Unless this is your first foray into investing, you have already heard the virtues of diversifying your portfolio by investing internationally. International diversification can potentially lower a portfolio's risk via uncorrelated or loosely correlated markets by holding investments in foreign currencies and markets. While this common knowledge is still true, it is less compelling than it used to be as an argument for international investing.
The real reason to invest internationally is to increase the growth opportunity in your portfolio. Over the short term, international investing is adequate as a risk management technique. Over the long term, however, the more important reason to participate is the potential opportunity to achieve substantial total returns: this is perhaps truer now than any time in history. The secular changes that are occurring and converging around the globe are creating a wave of opportunity that growth investors should embrace. As these trends continue, it is likely that global markets will move and act in a more synchronized fashion, thus slightly reducing the diversification benefit of international investing, but the growth opportunity should continue to improve dramatically. In major market corrections in the past, the world's financial markets did in fact move together but in the future even less significant events will likely become more correlated. Therefore, the real opportunity provided by international investing is to capitalize on some of the powerful secular trends that will shape the transformation of the world and its consumers, producers, politics, and capital. So what are these "global trends" that will improve your portfolio's potential?
Three secular trends driving global growth—the real reasons why international investing is attractive
Trend 1: Democracy and capitalism lead to wealth creation
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1 Source: U.S. Agency for International Development, "Global Trends in Democracy," 2002; Progressive Policy Institute, 2002 State New Index, June 2002
The first trend has been in existence since America was born but it has picked up considerable momentum after WWII and even more since the end of the Cold War. The growth in democracy around the world has been tremendous, with the world becoming freer and democracy taking hold like never before. In the mid 1970's, there were 39 democracies; today that number has tripled to 121, with several additional democracies currently on the margin. Those 121 democratic states represent 63% of all nations; more than triple the number in 1974, when there were only 39 democratic states, comprising 27% of all countries. Over the last 30 years this trend has almost certainly contributed to the largest reduction in poverty in the history of mankind.
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2 Source: World Bank, Central Intelligence Agency, Marc A. Miles, Edwin J. Feulner and Mary Anastasia O'Grady, 2005 Index of Economic Freedom (Washington, D.C.; The Heritage Foundation and Dow Jones & Company, Inc., 2005) at www.heritage.org/index.
History has shown that with democracy and freedom, improving standards of living and wealth follow. For example: In the past 40 years Japan's per capita income soared from 20% of that of the U.S. to 96%; Hong Kong climbed from 16% to 70%, and South Korea increased from 11% to 50%. Furthermore, as standards of living improve so does consumption, education and competition. In turn, these societal transformations change the economics as well: Democracy promotes freedom, transparency of government, and private property rights, all of which lower the costs of capital. This in turn improves returns on capital—a very bullish sign. In fact, current returns on capital are now higher than the cost of capital in most countries around the globe.
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3 Source: Jeremy V. Siegel, The Next Great Wave of Growth, Wall Street Journal, p. A14, March 23, 2005.
It's hard to talk about the spread of democracy without discussing technological advances: The speed of communications, expansion of media, and more recently the internet have helped drive the secular wave of democracy as the horrors of communism, fascism, and the failure of socialism could not be hidden from the world's populations. The potent combination of democracy and technological advances has created a virtuous circle of innovation and freedom leading to more innovation and freedom, which brings us to the next point: International investing is not so much about diversification as it is about globalization and the worldwide opportunity set.
Trend 2: Globalization means opportunities are world-wide.
Democracy's fueling of globalization has lead to spectacular growth in trade and the most rapid improvements in living standards in history:
- Global trade volume has risen by a factor of more than 35 times since the end of WWII
- In 1975 there were approximately 7000 multi-national companies: today there are more than 40,000
The world's financial markets are also truly global and interconnected. Bond markets are synchronized, and capital access is better than ever. China's entry into the WTO in 2001 changes the dynamics of world trade while India has become a significant factor in many global technology industries.
Looking ahead, the secular changes in productivity and communication as a result of the technology revolution is not nearly over. It will continue to filter to all corners of the globe. The dramatic growth in global media and entertainment are a part of this revolution. Much of the manufacturing of high technology products is outsourced as production becomes standardized, thus reducing costs. Technology has effectively followed a supply side model, not unlike what Henry Ford did in the 1920s: drive production up to drive costs down, and ultimately raise living standards for employees so they can afford the products. The technology revolution has accomplished this on a global scale, and will continue to alter economies and benefit consumers everywhere while providing jobs for many emerging countries' workers, vastly improving their living standards. One may not always know how technologies may be used but once prices come down enough, usage rises, innovation ensues, and productivity explodes.
Technology and globalization—benefits at every economic level
- Productivity increases prosperity in wealthier nations
- Higher value work raises living standards in poorer nations
- Communication accelerates pace of development
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4 Source: OECD, Labour Productivity Data, 2004
Trend 3: Demographics - the old consume and the young produce
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5 Source: U.S. Bureau of the Census, International Data Base, as of 9/30/2004 (latest available)
Like the broad benefits of democracy, the macro trend of global demographics is so vast on a long-term scale but hard to grasp on a day-to-day basis, especially considering the short-term focus of the media. As noted above, the globe's emerging economies are seeing their labor forces begin to expand and specialize in response to the export of technologies and whole industries by developed countries. Put simply, the developed nations are aging and will continue to consume, while the developing nations have young populations that want to work and pursue economic opportunities. Such demographics are producing a dynamic that will create a great deal of opportunity for less developed countries to produce goods and provide services to the more developed countries, again producing a virtuous circle of production, consumption and rising living standards. Over the next 20 years, developed nations' social costs will escalate dramatically, and emerging economies will be there to meet the marketplace demands.
The Calamos approach to international investing
Our nearly 30 years of successful investing includes many years of experience investing outside the U.S. Our international growth investment process, tools, and team are the same as that of our U.S. growth strategy: we have adapted our models for non-U.S. markets but our research criteria are the same. We need transparency and consistency in accounting, a regulatory environment that is fair and clear, a credible rule of law and property rights, and a stable value of account. Whether assessing a domestic or foreign company, we adjust accounting to a cash-based system, making comparisons across countries less complex. Furthermore, international markets are becoming much friendlier to non-local investors as the need for capital drives disclosure and clarity. Our goal is to find 75 growth companies out of the thousands that exist outside of the U.S. In the past, some of our best investments came from non-U.S. markets and we feel the opportunity today is excellent.
As long-term investors that believe in the power of democracy and freedom to promote wealth creation and improve living standards, we see an exciting period ahead. Globalization continues to blur the line between the meaning of "domestic" and "foreign," thanks to the macro trends discussed above. As more investors come to realize this, more will be inclined to view the opportunity set of investments not by national borders, but by growth prospects. We believe that the time is ripe to ride that secular wave, and actively pursue the best opportunities for growth, wherever they may be.