Non-U.S. company stocks: Investment Banks Create them, and they want you to buy them
Every U.S.-based investment bank pursues international corporate clients, but to serve them, they need U.S. consumers to buy non-U.S. stocks. The next time your firm emphasizes international investment, it is worth asking who that emphasis actually serves. Because while the case for international investing has two standard arguments, better returns and diversification, neither holds up particularly well under scrutiny.
Portfolio returns are not consistently better with international investing
There is no credible data showing that non-U.S. companies as a group consistently outperform U.S. companies for U.S. investors. The variables are too many: time frame, country, currency hedging, and corporate structure. Any credible statistician can construct a scenario where international investing wins, but it strains logic to say this can be replicated consistently.
You get no diversification advantage from blending US and non-US investing
Since China joined the World Trade Organization in the mid-1990s, the correlation between U.S. and non-U.S. markets has been tight, particularly during periods of liquidity stress. The argument that blending U.S. and non-U.S. holdings reduces portfolio risk has not aged well.
So why does the international investing argument persist?
The answer has less to do with your clients’ portfolios than with your firm’s income statement. We are being persuaded to buy internationally because our US banks want investment banking fees.
The top U.S. investment banks: JPMorgan Chase, Goldman Sachs, Citibank, Morgan Stanley, and Bank of America, all pursue international corporate clients aggressively. Roughly 30% of their collective investment banking fees come from outside the United States. When a foreign company wants to go public or raise capital, these banks lead the deal. And when they lead the deal, they need buyers. (Note: This information was derived from a variety of sources, and I can provide them to the inquisitive reader upon request. It’s not really easy to find.)
Consider five of the largest non-U.S. IPOs of the past decade, each led or co-led by one of these banks:
When you look back on how these mega IPOs have done against the S&P 500 500 since their underwriting, you discover that all underperformed our base US index:
SK Hynix, with a five-week track record, is the only one that has outperformed. And five weeks is not a track record.
Part of why the S&P 500 dominates global returns is its composition
The largest sector weighting in the index is technology, followed closely by communications services. Unlike consumer goods, where European companies lead, or automobiles, where Japan and Korea dominate, technology keeps getting cheaper even as its utility expands. The phone in your pocket costs more than it did ten years ago, but what it can do has grown by orders of magnitude. Federal Reserve Chairman Warsh has spoken at length about how deflationary AI is and will continue to be. That deflationary dynamic benefits U.S. technology companies disproportionately. It’s not obvious why a German automaker or a Saudi oil company is a better bet against that backdrop.
But back to the investment banking and financial advice connection: the asset management business
Among the largest holders of these mega-cap IPO companies are the biggest asset management firms in the country: Vanguard, Capital Group, and Fidelity. All of them advocate international diversification. All of them also do substantial business with the wealth management arms of the same banks that underwrote these offerings. In the grocery business, there is a term for this: shelf space. The same concept applies in asset management. Access to a bank’s financial advisors is valuable, and the firms with the most access are the ones advocating the same investments the banks need sold.
Each of these banks also employs a chief investment officer whose job is to give investment guidance to both institutional and individual clients. In every case, they advocate international investing, despite the performance record and despite the increasingly tight correlation between U.S. and non-U.S. markets.
Financial Advisors at all of the investment banks are positioned as objective fiduciaries shielding individual investors from market noise. But if these international markets consistently underperform the US markets, and the correlation of returns between US and non-US markets are tight, advocating these investments does not align with the financial advisor’s fiduciary duty of providing advice in the best interests of these individual clients. (It certainly aligns with the bank’s goals of doing successful public offerings for their corporate clients, though.) We know that an IPO is simply a way to transfer ownership of these companies from the corporation to outside shareholders. You can’t be an objective fiduciary, trying to behave in the client’s best interest if your firm is advocating that you invest in asset classes that consistently underperform US markets.
This is the conflict of interest
If you are an investment bank with corporate clients who want to distribute ownership to outside shareholders, and you also have a retail advisory arm whose stated job is to act as an objective fiduciary for individual investors, those two roles are in tension. The banks know this, and they have language in all their offerings pointing it out to investors. But disclosure is not the same as resolution. A chief investment officer advocating international investments, supported by asset managers with shelf-space relationships at the same bank, advocating those same investments to advisors positioned as objective fiduciaries – this cannot be living up to a fiduciary duty.
