John Bogle

A Respectful Disagreement with St. Jack

John Bogle

Anyone who has spent a significant amount of time on our Website will know that we have nothing but the highest respect for Jack Bogle, the Father of Indexing for Retail Investors. Recently, however, we saw this Bloomberg article where Bogle said that he would not risk investing outside the U.S. because, “The U.S. is the most productive country in the world. It is the most rapidly growing of the industrialized nations, other than Switzerland. We still have plenty of problems, but we’re much better than France, Britain and Germany. And we don’t even want to talk about Italy and Greece. And importantly—people forget this too quickly—we have the most established government and legal institutions…It’s hard to believe that the differences in returns over the long term will be huge…Why take the currency risk?”

Obviously, we cannot argue with Bogle’s assessment of where the U.S. stands economically with respect to the rest of the world, but we disagree with his contention that American superiority is a reason to not invest in other countries. The overriding principle of investing that we try never to forget is that risk and return are not merely related but are joined at the hip. Of all the countries in the world (with the possible exception of Switzerland), we would consider America to have among the lowest political risk, and while an investor may legitimately have a preference to invest only in American-domiciled companies, he should expect to pay for that preference with a lower expected return. One measure of the risk that the market assesses on a going-forward basis is the book-to-market ratio which tells us how much book value investors receive for every dollar invested.

Book-to-Market Ratios
As of 10/31/2014

Region  Book-to-Market Ratio
Russell 3000 Index (U.S. Total Market) 0.41
MSCI EAFE Index (Int’l Developed) 0.65
MSCI Emerging Markets Index 0.67

Source: Morningstar (accessed on 12/10/2014).

Currently, Mr. Market is giving us at least 50% more book value in the foreign markets for every dollar invested. If we do the same comparison on an earnings basis, the difference is still there but not as stark.

As to Bogle’s question of why to take the currency risk, we note that although currency risk does not generally carry a positive expected return, it does have the effect of lowering the correlation between domestic equities and foreign equities which is beneficial to the overall risk/return profile of the portfolio.

A few years ago, we published this article addressing the question of whether international diversification was still worthwhile, and although the returns of foreign equities have been disappointing compared to U.S. equities since then, we stand by our conclusion:

“IFA reminds investors that the essence of a good diversifier is its ability to move in the opposite direction as the asset that they wish to diversify. This means accepting the fact that there will be time periods where they would have been better off without the diversifier. The problem, however, is that there is no way to reliably predict when these time periods will occur, so the best course of action is to buy, hold, and rebalance a sensibly constructed global portfolio of index funds for the long term.”