Expanding Participants’ Opportunity
Unlocking the Global Opportunity
Expanding Participants’ Opportunity Set with Active International Equities
Over the past 15 years, the U.S. share of world market cap has fallen from 48% to 45%. American investors with only domestic equity exposure miss more than half of the world’s growth potential from international equity markets.
Adding international funds to DC plans can help participants take advantage of the wide range of investments now available outside the U.S. and can potentially smooth volatility and add incremental returns. As history shows, certain markets can generate stronger returns when other markets struggle.1
Most plan sponsors understand the importance of offering international equities in their DC plan investment lineup. In fact, 98% of all 401(k) plans offered an international equity component in 2015.
However, plan participants have been reluctant to include them in their own retirement portfolios. A BrightScope/ICI 2015 report found that when making equity investing choices, plan participants preferred domestic (36%) over international (8%) funds.
Why the discrepancy?
Three participant investment trends
1. Reliance on U.S. equities
To the casual observer, the investment landscape beyond the U.S. today may look less than attractive: Europe’s economic instability, Japan’s fitful attempts to overcome decades of stagnation, China’s struggle to restructure its economy and recent currency devaluation. Additionally, prospects for further turmoil in emerging markets may suggest to participants that the best investment choices remain U.S.-based.
However, recent dips in U.S. equity markets this year — after a historic run since March 2009 — support the argument that participants should increase their international equity allocations for increased diversification.
Source: Morningstar as of 2/29/2016; 3-year rolling returns of MSCI World ex-USA GR USD minus 3-year rolling returns of the S&P 500 TR USD (1973–2015). The MSCI World Index measures the performance of the large- and mid-cap segments of world equity securities. It is free float-adjusted and market-capitalization-weighted. Investors cannot directly invest in any index. Actual returns will vary. Past performance is no guarantee of future results.
2. Home country bias
Participants may choose to seek out what is familiar to them — preferring to own stocks of companies domiciled in the U.S. This “home bias” causes them to miss out on opportunities over the long term.
Besides raising a portfolio’s volatility risk, an over-allocation to domestic equity introduces the risk of having too many highly correlated assets moving in sync when the market declines.
3. Lack of knowledge
Even as the globalization of financial markets has made more investment opportunities available, individual investors and plan participants in the U.S. have been reluctant to add international allocations to their portfolios. This reluctance to “go global” may reflect participants’ long-held view of the U.S. as the world’s sole economic superpower, rather than the present-day reality of more widely distributed global economic growth.
Helping participants understand the potential international investments can play in further diversifying their portfolios and delivering incremental risk-adjusted returns can help improve their comfort level with international equities. As the chart below shows, adding an international equity component can reduce risk (as measured by standard deviation), without diminishing returns.
Past performance is no guarantee of future results. U.S. Equities are represented by the S&P 500 Index. International is represented by Global Financial Data World ex-U.S. Index from 1950 to 1969 and MSCI EAFE from 1970 to 12/31/15. Globally Balanced is a portfolio of 25% International, 5% Emerging Markets, and 70% S&P 500. Emerging Markets is represented by Global Financial Data Emerging Market Index from 1950 to 1987 and MSCI Emerging Markets from 1988 to 12/31/15. Portfolio is rebalanced on a monthly basis. Period is based on annual returns from 1950 to 2015. All returns used in calculations are in U.S. dollars and represent total returns. Other allocations may produce different results.
The S&P 500 Index is a representation of U.S. large-cap equities. The MSCI EAFE is a proxy for equity market performance across developed markets in Europe, Australia, and Southeast Asia.
The Global Financial Data World ex-U.S. Index is a proxy for equity market performance across developed markets excluding the U.S. The MSCI Emerging Markets is a proxy for equity market performance across emerging markets.
The Global Financial Data Emerging Market Index is a proxy for equity market performance across emerging markets. It is not possible to invest directly in an index. Standard deviation is the statistical measure of the degree to which an individual value in a probability distribution tends to vary from the mean of the distribution. Sharpe ratio is a risk-adjusted measure that determines reward per unit of risk. The higher the Sharpe ratio, the better.
Amid opportunity, key risks to be managed
Active managers with international risk experience, knowledge and nimbleness can potentially reduce the impact or enhance the advantage of international opportunities. While opportunities are abundant in international equities, the perhaps unfamiliar risks posed by currency fluctuations, political and economic turmoil and a lack of transparency are unique to global investing and worthy of attention.
It is important to note, while opportunity can be found in politically delicate situations, investment risk must always be managed carefully.
Active investment managers can employ fundamental research to identify individual opportunities in international developed markets, and also in particularly fast growing emerging and frontier markets that other investment managers have not yet uncovered. Global investors should keep in mind the differences between emerging market economic success stories, such as India, that offer improving governance, attractive equity valuations and much higher projected growth than the U.S., and riskier markets.
Active managers can avoid potentially underperforming investments otherwise included in passively managed portfolios. The ongoing evolution and expansion of the opportunity set in global markets showcases the potential for active managers to generate alpha.
Plan sponsors should consider these three steps:
1. Ensure that the Investment Policy Statement (IPS) outlines the approach to and philosophy about the international equity offerings in the plan. It’s also important for plan sponsors to consider the merits of both active and passive international equity options.
2. Confirm that the international equity options provided are suitable for the participants based on their needs and behaviors. This requires that plan sponsors and their investment advisers and committees:
• Select international equity funds that actively manage risks with an eye toward reducing volatility, allowing participants greater comfort allocating a portion of their portfolio to international equity.
• Consider relative “risk-adjusted” performance rather than just annual returns in the selection process. Measures of risk-adjusted returns include Sharpe ratios, information ratios, Treynor ratios and Jensen’s alpha. Plan advisors can help sponsors evaluate their current international equity funds through this lens.
3. Provide participants with information and guidance on the benefits of investing beyond U.S. borders as part of the plan’s education efforts.
1Callan Associates, The Callan Periodic Table of Investment Returns (1995–2015).
Investors should consider the investment objectives, risks, charges and expenses of a mutual fund carefully before investing. To obtain a prospectus, or a summary prospectus, if available, that contains this and other information about a Dreyfus fund, contact your financial advisor or visit dreyfus.com. Read the prospectus carefully before investing. Investors should discuss with their advisor the eligibility requirements for Class I shares, which are available only to certain eligible investors, and the historical results achieved by the fund’s respective share classes.
Diversification and asset allocation cannot ensure a profit or protect against loss of principal.
Main Risks — Dreyfus International Equity Fund
Equity funds are generally subject to market, market sector, market liquidity, issuer and investment style risks, among other factors, to varying degrees. Investing internationally involves special risks, including changes in currency exchange rates, political, economic and social instability, a lack of comprehensive company information, differing auditing and legal standards, and less market liquidity. These risks are generally greater with emerging market countries.
The Boston Company Asset Management, LLC is the fund’s investment adviser. The fund’s administrator is The Dreyfus Corporation. Each is a subsidiary of The Bank of New York Mellon Corporation. BNY Mellon Investment Management is one of the world’s leading investment management organizations and one of the top U.S. wealth managers, encompassing BNY Mellon’s affiliated investment management firms, wealth management services and global distribution companies.
BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation. Dreyfus is the primary mutual fund business of BNY Mellon. MBSC Securities Corporation, a registered broker-dealer, member of FINRA and subsidiary of Dreyfus, is the distributor of Dreyfus mutual funds.
Main Risks — Dreyfus/Newton International Equity Fund
Emerging Market Risk: Emerging markets tend to be more volatile than the markets of more mature economies, and generally have less diverse and less mature economic structures and less stable political systems than those of developed countries. The fund’s concentration in securities of companies in emerging markets could cause the fund’s performance to be more volatile than that of more geographically diversified funds.
Equity Risk: Equity funds are subject generally to market, market sector, market liquidity, issuer and investment style risks, among other factors, to varying degrees, all of which are more fully described in the fund’s prospectus.
Foreign Currency Risk:Investments in foreign currencies are subject to the risk that those currencies will decline in value relative to the U.S. dollar, or, in the case of hedged positions, that the U.S. dollar will decline relative to the currency being hedged.
Foreign Investment Risk: To the extent the fund invests in foreign securities, its performance will be influenced by political, social and economic factors affecting investments in foreign companies. These special risks include exposure to currency fluctuations, less liquidity, less developed or less efficient trading markets, lack of comprehensive company information, political instability. and differing auditing and legal standards.
Dreyfus is the fund’s investment adviser. The fund’s sub-investment adviser is Newton Capital Management Limited. Newton is a subsidiary of The Bank of New York Mellon Corporation.