Our Case for International Equity Investing
For many investors, the S&P 500 Index or the Dow Jones Industrial Average represents the stock market. Whether it is through the newspaper or the nightly news, investors are constantly reminded of these indices and how they fluctuate on a daily basis.  These comprehensive indices represent the largest US companies, but they exclude the rest of the world. In fact, the DJIA represents just 17% of the total US equity market while the S&P 500 represents 52%.

Though the US remains the center for global commerce, approximately 80% of global output and over half of the world’s equity market capitalization comes from countries other than the United States. In short, there is a vast universe of investment  alternatives outside the United States.

The second answer is Investment Opportunity.  Due to the emotionally charged nature of financial markets, where investor sentiment can shift from unbridled optimism to fear and uncertainty seemingly overnight, stock prices can fluctuate much more than the underlying value of the companies they represent. Astute investors can step in and take advantage of these opportunities, adding value to their portfolios over time. Obviously, this approach is not limited to domestic investments. By broadening the search for attractively priced stocks to markets around the world, investors increase their opportunities for success. Thanks to an increase in transparency, we can now analyze publically traded markets around the world with the same valuation methodology we have used domestically for decades. In some cases, fiscally responsible countries are growing faster than the US while their stocks trade at relatively attractive valuations. These countries, we believe, represent investment opportunities.

Unique Challenges
While international stocks have long offered unique investment opportunities and potential diversification benefits, historically it has been difficult for investors to efficiently commit capital to specific international markets.  Fortunately, this lack of access has been resolved with the proliferation of international Exchange Traded Funds (ETF). ETFs are a unique investment tool providing US investors access to a group of diversified securities through a single transaction. Like individual stocks, these ETF shares trade on domestic exchanges in US dollars.  With over 900 ETFs currently available, nearly all international markets are now easily investable.Currency risk is another challenge faced by international investors. Since we operate in a dollar denominated society, the return on investment for international investments is the combination of the investment return and the change in currency value over the holding period. Analysis of these investments therefore requires not only an understanding of the investment fundamentals but also the potential for currency fluctuations.

How Are We Positioning Investments Within the International Markets?
When assessing the investment merits of an international opportunity, we generally analyze the country’s fiscal position, economic vitality, currency characteristics, political climate, and equity market valuation. Within this framework we are then able to determine if a market offers an attractive investment opportunity. Currently, we believe the markets of Australia, Brazil, Canada, China, and South Korea each offer above-average return potential. Though many international companies trade on US exchanges, we prefer to invest in broad based baskets of securities to avoid the specific risk of a single foreign stock.On the following pages, we detail the merits of these investments and explain why we believe investing in these markets offers attractive risk adjusted opportunities for US investors.

CANADA – iShares MSCI Canada Index Fund (EWC)
This ETF invests in the largest Canadian publicly traded securities. Canada, a country rich with natural resources, has benefitted from rising demand for copper, gold, oil, and wheat from emerging economies such as India and China. Canada is the second largest exporter of natural gas in the world and sits on the largest pool of proven oil reserves outside the Middle East. In a strong recent indication of the vitality of its economic recovery, Canadian 1^st Quarter 2010 GDP expanded at the fastest pace in a decade. Also, the Bank of Canada recently raised short-term interest rates, the first such move in the Group of Seven (US, Germany, France, Italy, Japan, UK, and Canada), in part due to a robust economic recovery and an improving employment market (current unemployment rate is 8.0% and trending down).  Fiscally, Canada remains the least indebted country within the G7 as measured by a deficit versus GDP ratio.With corporate profits expected to grow approximately 49% over the next twelve months, we believe the Canadian market offers a unique opportunity for investors. This fiscally healthy country with solid economic growth prospects is valued at just above the Price/Earnings multiple of the S&P 500 Index.

BRAZIL – iShares MSCI Brazil Index Fund (EWZ)
This ETF invests in the largest publicly traded securities in the Brazilian market as measured by the MSCI Brazil Index. Driven by a rapidly expanding middle class and growing natural resource base, Brazil has positioned itself as one of the 10 largest economies in the world. The combination of a rapidly growing economy and conservative government spending has produced one of the lowest fiscal deficits in the G-20 countries and a high investment grade debt rating.

Brazil’s long-term growth outlook is very attractive. As the chart below shows, economic growth is expected to remain above-average as the country continues to benefit from a rise of new consumers and a productive workforce (average age is approximately 28). With corporate profits expected to grow approximately 42% over the next twelve months, we find this vibrant international market compelling at 11x earnings.

AUSTRALIA- iShares MSCI Australia Index Fund (EWA)

This ETF invests in the largest publicly traded securities in the Australian market. Powered by a dominant mining industry and conservative government spending, Australia was one of the few developed countries to escape the recession of 2008-2009. Given the severity of the recession, we view this as a testament to the viability of the country’s economic health. During the country’s remarkable 18 years of consecutive growth, the government has bolstered financial oversight and attracted both capital and labor to its dominant materials sector. Bolstered by a low 5% unemployment rate, strong consumer spending, and very little public debt, we believe Australia represents a fundamentally sound economy with a well above-average outlook.

Given the economic stability that Australia offers, we view its equity market’s current valuation discount to the S&P 500 as unwarranted. With corporate profits expected to increase nearly 50% over the next twelve months, Australia affords a unique opportunity for investors.

CHINA - iShares FTSE/XINHUA China 25 Fund (FXI)  
This Fund seeks investment returns that correspond to the price and yield performance of the FTSE/XINHUA China 25 Index, or the 25 largest publically traded H-shares on the Hong Kong Stock Exchange. We believe this Fund offers the best exposure to the largest Chinese blue chip companies. While its real estate market has garnered negative press recently, China’s economy continues to grow at rapid annual rates. Driven by a boom in industrial spending and a burgeoning middle class, China GDP has expanded by more than 8% annually for the past nine years and this growth is expected to continue. The Chinese consumer, bolstered by a low 4% unemployment rate, has increased spending in recent years, a change from years of high savings rates – adding another engine of growth to the country.  While estimated corporate profit growth of 17% is low compared to some of our other recommended investments, we view this number as impressive given that many of these companies were able to grow earnings during the global economic downturn, resulting in a lower year/year percentage gain comparison. Valuation is also compelling.

Given these companies’ proven ability to grow earnings at above-average rates of growth, this ETF has commanded an average valuation of approximately 20x earnings over the past five years. Priced at 14x earnings today, we believe this discount offers investors a unique opportunity to invest in one of the fastest growing global economies.

SOUTH KOREA - iShares MSCI South Korea Fund (EWY)
This Fund invests in the largest publically traded securities of the South Korean stock market. Like Australia, South Korea was able to dodge the global recession by posting positive economic growth during 2009. South Korea, like Australia, possesses a very strong consumer sector empowered by low borrowing rates, an unemployment rate under 4%, and low inflation rates. Government finances are also in enviable shape with both the current account and fiscal budgets showing surpluses.  

South Korea’s equity market, dominated by global technology leaders, currently trades at one of the lowest earnings multiples (10x) of all developed market countries. Given the economic health of this country and with its largest companies expected to increase earnings 30% over the next twelve months, we believe this valuation is irrationally low and represents an undervalued and underappreciated market for investors.

In Closing
Many years of international investing experience have convinced us of the value non-US equities can provide our clients. As asset managers, our charge is to deliver suitable risk-adjusted returns for our clients by seeking out attractive investment opportunities. By keeping a broad international perspective, we have more opportunities from which to choose.  Currently, we have allocated 25% of our equity funds to these markets. We believe this exposure complements the significant international exposure most US companies provide.

Of course, investing in international equities involves unique risks such as political, economic, and currency risks. However, by partnering with an experienced asset manager, investors can address these risks and take advantage of the numerous opportunities international markets can provide.

For More Information
If this presentation has piqued your curiosity, we encourage you to contact Bruce Raabe at (415) 925-4000 or braabe@collins-co.com to determine if these investments would complement your existing wealth management strategy. 

Disclosure
None of the information contained within this article constitutes, or is intended to constitute, a recommendation by the Author or Collins & Company that any particular security, investment, or strategy is suitable for any specific person. None of the information contained in the article is, or is intended to be, personalized investment advice. Investments or strategies mentioned in the article may not be suitable for all individuals. All readers of the article should make their own independent decision regarding the investments discussed. The material contained in the article does not take into account each reader’s particular investment objectives, financial situation, or needs. All readers should strongly consider seeking advice from their own investment adviser or contact Collins & company for a Discovery Meeting.

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