The flow of funds out of U.S. equities and international equities—particularly emerging markets—is well documented, and emerging markets have outperformed as an asset class over the 10 years ended Aug 31, according to a new research paper from Vanguard, "Are Investors Truly Embracing International Diversification?" by Christopher Philips, Francis Kinniry Jr. and Yan Zilbering.
But even as the paper encourages diversification of equity allocations and a more global investing perspective, it cautions that the "speed and magnitude" of the flows into emerging markets equities over the latest three years and the "apparent positive correlation between trailing returns and cash flows," might lead investors to expect returns like these to continue and that this could be "unrealistic."
A Higher Proportion of International Equities in Emerging Markets
The report explains that, "allocations to stock funds investing abroad now account for 30% of all U.S. equity mutual fund holdings," nearly double the international equity allocation of a decade ago. The authors assert that, "we believe that investors should strive to be more diversified rather than less, and Vanguard suggests that most investors consider allocating 20%–40% of their equity holdings to stocks abroad."
Their analysis shows that as of August, investors have allocated just over 30% of their equity holdings to international equities, close to what they'd allocated internationally in Dec. 2007, but within the international mix, the current allocation to emerging markets is higher. "We also believe that, within an allocation to non-U.S. stocks, countries and regions should be represented in proportion to their global market-capitalization weightings."
As AdvisorOne.com has reported, the Vanguard paper confirms that net flows to emerging markets have been remarkable. Flows "to non-U.S.-focused funds were significantly positive," for the one-, three-, five- and 10-year periods ending August 31. For the one-year period, 66% of cash
