"Why do you consider the U.S. the 'least worst' place to invest today?"
I recently posed that question to Chuck Akre, manager of the Akre Focus Fund, referring to his statement in his most recent shareholder letter.
"It's the territory that I know," he responded. Despite its problems, he said, the U.S. "will prosper and overcome adversity as we always have."
Let freedom ring!
I happen to share Akre's opinion, and my personal portfolio reflects this view. It's stocked with dividend-paying U.S.-based multinationals and mid-caps that I know backward and forward.
Many folks share this "home bias," consciously or subconsciously -- perhaps for good reason. A 2001 study by Joshua Coval and Tobias Moskowitz found that fund managers earn 2.7% more per year on local investments versus non-local ones.
Makes sense, right? First, we have an informational advantage with local companies, compared to, say, a newly public company in India. I've been a longtime customer of Starbucks
In contrast, I have little insight into what makes South Africa-based electronic payments provider Net 1 UEPS Technologies
On the other hand, we need to recognize that we may be "too confident" in local companies. In Your Money and Your Brain, Jason Zweig notes:
A study run jointly in the U.S. and Germany found that German investors expected their stock market to outperform the U.S. by two to four percentage points per year. Meanwhile, U.S. investors expected the Dow to beat the German market by almost exactly the same margin.
So while we may be confident that our local investments will outperform foreign counterparts, that isn't reason enough to buy a stock. We still need a well-rounded investment thesis.
Broaden your horizons
Even though our perceived competence and confidence level is higher with local stocks, that shouldn't excuse us from learning about foreign stocks, which could offer some truly great opportunities.
Owning U.S.-based multinationals that do at least half of their business abroad, like Google
For that matter, owning certain emerging-market exchange-traded funds like iShares FTSE/Xinhua China 25 or iShares MSCI Brazil isn't enough, either. You need to look under the hood first. The top holdings in these ETFs are mainly megacap names like Sinopec
To find true successes in emerging markets, you'll need to look into smaller and undercovered stocks in high-growth economies like China and India, where markets remain inefficient. In such unknown territory, proper insight can yield tremendous returns.
About that insight ...
It's time-consuming enough for domestic investors to get a grip on large international companies, let alone all the cultural nuances and economic catalysts of say, a small Chinese company that does most of its business in rural, tradition-steeped backwaters.
To get this sort of information, you really need to learn all these things firsthand. That's not easy for most investors, who are busy juggling work and family life, with a little time for stock research squeezed in between.
Still, the benefits of this extensive research can be quite rewarding. When Motley Fool Global Gains team members made their first trip to China in June 2008, they met management and toured the facilities of the then-$53 million China Green Agriculture. Blown away by the upside potential, they recommended the stock to members upon their return.
I'm not sure even they expected the company to subsequently return 330% so quickly -- small-cap Chinese agriculture stocks can be a volatile and unpredictable lot, after all, making diversification critical. But China Green Agriculture's success demonstrates the powerful combination of local information advantage and inefficient markets.
Think local and global
The U.S. economy will continue to improve, and American investors shouldn't discount our collective informational advantages in local stocks. Still, if you're looking to add some high growth potential to your portfolio (in moderation, of course), along with greater international exposure, go with small, undercovered emerging-market stocks. In short, they're the stocks you need to know.
Our Global Gains team members can help you get started. They're about to depart for their next trip to China to find the types of undercovered companies I discussed above. If you'd like to receive their dispatches, as well as a free report with still-good buys they uncovered during their previous trip, enter your email address in the box below.
This article was originally published on April 5, 2010. It has been updated.
Fool analyst Todd Wenning's random fact of the day is that "bookkeeper" is the only word in the English language with three consecutive double letters. He owns shares of Akre Focus. Google and Net 1 UEPS Technologies are Motley Fool Rule Breakers recommendations. Starbucks is a Stock Advisor selection. China Green Agriculture and Net 1 UEPS Technologies are Global Gains picks. Petroleo Brasileiro is an Income Investor recommendation. The Fool owns shares of China Green Agriculture and has a rockin' disclosure policy.