is a risk assessment technique often used to reduce the probability that a portfolio will incur large losses. This is performed by assessing the likelihood (at a specific confidence level) that a specific loss will exceed the value at risk. Past performance is not indicative of future results. An investment cannot be made directly in an index.

Avoiding Overly Complex Strategies

Broadening one’s investment scope has many positive elements. But that doesn’t mean branching out to the unfamiliar is always the best approach. That’s because failing to understand the properties of an investment can lead to improper risk-taking. A perfect example is retail investors who recently pursued short volatility strategies. These volatility contracts are complicated instruments and many investors didn’t understand the risks they entailed. Sure enough, when market volatility suddenly spiked in early February it led to extraordinary losses. The lesson here is crystal clear: complex, esoteric securities or strategies are best left out of most individual portfolios.

Conclusions

The benefits of broadening one’s investment universe include a greater array of return opportunities and enhanced portfolio diversification. The proper approach to this strategy, such as how much to allocate to international equities, will vary by investor and depend on their goals, time horizon, and risk tolerance. A professional investment advisor can review a person’s specific circumstances and develop a course of action that’s best suited for their needs.

Opinions expressed are current opinions as of the date appearing in this material only. The information and opinions contained herein are for general information use only. MainStay Investments does not guarantee their accuracy or completeness, nor does MainStay Investments assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. There can be no guarantee that any projection, forecast, or opinion in these materials will be realized. Past performance is no guarantee of future results.

About Risk

All investments are subject to market risk, including possible loss of principal. There is no assurance that the investment objectives mentioned will be met. Diversification cannot assure a profit or protect against loss in a declining market.

Index performance is shown for illustrative purposes only and does not predict or depict the performance of any specific investment. Indices are unmanaged, include the reinvestment of dividends, and cannot be purchased directly by investors. Past performance does not guarantee future results.

The MSCI Emerging Markets Index captures large- and mid-cap representation across 24 Emerging Markets (EM) countries. With 839 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.

The MSCI All Country World Index captures large- and mid-cap representation across 23 Developed Markets (DM) countries. With 1,652 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.

The MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada.

The S&P 500 Index is an unmanaged index and is widely regarded as the standard for measuring large-cap U.S. stock market performance.

SAS Group, Strategic Asset Allocation & Solutions Group, is a division of New York Life Investment Investments. MainStay Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. MainStay Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. NYLIFE Distributors LLC is located at 30 Hudson Street, Jersey City, NJ 07302. ALPS Distributors, Inc. is not affiliated with NYLIFE Distributors LLC. NYLIFE Distributors LLC is a Member FINRA/SIPC.

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Jonathan Swaney

Managing Director and Senior Portfolio Manager, MainStay Investments

Jon is a Managing Director and Senior Portfolio Manager in the Strategic Asset Allocation & Solutions Group.  His current focus is on management of the MainStay and third party asset allocation strategies

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