Many investors have a so-called “home bias,” allocating to their domestic market in greater proportion than would be expected based on its representation in global equity markets. Asia-based investors are no exception. Here we present our U.S. equity icons as one potential way to provide diversification for Asian investors.
The breadth and depth of the U.S. equity market means that investors risk overlooking a significant chunk of the global equity opportunity set by under-allocating to U.S. equities, which may result in a large active share compared to a global benchmark. For example, Exhibit 1 shows that the U.S. was nearly three times larger than the entire investable Asian equity market, with smaller U.S. equity segments as large as entire local stock markets. The S&P 500® makes up nearly half of the pie, with the S&P MidCap 400® and SmallCap 600® being larger than the Australian and Hong Kong stock markets, respectively.
Beyond U.S. equities representing a significant portion of the global opportunity set, their distinct sector weights may help investors to overcome domestic sector biases. Exhibit 2 shows GICS® sector weights of the S&P Pan Asia BMI and the relative weight compared to the S&P Global BMI and the S&P 500. The S&P Pan Asia BMI’s largest weights are in Financials (17%) and Information Technology (16%), with its smallest weight in the Energy sector, at 3%. Some key differences between the S&P Pan Asia BMI and S&P Global BMI and S&P 500 are that the global and U.S. benchmarks have a larger weight in Health Care and Information Technology and lower weights in Consumer Discretionary, Materials and Industrials.
The performance of U.S. equities may also motivate some to consider incorporating U.S. equities alongside domestic equities. Exhibit 3 shows the cumulative performance, in USD terms, of the S&P Pan Asia BMI versus U.S. equity indices since Dec. 30, 1994. The right-hand bar chart shows the annualized total returns of various single stock market indices against the S&P 500, S&P MidCap 400, S&P SmallCap 600 and DJIA®. Quite clearly, the U.S. equity indices outperformed, historically.
Exhibit 4 shows that the outperformance of U.S. equities was not driven by currency effects. Indeed, the S&P 500 outperformed single-market indices (as represented by the S&P Global BMI sub-indices) in local currency terms as well.
Exhibit 5a also shows the potential diversification benefit of incorporating U.S. equities: there was a non-perfect correlation with Asian equities over the last 28 years. Exhibit 5b also highlights that several single-market indices rank significantly lower in terms of correlation, with China having a 0.4 correlation to the U.S. since Dec. 30, 1994.
Unsurprisingly, perhaps, incorporating allocations to the S&P 500 could have improved risk-adjusted returns. For example, Exhibit 6 shows the annualized returns and volatility for various hypothetical combinations of the S&P 500 and the S&P Pan Asia BMI. These hypothetical combinations rebalance back to the target weights at each year end.
Portfolios that included some proportion of the S&P 500 posted higher returns than a 100% allocation to the S&P Pan Asia BMI. The high returns were also achieved at a lower annualized risk.
Check out more research and insights on the S&P 500 and DJIA at https://www.spglobal.com/spdji/en/education/article/comparing-iconic-indices-the-sp-500-and-djia/ and https://www.spglobal.com/spdji/en/education/article/regional-relevancy-of-sp-500-and-dow-jones-industrial-average-futures-in-asia.The posts on this blog are opinions, not advice. Please read our Disclaimers.