Equities have been on a roll. For most investors, the question lately has been not whether or not to be in stocks, but what portion of their total portfolio should be in equities. 

There's a second question they should be asking: "What should the allocation be within equities?"

It can make a big difference. Take a look:

Just so we are all clear, let's look at some definitions:

Capitalization: Market capitalization represents the aggregate value of a company stock. If a company has 500 million shares outstanding and their current market price is $10 per share, their market "cap" is $5 billion. For U.S. Stocks we have large caps ($9.6 billion and above), mid caps ($2 to $9.6 billion) and small caps (less than $2 billion).

Growth Investing and Value Investing: Often presented as two competing styles of investing. Value investing emphasizes buying shares below their intrinsic value. Growth investing emphasizes buying shares in companies with high growth rates.

International: Includes investments, either directly or through funds or ETFs in foreign stocks or American Depository Receipts. International is typically divided into two categories: Developed countries- such as Western Europe and Japan, and emerging countries- such as China, India, Brazil and dozens of other developing countries.

Understanding the One Year and Five Year Results:

1.       Mid and small cap stocks have outpaced large caps. By their very nature, mid and particularly small cap stocks are riskier than large caps. Large caps stocks historically do best when the economy is expanding broadly and inflation is low.

2.       Growth stocks have outperformed value stocks. Value investors buy stocks that are trading at relatively low valuations and slow growth. Growth stocks are just the opposite. Value investors have not been rewarded as much as growth investors in the U.S. during these uncertain times.

3.       International developed stocks (for example, stocks of Western Europe and Japan) have fared somewhat similarly to US large caps. 

4.       International emerging market stocks, while more risky, have outpaced international developed returns in the current year and, in the last five years, have outpaced all other indices.

 Some Questions to Consider in Allocating within Equities:

1.       What is your risk tolerance? Small caps and emerging market investments are typically the riskiest equity investment styles.

 

2.       Should your investments be in growth, value or a blend?

 

3.       How much should be in international? About 50% of the global market capitalization is in U.S. Companies. The corollary to that is that 50% is not. Approximately 30% of the revenues of the S&P 500 companies are generated outside the U.S. Hence, domestic stocks exclude three-fourths of the global economy.

 

Many investors have "home bias", a tendency to overweight in domestic stocks.They should diversify their equities by investing in international stocks. Other countries-with potentially unique products and customer sets- may weather market upturns and downturns differently than the U.S.

 

4.       How much should be in emerging markets? Emerging markets (think China and India) tend to have higher growth than developed markets. Emerging countries make up 85% of the world's population and 46% of the world's economic output. They're growing faster than developed countries, perhaps 2 to 3 times faster in the next few decades according to IMF. In addition, emerging markets tend to have less-efficient markets, which can lead to higher returns.

Emerging countries typically have young working-age populations, export strength, low levels of debt and growing household income, health resources, natural resources along with prudent fiscal policies. Contrast these characteristics with those of the developed countries!

5.       What are some of the risks in international investing? First, there is political and regulatory risk. Second, there may be difficulty obtaining timely and accurate information. Also, there is currency risk. Finally, trading can be less liquid and access to funds may be restricted or delayed.

Conclusion:

Optimizing the allocation within equities by using the various styles can make a real difference. Results for last year and the last five years demonstrate this. If you would like to discuss your allocation in greater detail, please give us a call.