Dispelling the Myths of International Investing

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1 LEADERSHIP SERIES Dispelling the Myths of International Investing There are multiple reasons to consider an increased allocation to this often-misunderstood asset class. The long-term rally in U.S. stocks has benefited many investors. However, it s also led to unintentional home-country biases in many equity portfolios for U.S. investors. Overexposure to a single geography breeds diversification risk in a portfolio, leaving it vulnerable to a downturn in that geography and underexposed to a rally in other parts of the world. With that in mind, investors may want to re-examine the global mix of their equity allocations, and increase their international exposure if they re too heavily weighted in domestic stocks. There are powerful reasons to invest outside the U.S., such as enhanced diversification, the potential for better risk-adjusted portfolio returns, and a larger opportunity set, among others. Nevertheless, many investors still lack international exposure, often due to misperceptions about the asset class. Here are five of the most common myths investors cite for not investing overseas, contrasted by what Fidelity believes are more realistic perspectives about the asset class. EXHIBIT 1: Investors who held only U.S. stocks missed out on the world s best-performing equity markets. World s Top-Performing Developed Stock Markets, 2005 to 2016 (Calendar year returns in USD) 2005 Canada 29% 2006 Spain 50% 2007 Finland 50% 2008 Israel 29% 2009 Norway 89% 2010 Sweden 35% 2011 Ireland 14% 2012 Belgium 41% 2013 Finland 48% 2014 Israel 24% 2015 Denmark 24% 2016 New Zealand 19% Source: FactSet, MSCI country indexes, as of Dec. 31, Past performance is no guarantee of future results. It is not possible to invest directly in an index. All indices are unmanaged. Please see appendix for important index information.

2 MYTH 1: The U.S. is the world s bestperforming stock market Reality: Not true. While U.S. stocks have had higher returns than overseas equities in aggregate for the past several years, the best-performing stock market for each of the past 30 years has been located outside the United States (Exhibit 1 shows the best-performing developed stock market during the past dozen years). Historically, broad international and U.S. stock performance is cyclical: One typically outperforms the other for several years until the cycle reverses (Exhibit 2). Timing these rotations is difficult, though, which is why it s important to have both U.S. and non-u.s. exposure in an equity portfolio. Investors underexposed to foreign stocks could miss significant gains when markets overseas rally, or suffer losses when U.S. stocks decline. EXHIBIT 2: Given their cyclical nature, international stocks will likely eventually make a comeback and outperform their U.S. peers. 40% 30% International Outperforms U.S. 20% 10% 0% 10% 20% 30% International Underperforms U.S MSCI EAFE Index vs. S&P 500 Total Return Index. Source: FactSet, as of Dec. 31, Past performance is no guarantee of future results. It is not possible to invest directly in an index. All indices are unmanaged. Please see appendix for important index information. 2

3 DISPELLING THE MYTHS OF INTERNATIONAL INVESTING MYTH 2: International investing is too risky Reality: International stocks in combination with U.S. stocks can actually lower risk in an equity portfolio, compared with an all-u.s. portfolio. That s because the performance of U.S. and international stocks is typically not closely correlated, 1 which thereby reduces risk. Historically, a globally balanced hypothetical portfolio of 70% U.S./30% international equities has produced better risk-adjusted returns (Sharpe ratio) and lower volatility (standard deviation) than an all-u.s. portfolio (Exhibit 3). Also, the absolute return of the globally balanced portfolio is almost level with that of the all-u.s. portfolio, despite the recent multiyear rally in U.S. stocks. And given the cyclicality of U.S. and foreign stock returns, it s reasonable to assume their relationship will revert to its historical norms, with a globally balanced strategy outperforming an all-u.s. approach at some stage. EXHIBIT 3: International equity exposure may decrease portfolio risk over the long term. MYTH 3: U.S. multinationals provide adequate international diversification Reality: The stocks of large U.S. companies with operations overseas (multinationals) are sometimes highly correlated to the performance of the overall domestic stock market. However, highly correlated stocks in a portfolio may indicate a lack of diversification. Therefore, U.S. multinationals are not always good replacements for international stocks for diversification purposes. Exhibit 4 compares the average correlations of several U.S. multi- nationals to their foreign counterparts with U.S.-listed shares. The non-u.s. stocks shown have had lower correlations to the S&P 500 over the past three years, which typically signals better diversification benefits. EXHIBIT 4: International stocks can provide more diversification benefits than U.S. multinationals to 2016 U.S. Portfolio International Portfolio Globally Balanced Portfolio 70% U.S./30% Int l THREE-YEAR MEGA-CAP CORRELATIONS WITH THE S&P 500, 2014 TO 2016 CONSUMER STAPLES Annualized Returns 11.2% 9.3% 10.8% Procter & Gamble (U.S.) 0.45 Unilever (U.K.) 0.10 Standard Deviation 14.3% 15.2% 13.2% Sharpe Ratio Hypothetical globally balanced portfolio is rebalanced annually in 70% U.S. and 30% foreign stocks. U.S. equities: S&P 500 Total Return Index; International equities: MSCI ACWI ex-usa Index. Source: Bloomberg Finance L.P., Fidelity Investments (AART), as of Feb. 16, Past performance is no guarantee of future results. It is not possible to invest directly in an index. All indices are unmanaged. Please see appendix for important index information. AUTO Ford (U.S.) 0.72 Hyundai Motor (So. Korea) 0.31 TECHNOLOGY Oracle (U.S.) 0.73 SAP (Germany) 0.60 Source: Morningstar, as of Dec. 31, Company names shown here are for illustrative purposes only and not a recommendation or an offer or solicitation to buy or sell any securities. 3

4 MYTH 4: One needs to hedge currency to improve international stock returns Reality: Actually, no, it doesn t, at least not over the long term. Currency hedging (holding a stock denominated in a foreign currency and an equal but opposite short position in the currency itself) is intended to prevent currency fluctuations from hurting the stock price. While it sounds good in theory, the time and cost it takes to hedge currency has not paid off over time. Since 1973, currency hedging has detracted from returns in 50% of quarters, and contributed to returns in 50% of all quarters (Exhibit 5). Timing currency movements is extremely difficult, even for professional investors. Plus, currency tends to be a relatively small component of returns over time, especially compared to earnings growth and price-to-earnings ratio expansion. What s more, on an aggregate basis, an unhedged strategy (MSCI EAFE U.S. Dollar Index) has outperformed a hedged strategy (MSCI EAFE Local Currency Index) by roughly 1% on an annualized basis since EXHIBIT 5: Historically, hedging currency has hurt returns as often as it s helped them. Percent Return (%) Periods when foreign currency boosted returns Periods when foreign currency detracted from returns 3/31/1973 3/31/1976 3/31/1979 3/31/1982 3/31/1985 3/31/1988 3/31/1991 3/31/1994 3/31/1997 3/31/2000 3/31/2003 3/31/2006 3/31/2009 3/31/2012 3/31/ /31/2016 Quarterly returns of MSCI EAFE USD Index vs. MSCI EAFE Local Currency Index, 1973 to Source: Morningstar, Fidelity Investments, as of Dec. 31, Past performance is no guarantee of future results. It is not possible to invest directly in an index. All indices are unmanaged. Please see appendix for important index information. 4

5 DISPELLING THE MYTHS OF INTERNATIONAL INVESTING MYTH 5: After fees, actively managed international funds don t compete with passive strategies Reality: Actually, just the opposite is true. Historically, actively managed international funds have significantly outperformed their passive peers, even after fees. In fact, since 1992, the average actively managed large-cap international fund has beaten its benchmark index by 0.84% annually (see Exhibit 6). 3 In comparison, the average large-cap international index fund has trailed its benchmark by 0.31%. That s a difference of 1.15% per year (including fee impact) in favor of active funds. When EXHIBIT 6: Actively managed international funds have historically beaten their index fund peers by a sizable margin. Average Yearly Excess Returns (in Basis Points) for International Equity Funds, Active Passive it comes to equity performance, company selection is by far the biggest driver of returns twice as important as country or sector selection. This gives larger active managers the advantage, because they have the resources and flexibility to select or avoid specific companies in an index, while index funds are exposed to all companies good and bad in a particular investment universe. Investment implications For each of the past 30 years, the best-performing stock markets have been located outside the United States. That means investors who were focused solely on U.S. stocks missed out on attractive opportunities for growth and diversification. Historically, a globally balanced portfolio consisting of 70% U.S. and 30% international equities has provided competitive absolute returns, lower volatility, and better risk-adjusted returns than an equity portfolio consisting of just U.S. stocks Fidelity believes taking an active approach to security selection can be a compelling way to achieve favorable returns when investing internationally. So consider increasing your allocation to international stocks. It could make a world of difference in your portfolio Fidelity Thought Leadership Vice President Matt Bennett provided editorial direction for this article. Fund data from Morningstar, including closed and merged funds. International funds labeled as foreign large growth/value/blend by Morningstar. Average excess returns: the average of all monthly one-year rolling excess returns for all funds in the set under analysis, using overlapping one-year periods and data from Jan. 1, 1993 to Dec. 31, Excess returns are returns relative to the primary prospectus benchmark of each fund, net of fees. Basis point: 1/100th of a percentage point. Past performance is no guarantee of future results. This chart does not represent actual or future performance of any individual investment option. Source: Morningstar, Fidelity Investments, as of Dec. 31,

6 Endnotes 1 See Glossary of Terms below. 2 FactSet, as of Dec. 31, Fidelity Investments, Some Active Funds Rise Above a Tough Year, March Before investing in any mutual fund, please carefully consider the investment objectives, risks, charges, and expenses. For this and other information, contact Fidelity for a free prospectus or, if available, a summary prospectus. Please read it carefully. Unless otherwise disclosed to you, in providing this information, Fidelity is not undertaking to provide impartial investment advice, or to give advice in a fiduciary capacity, in connection with any investment or transaction described herein. Fiduciaries are solely responsible for exercising independent judgment in evaluating any transaction(s) and are assumed to be capable of evaluating investment risks independently, both in general and with regard to particular transactions and investment strategies. Fidelity has a financial interest in any transaction(s) that fiduciaries, and if applicable, their clients, may enter into involving Fidelity s products or services. Glossary of Terms Sharpe ratio compares portfolio returns above the risk-free rate relative to overall portfolio volatility. A higher Sharpe ratio implies better risk-adjusted returns. Standard deviation is a statistical measure of market volatility, measuring how widely prices are dispersed from the average price. A low standard deviation indicates that the data points tend to be very close to the average, and a high standard deviation indicates the data points are spread over a larger range of values. A higher standard deviation represents greater relative risk. Correlation measures the interdependencies of two random variables that range in value from 1 to +1, indicating perfect negative correlation at 1, absence of correlation at 0, and perfect positive correlation at +1. Price-to-earnings (P/E) ratio shows the relationship between a stock price and its company s earnings (or profits) per share of stock. Information presented herein is for discussion and illustrative purposes only and is not a recommendation or an offer or solicitation to buy or sell any securities. Views expressed are as of the date indicated, based on the information available at that time, and may change based on market and other conditions. Unless otherwise noted, the opinions provided are those of the author and not necessarily those of Fidelity Investments or its affiliates. Fidelity does not assume any duty to update any of the information. Investment decisions should be based on an individual s own goals, time horizon, and tolerance for risk. Nothing in this content should be considered to be legal or tax advice and you are encouraged to consult your own lawyer, accountant, or other advisor before making any financial decision. Stock markets, especially non-u.s. markets, are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments. Foreign securities are subject to interest rate, currency exchange rate, economic, and political risks, all of which are magnified in emerging markets. The securities of smaller, less well-known companies can be more volatile than those of larger companies. Growth stocks can perform differently from the market as a whole and from other types of stocks, and can be more volatile than other types of stocks. Value stocks can perform differently from other types of stocks and can continue to be undervalued by the market for long periods of time. Investing involves risk, including risk of loss. Past performance is no guarantee of future results. Diversification and asset allocation do not ensure a profit or guarantee against loss. All indices are unmanaged. You cannot invest directly in an index. Index definitions Standard & Poor s 500 (S&P 500 ) Index is a market capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance. S&P 500 is a registered service mark of The McGraw-Hill Companies, Inc., and has been licensed for use by Fidelity Distributors Corporation and its affiliates. MSCI All Country World ex-u.s. Index is a free float-adjusted market capitalization-weighted index designed to measure the equity market performance of developed and emerging markets, excluding the U.S. MSCI Europe, Australasia, Far East Index (EAFE) is a market capitalization-weighted index that is designed to measure the investable equity market performance for global investors in developed markets, excluding the U.S. & Canada. MSCI Emerging Markets (EM) Index is a market capitalization-weighted index designed to measure the investable equity market performance for global investors in emerging markets. 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