Foreign stocks in Behavioural Portfoilos .pdf

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Investors like the idea of diversification. They like
the idea of getting the highest possible expected
return for the risk they are willing to assume. But
risk has meaning only when looking forward into
the future. Risk fades away when looking at the past.
When investors look at the past, they do not want
diversification and they do not want a reduction in
risk. They want to have been in the best performing
asset class. The best performing asset class over the
last few years was the class of U.S. stocks.
The last few years have been painful to investment
advisors who advocated diversified global
portfolios. Investment xenophobes like Lowenstein
are triumphant as they bash
advisors who encourage
investors to venture out of the home market:
Thus, the “sound” investor is defined as one
who has moved a goodly chunk of his money
out of the society he knows to countries with
which he is unfamiliar, each according to their
market weights. Indeed, not to put assets in such
terra incognita is deemed to be “unsound.”
More than one so-called expert has recoiled with
horror at the news that my own family is geographically
undiversified. We have no money in
the former Yugoslavia, none in the present Argentina,
none in the future Republic of Antarctica,
none in Zambia, Belgium, or Kazakhstan.
Lack of familiarity and recent dismal returns
make foreign stocks unattractive to U.S. investors.
And mean–variance arguments emphasizing the
low correlations between foreign stocks and
domestic ones are not likely to change either fact.
Typical investors who bought foreign stocks in the
1990s did not buy them for their mean–variance
benefits. They bought them for the upside-potential
layer of their behavioral portfolios; they expected
foreign stocks to make them rich. The bad news for
those who ventured into foreign stocks in the 1990s
is that the returns were dismal. The good news for
advisors
is that investors are now familiar with
foreign stocks. Familiarity makes foreign stocks
more acceptable. Therefore,
all that might be
needed for an increase in the foreign stock allocations
in U.S. investors’ portfolios is a sustained
increase in the returns of foreign stocks. The Philippines
Composite Index that was down 30.55 percent
for the year ending March 31, 1998, was up
19.75 percent for the quarter ending March 31, 1998.
The Kuala Lumpur Composite Index that was
down 40.19 for the year was up 21.04 percent for the
same quarter. McGough (1998) wrote:
Some analysts have begun questioning the wisdom
of putting money in foreign-stock funds.
“But the strong showing of international funds
in the quarter restores your faith in international
investing,” said Susan Dziubinski, editor
of
Morningstar Investor
, a newsletter. “There are
opportunities in other countries.”