Some of our clients occasionally express concern about the situation in Europe. Here’s what our Director of Research, Larry Katz, has to say about Merriman portfolio exposure to those markets:
Europe’s ongoing debt problems have prompted many investors to consider their European exposure, especially to the euro zone’s weaker countries. While there certainly could be global impacts emanating from any area of the world, a major benefit of true global diversification is the controlled direct exposure to the problems of any given geography.
For example, one of our major portfolios is MarketWise Tax-Deferred, a globally diversified, buy-and-hold portfolio with a value and small-cap tilt. Half of the stock exposure of this portfolio is in the United States. The other half is distributed throughout the world.
Of the 50% overseas exposure, as of the end of March 2012 just over 22% was in Europe. Notably, most of that exposure was to the stronger European countries. The top six European countries by exposure (United Kingdom, France, Germany, Switzerland, Sweden and the Netherlands) comprised almost 18% of the total invested in Europe. The weaker countries of Greece, Ireland, Portugal, Spain and Italy totaled only 1.73%.
So a 60/40 stock/bond portfolio had just over 1% exposure to these five troubled countries.
Every portfolio has to incur various risks to generate returns. The key is to intelligently diversify so that, under a variety of market conditions, those risks remain under control.
Is it a smart bet to reduce European exposure? It seems certain that these markets will continue to underperform for the next one to two decades.
Based on recent political and economic events we understand the skepticism surrounding the long-term growth prospects of European markets. However, we do not feel it is a foregone conclusion that European markets will produce sub-par returns over the coming decades. In its simplest form I see three potential outcomes:
1) European markets underperform
2) They keep pace with other financial markets
3) They outperform.
Under scenario one you are correct and moving out of European markets would have been a good move. “Would have” being the operative phrase. There is certainty in the past not in the future. On the flip side there is the chance that European markets outperform in the coming decades. Under this scenario we should have increased the European exposure. Again, should have – past tense.
We are not making tactical bets based on current political and economic circumstances. Rather, we are using historical data in conjunction with decades of academic research to build well-diversified portfolio designed for the long-term.
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