U.S. Investments in Foreign Securities
Malkiel, Burton G., Journal of International Affairs
My assignment is to talk about international capital flows, and in particular U.S. purchase of foreign securities. I will first examine what might be responsible for the recent surge of interest in foreign securities on the part of U.S. investors. I will then present the reasons for which one might be suspicious about the staying power of some of the factors that have made international investing popular recently, as well as the intellectual justification for U.S. citizens to invest abroad. Finally, I will say a few words about the outlook for international investing in the period ahead.
In recent quarters, there has been a very sharp increase in the net purchases of foreign securities by U.S. residents. In the third quarter of 1993, for example, there was more than $45 billion in net purchases of foreign securities, and it is estimated that the full year 1993 will come in at something over $160 billion, three times the amount for all of 1992.
Well over half of those capital flows represent equity purchases in a recent trend toward global diversification by U.S. investors. There have also been significant U.S. purchases of foreign bonds in recent quarters. While some part of these capital flows can be explained by the increasing globalization of pension-fund portfolios, university portfolios and the portfolios of other institutional investors, there also has been a dramatic increase in the purchase of foreign securities by U.S. mutual funds. This in turn has reflected the decisions of individual investors to place their money in international mutual funds.
Net flows into international equity mutual funds have risen from close to zero or negative in the late 1980s to $17 billion in the fourth quarter of 1993. That number slightly overstates the amount going into foreign securities because it combines two types of mutual funds: international funds, which invest only in foreign securities, and global funds, which invest in both U.S. and foreign securities. The interest in these kinds of mutual funds is tremendous. The total flow of investments into emerging markets equity funds was essentially zero in the beginning of the 1990s and rose to $5.5 billion in the fourth quarter of 1993.
What is responsible for this recent interest in international investing? The first answer is that generally, U.S. portfolios are overweighted with home-country securities and equally underweighted with foreign securities. The most recent estimate by Merrill Lynch is that U.S. investors have approximately 4 percent of their portfolios invested abroad, while about two-thirds of the world's capitalization of equity markets is foreign. If you play the game of solving various models of portfolio selection with alternative risk aversion parameters, it appears that U.S. investors ought to be putting as much as half of their funds in foreign securities. So I believe at least a part of the increase in U.S. purchases of foreign securities reflects the realization that we have been underusing foreign securities and that they are underrepresented in our portfolios.
I think probably an even more important reason, however, is that recent returns for foreign securities have been excellent. Figures from a recent T. Rowe Price advertisement show that in recent 10-year periods, foreign stocks have outperformed U.S. stocks. A Dreyfus ad shows, once again, an excellent performance of foreign equity markets. One of the emerging markets, Hong Kong, shows the biggest 10-year rate of return: 36.05 percent, well over twice the U.S. rate. I am sure that a good part of the increase of foreign security purchases is motivated by such advertisements, which rely on these kinds of recent rates of return.
Finally, with respect to the bond market, at the start of the 1990s, interest rates in Japan and Switzerland were lower than in the United States. If you look at Canada, France, Germany, Italy and the United Kingdom, however, interest rates averaged about 200 basis points, 2 percentage points higher than in the United States. …