Loading summary
Transcript53 lines
- [00:00]
Ben Carlson
Today's Animal Spirits Talk youk Book is brought to you by Franklin templeton. Go to franklintempleton.com to learn more about their whole suite of international ETFs, including the Franklin International Core Dividend Tilt Index. That's Ticker D I V I Divvy. To learn more, franklin templeton.com.
- [00:18]
Michael Batnick
Welcome to Animal Spirits, a show about markets, life and investing. Join Michael Batnick and Ben Carlson as they talk about what they're reading, writing and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of of Ritholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast.
- [00:48]
Ben Carlson
Welcome to Animal Spirits with Michael and Ben. Michael when I entered the Internet, the Investing World Talking 2005 ish, this is what everyone wanted to invest in. China, the BRICs, emerging markets then I guess you would say IFA type of strategies.
- [01:12]
Todd Matthias
And the story was what just the global economic engine is going to be powered by growing population, coming into the modern world, that sort of stuff.
- [01:19]
Ben Carlson
Yeah, there's more growth there, there's more people there. You know, the Brazil, India, China thing, it was just like this vibe. They're building up their middle class. This is the place to be. And emerging markets were on fire that whole decade and now even coming out of the great financial crisis, cause I think emerging markets crashed like they fell by two thirds in the, in the 2008 crisis. It was, we were down 56%, they were down like 60 some percent, 67% or something. But even coming out of the crisis people were thinking, remember, remember the new normal stuff for the US like was prevalent. The US isn't going to grow anymore. This is where the growth is. And obviously that's just not the case anymore internationally. And it's interesting to see the snapback in international stocks this year because a lot of people are saying yes, finally diversification is working. But there's also a lot of people saying no, no no no no, zoom out, this is a blip, don't worry. And I think there's a lot of skepticism here. So I think this is kind of a, you have to show me. Don't just tell me what happened historically when it comes to international investing. And I think it's, it would take a while to change, change habits and I think it would be foreign investors would change their habits before US investors in a lot of ways.
- [02:34]
Todd Matthias
So no better guest to speak with today about the home country buys and international diversification than Todd. Matthias. Todd is the head of US Product strategy and development at Franklin Templeton Investments. You know, Franklin is one of the oldest global investment management firms founded in 1947. And sir, did you know that off.
- [02:56]
Ben Carlson
The top of your head?
- [02:58]
Todd Matthias
No, I have the Internet.
- [03:00]
Ben Carlson
Okay.
- [03:01]
Todd Matthias
And Sir John Templeton, if memory serves, made a boatload of money investing in Japanese stocks during the boom.
- [03:09]
Ben Carlson
I remember the story of him buying every stock that was trading for under a dollar or something and just hoping that the ones that did well would make up for it. Yeah, it's a great. What if I wanted to become Sir Ben Carlson? Who do I have to apply? Sir Michael Badnik. It doesn't roll off the tongue as well, does it? Sir John Templeton. That sounds like a guy who should have a sir in front of his name.
- [03:29]
Todd Matthias
Yeah, he did. Well, he does or he did.
- [03:31]
Ben Carlson
All right, so we talked all about the international markets diversification, benefits, different ways advisors are allocating internationally, and why different factors tend to work better internationally. So here's our talk with Todd. Todd, welcome to Animal Spirits.
- [03:53]
Todd Matthias
Thanks for having me.
- [03:54]
Ben Carlson
All right, the way I see it, the big valuation debate these days is, okay, U.S. valuations are much higher than international valuations, but that makes sense because the US has higher quality companies, especially on the tech side. They have bigger margins and they're just better quality. So it makes sense that there's a valuation premium for the US but the other side of this is. Wait, wait, wait. Yes, that's true, but the valuations already take that into account. And so I feel like there's this push and pull between US international. And I'm just curious where you stand on that side of the debate.
- [04:33]
Todd Matthias
Yeah, you have really kind of two different market dynamics. Right. You have a US economy, like you had mentioned, really tech, heavy tech, comm services. So these are business models that tend to, like you had said, higher in quality, more cash on hand. They're not distributing that cash necessarily. They're reinvesting that through research and development and then international markets, healthcare, vehicle manufacturing, a lot of financials. So again, just different structures in these markets, but it doesn't mean that these shouldn't be held in tandem. So the debate is one going to outperform the other. In the short term, you're going to see divergence. In the long term, you've seen some really meaningful outperformance from the U.S. over the past 15 years, the U.S. has outperformed developed international markets by 487% cumulatively. So it's hard for a lot of investors to get over that hurdle. Okay, why would I invest internationally? I get cheaper valuations, but has that actually turned into better equity performance for me? So you have these competing forces in terms of not only the structure of the market, but then what does that lead to in terms of the behavior of that equity market? And does it actually lead to a catalyst for diversification? The only free lunch we know in investing.
- [05:57]
I saw a tweet yesterday that blew my face off. It's showing going back to 2015. Who's this from? This is from Schroder's ex. Magnificent Seven. European earnings growth has been similar to the US over the past decade. I couldn't believe it.
- [06:16]
That doesn't surprise me. You strip out those companies that you see all these reports similar that attribution. Remove the top 10. How much did the bottom 490 contribute to the performance? It's not as material as you think. It's really those top 10 that have been driving the growth. You look at Nvidia, you look Tesla, Netflix, Microsoft, Apple, those are the names that are driving the growth in the US Market. Which again, makes even more of a case for potentially diversifying with International. Is that those top 10, while they can swing one way, what's stopping them from swinging the other? In particular, with the geopolitical nature and tensions in the global economy today, the.
- [07:00]
Ben Carlson
Catalyst is the hard part. You mentioned the valuations. You could have made the same valuation case seven years ago and been wrong ever since. Right. And it's funny, Michael and I are having a conversation, I think it was in December, saying that, like, I can never remember the sentiment being this bad in International my entire career. Like, you, you were right. People were saying, why would I ever own anything besides US Stocks, especially the big US Stocks. It doesn't make any sense. And then, and I don't think anyone could have guessed, well, you know, we're going to have this trade war and that's going to make the dollar go down and it's going to make international stocks. You know, it's going to make these countries like Germany finally decide to pull the bazooka on the fiscal side and it's going to completely change and a catalyst no one could have seen. But I'm curious because a lot of people look at the returns this year and say international is beating the US By a wide margin. But, well, a lot of that is the dollar falling. How much do you think the currency interplay matters here? Because that's been one of the headwinds for international investors in the US since really 2008 or so.
- [07:55]
Todd Matthias
Yeah, currencies comes into play. It's huge. It can go one way or the other. Over the long term it tends to wash itself out. So it's volume for the sake of volume, but it does impact return. And you make a good point. You go back, has anyone expected or has seen anything but US equity outperformance? And I almost look at it as the pre GFC market entrance and the post gfc. I'm a pre GFC market entrant. So I actually had seen em outperform international markets outperform. But it's not people just new to the industry, it's people new to investing. So it could be your parents and they just actually rolled over the 401k or got a financial advisor for the first time. So this is the first time they're looking at their statements and it begs the question why am I going to invest outside the US and actually if you start talking to FAs there's some really interesting opinions out there. I was talking with a dad at hockey practice and he's a wholesaler here in the Bay Area. Cover someone down in Silicon Valley, billion dollar book, single tech stocks and S&P 500 exposure. That's it. It's worked 100% right. But bonds are risky for that advisor. International is risky for that advisor. You see these ends of the spectrum where you have advisors with really good strategic long term asset allocation plans and that's working this year and it should work over the long term. You're trying to soften those periods of short term bull because you want your clients invested for the long term. You don't want whipsaw decisions. And the more concentrated you are, the more open you are to potentially having your client make whipsaw decisions. So it really comes back to those basics of diversification and long term strategic asset allocation.
- [09:42]
What do you think it would take in terms of underperformance from the US side? Like how long and what sort of gap would it take for people to question their priors of. All right, I guess maybe it doesn't make sense to put all my eggs in the big, the mega cap tech basket.
- [09:59]
We're at almost 700 basis points year to date, maybe through April. So maybe that's changed a bit because May's been pretty strong. You are seeing sentiment change. So it's got to be sustained. And there's a number of, there's a lot of Dynamics there at play. You have the current and then potential future administration and what policies they put in place and how will that impact the US economy in particular from a volatility standpoint? You have the dollar, which we had mentioned just previously. Is it going to be weakness? What's its role as a reserve currency? Where did digital assets come into play there? And then you have debt to GDP which ours continues to skyrocket. But then you counter this, so those are cases that could potentially lead to more sustained underperformance for the US and then you counter this with our tech, our innovation, our consumer strength, our ability for corporations, risk appetite. Risk appetite, right. Ability to set up a business in the US is very different than setting up a business in Germany. And so, you know, are the US has. I'm not going to bet against the US over the long term, but again, I'm always not going to have all my eggs in one basket.
- [11:12]
So if you were to zoom out from the advisor's point of view or the DIYer's point of view, who is of the mindset that I just don't need foreign stocks and you talk about the gap year to date. Well, they would say, well zoom out. If you look at a chart of SPY divided by acquia or whatever or ifa, it's a blip, right? Like okay, there's been a million of these corrections where the international takes the baton for a few minutes. And a point that resonates with me at least a little bit is we are so much more reliant on our stock market, on our capital formation in terms of providing for retirement. And again, having that risk mindset than the rest of the world, it's just different and it's structural and it's not going to change now is a counterpoint to that. So what, what does that have to do with the equity markets?
- [12:02]
Yeah, I mean like again, I look at that advisor and zoom out of those 15 years, there's three years of outperformance for international markets. And it tended to be the challenging years. Right. Again, where the dollar maybe struggled. So why invest? I think where we've seen success as a provider in talking with that advisor is okay, you're still getting exposure through the US consumer because these are household names. So if you look at something like, I don't know, Divi, which is a core dividend till product from us, and you look at some of the top names, Novartis, hsbc, Toyota, and these all are paying really attractive income rates and so they start seeing those names like okay, great, I love that I have diversified health care. I'm thinking about what's happening in the US economy from weight loss, drugs and potentially able to benefit from the US consumer, but do it at the valuation that you're seeing in Europe and other non US markets. So it is a great diversification play that's in a play to get income. It's a play to get household names, blue chip names. And again, they're not as top heavy in an overall index based exposure as you see in the S&P5 like we talked about the top 10 or the Mag 7.
- [13:18]
So Todd, you're the head of US product strategy and development, so you're the perfect person to ask this question. When you speak to advisors, do they want a product that is global in nature like you mentioned Divi. Do they want a global divi or do they prefer like. No, no, no. This is my US ETF and these are my international ETFs. How do they like prefer to slice.
- [13:37]
It right, US investors. So I've been fortunate to work overseas as well and we can talk about the impact on currency on my bank account when you're living through Brexit. But if I look at a US investor, no, it's building block exposure. I'm thinking about how do I pair international with US with my fixed income. What are those weights? What are the dynamics? What do I want out of each piece? What is the intent of the strategy? Is it growth, is it income? Where am I in the stage of my kind of the life cycle of my investment? If I think about the European investor, much more global in nature. If you were to look at the composition of the ETF market in emea, there is a lot more global exposures with scale significant assets than you see in the US So it's a very different perception. That doesn't mean that this home country bias that we see in the US isn't pervasive everywhere. Preparing for this, I was looking at an IMF and World bank study that actually can measure the amount of domestic equity owned by the domestic investor. So you do see the pervasiveness of that home country bias everywhere in the world. Varying extremes. On one extreme you have Russia. 96% of its equity is owned by the domestic consumer, which, which wasn't probably great when they invaded the Ukraine and then the impact on their currency. On the other end of the spectrum is Austria, so 25%. But take into account Austria's weight in MSCI acqui. So an index of US global EM7 basis points. So you're seeing a wide spectrum there perspective for the listeners is the US is sitting at 75%. So somewhere in the middle, but still a pretty big home country bet. And you would tend to see one of these home country bias. You'd want to see it where you have faith in the government, so you have a strong democracy and it's natural. Right. You think you have greater insight into the economy. You're more comfortable with what's happening there. So there's this, I don't want to call it a false sense, but there's a sense of confidence in investing in your local economy with your local currency that's going to lead to this pervasive home country bias across the world.
- [16:01]
Ben Carlson
And it actually makes the most sense in the U.S. obviously because we're like 65% of the global stock market now. So it makes sense here. But what you've seen in recent years, especially I'd say in the last 10 years or so, is huge flows from foreigners into US stocks and that's been helped by a stronger dollar for them. Right. That's translated into strong gains in the US And a currency kicker. And now we've seen again just in the last five or six months or so because I think foreign foreigners make up something like 20% of the US stock market now. So it's a pretty big slug. So we're seeing some reversal. So I guess my question is how important are foreign investors to our stock market? Because if there is this reversal where they say, wait a minute, the US Exceptionalism premium is going to take a hit, we're going to invest more in our own countries, is that a risk to US Stocks?
- [16:46]
Todd Matthias
Yes, flat out, yes. And that could be one of those drivers to sustained performance internationally is concern, particularly right now, concerned of the geopolitical tensions. Flip side of that is that you're actually seeing foreigner ownership restrictions at the public plan level from say Latin American pensions. You see in Asia as well, where they have caps of somewhere between 25 and 50% of how much that public plan can invest overseas. There's a bit of loosening there. So you could see greater investment into the U.S. so those two things are at odds. But there is an impact. The bigger impact is probably a more more on the treasury side than it is anything and how that impacts our currency. But for sure we are reliant, like we talked about 75%. You made the quote. So it's probably 20 to 25% is held by foreign investors. You continue to want to see that increase as we are such an impact on the global economy. And as we play that role, like you said, 65% of the market cap in a global index, you can't risk not owning the US kind of right now.
- [17:58]
One of the biggest themes in ETFs over the last couple of years has been the rise of active, particularly covered call strategies where investors are addicted to the income. They love it. And I understand one often overlooked area of or benefit potential benefit of investing internationally is they do have significantly higher dividend yields than we do.
- [18:25]
You're absolutely correct. And as someone who leads product strategy, so is kind of built to think about the investor and then crafting new product to suit those sensitivities suits those needs. We have a suite of international dividend products. You think you don't need a multiplier effect, you don't need three of them. But when I say I want to invest in dividends and you talk to an end advisor, it's do I want income, do I want risk reduction, do I want stable growth? Dividend can mean a whole host of things to an end in client. And you want a product that tilts towards those sensitivities kind of equivalently. So we developed divvy, which is a core dividend tilt. So you're supposed to have like a beta of one. Right? So you don't have big sector bets, you don't have big country bets. It becomes tracking or controlled. So a great asset allocator tool. You'd mentioned high dividends xidv, which is our dividend multiplier product. Right. So it's part of our X suite. So you talked about again, these enhanced covered call strategies. This is an international dividend product with a 7% yield, long only equity.
- [19:33]
And I assume that these are not necessarily like if I was a US investor investing in US companies with a 7% dividend yield, I'm like, whoa, red flag, red flag. Why are the 7% dividend yields that come from overseas investments not of the same red flagginess?
- [19:51]
Traditionally they pay more in this part of the market and the composition of that market, like we had said up front, not tech heavy, financials heavy. I mean, what Volkswagen pays 6.6%, Porsche pays over 5%.
- [20:06]
And I assume these companies, the dividends are stable or do they cut them in times of stress?
- [20:12]
Covid?
- [20:13]
Sure.
- [20:13]
Yeah. I think there were some requirements in the European Union from a dividend payout perspective.
- [20:18]
Ben Carlson
So wait, sorry, sorry to cut you off. I'm looking at the holdings here of this xidv. Why is it that the automakers pay such high dividends, that surprises me. Is that just because the US automakers have been in trouble and have cut theirs in recent years?
- [20:32]
Todd Matthias
Yeah, more times than not. And then it's just their buyer base. Once you start paying, it's hard to stop. So you're paying a stable amount. And you see this, particularly even in Japan, is once I pay the dividend, there's an expectation from the investor and there's a lot of folks that buy that equity for that dividend. And so if you start cutting, there's a perception that's going to not only impact your payment, it's going to impact the actually underlying equity itself. So the automakers, it's again, across the board, right? It's a Porsche, Volkswagen. You also see it Toyota, Toyota's 3.4. 3.4 from a Japanese automaker is actually quite strong. What is that? That's more than double what you get from the S and P5.
- [21:16]
Ben Carlson
So one of the things that we've looked at, and maybe this is recency bias speaking, is just that the factors haven't worked in the US for a while, like any factor you want, besides, I guess, growth or beta quality. But value, quality, dividend hasn't worked very well in the us, but a lot of the studies have shown that actually those quality, those factors have been working just fine internationally. Is that the case in your research as well?
- [21:41]
Todd Matthias
Value in particular has worked really well in the European environment. I think there's an absence of ability to buy quality in those markets. There's not as much quality because there's not these unbelievably strong balance sheets like you have in the us. So if there's an absence of one factor, you're going to be seeing a gravitation towards another factor. So if you were to see in the US a lack of an ability to tilt towards quality or towards growth because there's a deteriorating fundamentals from a, let's call it an roe or an ROE standpoint in some of these tech companies, then you would particularly see maybe value come into play. We know that factors are cyclical. It's how long term can they have sustained potential outperformance. These are all rooted in academic studies and maybe that's on the US side, Maybe that's more particular to what we see in US Large cap versus small values done well. So again, it's component and segment of the market by segment of the market. But when you talk about Europe, values done really well, which has again been a great tailwind for those that want to invest in international income products as those are going to have a natural value bias to them because of the dividend yield.
- [22:59]
Ben Carlson
When you're building the dividend strategies, are you looking for specifically companies that never cut their dividend or they've been giving a dividend for the past 10, 15, 20 years, whatever it is the Aristocrats or are raising their dividend each year? Are you looking for specifics like that when building these portfolios?
- [23:14]
Todd Matthias
It comes into play. LVHI is a product that really looks for companies that have supportive earnings so that they can meet future payments. But in totality, I want to actually think about the portfolio. I don't want to just build ETF with is just a collection of stocks. I want to think about the portfolio in totality and how the interplay between those stocks. So if I can use a risk model to provide greater predictability and that's what investors want. They want greater predictability. They're used to it in their everyday lives now. They're used to it from how reliant they are on technology. I historically made the case of how do you get from your house Ben to Michael's right, you're going to throw in Waze and you're not going to be printing out MapQuest anymore. You're not bringing your map atlas and you're going to say, hey Michael, I'm going to be there at 11:22. And you get frustrated when it moves by five minutes because there's a traffic buildup or there's a construction that wasn't the case years ago. So our investors are aiming for greater predictability and ETF construction, product construction has actually kind of followed suit is how can I use institutional portfolio techniques to provide greater predictability to my end investor? So they know what they're getting into, they know the risks they're taking, they know the trade offs and when they put that in the portfolio, they know how that will behave and it makes asset allocation and the overall then goal setting for them and their end client much more palatable.
- [24:49]
I'm sure the answer is it depends on the advisor. But when you're talking to them about international exposure, are they thinking at the geography level, the sector level, are they thinking that I don't really care for China, but I hear that India's got a great growth story. What are those conversations like?
- [25:08]
It's a bit of both. We were doing an RA forum and we asked a group of 20 people, raise up your hands how much international exposure you have. It dwindled down to the place where it was really single digit exposure. Many of them were planning to increase and then it's somewhat idiosyncratic. Then you talk to the one advisor like I mentioned earlier who's all tech single stocks. I had a friend who used to cover a Canadian advisor who ran an $800 million book was all Canadian equity. I would say they blanketed as risk and you back into your risk assets. So international is going to be what they would think risky assets ems a little bit further out the spectrum. And then if I want to be tactical I'm going to think about that interplay between India and China and how do I get exposure there. India has been a great economy and a great investment over the past five years for a lot of clients. A meaningful outperformance relative to other international markets kind of kept pace a bit with US markets meaningfully outperformed China, one of the fastest growing economies that has a relatively young population. It's investing in infrastructure, investing in technology. We have a ticker flin one of the lowest cost India exposures in the complete marketplace that has been able to gain a lot of assets because people are wanting to make either a strategic or a tactical play on Indian equity. And this is a great way to do it. And if you think about that relative to China, there are a lot of things at odds for China right now. I wouldn't necessarily bet against for the long term but there's uncertainty, there's concerns with the US relationship. There's potential tail risk of a war in the South China Sea. Then you look at the state specific legislation. So there's public plans here in the US in specific states that are now not allowed and they have to pull money out of their investments in China tends to be right leaning states. But this is Florida, Tennessee, Texas I believe there's maybe eight or nine others in process. So then you actually get to when we talk about blanket is it international, you're starting to see some of these more institutional level clients. Look at EMX China. Is that a way to invest in particular as you've seen India start to actually kind of come almost in parity with China as the largest weights in emerging markets.
- [27:34]
Ben Carlson
I was just going to ask you that. Do you see more clients that are trying to pick and choose these countries in emerging markets? Because it does seem that the blanket emerging market exposure anymore maybe that's another thing that has kind of fallen by the wayside especially for financial advisors in the US Are they trying to pick and choose which countries are going to outperform the best.
- [27:52]
Todd Matthias
We're seeing some of that, particularly from more institutionally minded clients. But you're right, if you have this spectrum and a lot of my equity is in us, if I want to step out and take risk, I'm either going to drop down capitalization in the US market and go to mid cap or I'm going to go to small cap. My next step is international on the risk spectrum. Even though if you look at it from a standard deviation perspective, it's on par with the US and then em, it's almost been forgotten. We had mentioned the pre GFC post GFC entrance into financial markets. When I entered the industry at the earlier part of, let's call it 2006, 2005, everyone was investing in EM, right? It was like I'm going to put 25% of my allocation to EM because it had performed so strongly. Now it's the forgotten child. Just invest in em. There's not nearly a strong case for it when you look at the risk levels compared to the us so if you are going to invest into it, why wouldn't I just pick one? Do I pick China, do I pick India? Do I pair those two together and that becomes my exposure? That dynamic could change over the long term. Right?
- [29:05]
Ben Carlson
Because those two countries make up what, half of the EM index probably and I think China is like a third. So making that bet of I'm going to go X China, you're betting against the second biggest economy and the biggest emerging market exposure. That has probably worked for most people because the Chinese stock market hasn't done that great. But that's a big bet you're making.
- [29:25]
Todd Matthias
Either they have to. If we talked about the public component, there's a requirement to not be investing in China or they're doing it strategically in a sense that I'm going to buy EMX China or I'm going to buy India is my EMX China exposure. And then I can actually play with my China weight. So maybe right now, because of these geopolitical tensions, because of the supply chain issues, because of these tail risks in the South China Sea, maybe I'm going to lower that strategic investment and as those things, as I get more comfortable with that, maybe I increase the weight. So having single country ETFs available at scale and at low costs allow investors to tactically make these decisions and toggle those weights pretty seamlessly.
- [30:13]
All right, Todd, great stuff. For people that want to learn more about the Franklin suite of products, where do we send them?
- [30:18]
Franklintempleton.com A lot of great insights there ways you can learn about our suite of ETFs as well as what's going on in the economy.
- [30:26]
Awesome. Appreciate the time.
- [30:27]
Awesome. Thanks guys.
- [30:31]
Ben Carlson
Okay, thanks to Todd. Remember, check out franklintempleton.com to learn more about all the strategies we talked about today and email us animalspiritscompoundnews.com.