The TSP I Fund, which focuses on equities from foreign developed markets, has performed poorly since its inception in 2001.
Indeed, the Japanese stock market has been in a bear market for 30 years, and the European stock market has been in a bear market for 20 years, as they have both gone from very high valuations to rather low valuations, and their economic growth rates have slowed.
The United States has seen similar bear markets in the past, and overall these indexes tend to behave similarly over several decades, but we have recently been in a big cycle of outperforming US stocks.
I have been rather bearish on Fund I since 2016, and indeed my first post on FEDweek at the end of this year was about the issues associated with Fund I. However, I was more favorable to emerging markets during this time. , and over the past year I have also warmed up to Fund I, due to such a long period of underperformance and therefore an improvement in valuation.
In 2020, Fund I was again in crisis as the worst performing TSP fund.
Part of this discrepancy stems from Europe’s relative lack of exposure to technology, and hence slowing earnings growth rates.
If we take a look at Vanguards’ top three equity funds, we can see the growth rates and valuations of different stock market regions. In the chart below, the first column represents the total US stock market, which roughly corresponds to Fund C and Fund S combined. The second column is the international developed equity market, which roughly matches Fund I except that it also has exposure to Canada and South Korea for around 13% of its allocation, while Fund I does not. not invest in these countries. The third column is the set of companies in emerging markets, which strongly includes China but also includes many other countries:
US stocks are by far the most expensive, but they come with decent growth rates. Foreign developed markets offer lower growth rates, but also much lower valuations. Emerging markets have growth rates about as high as US markets, but have valuations about as low as foreign developed markets and also have overall technology sector exposure similar to US markets.
Performance tends to go in cycles, although there is no guarantee. In the 1980s, foreign developed markets were the best performers in terms of equity returns. In the 90s, the United States was the best. In the 2000s, emerging markets were the best. And in the 2010s, the United States was once again the best. Who will be the best of the 2020 decade? Based on valuations and growth, I guess it would be emerging markets, but of course we can’t figure that out until we look back almost ten years from now. Usually, the best performing region of the decade starts the decade cheap, and by the end of the decade gets expensive.
Emerging markets typically have more volatility, currency risk, and jurisdictional risk than U.S. and foreign developed markets, but in return, they typically have high earnings growth, lower valuations, and sometimes lower debt. . For most people, it would be a bad idea to go all-in in emerging markets, and yet having a share of them in a portfolio and occasional rebalancing historically improves long-term returns.
The TSP unfortunately has no exposure to emerging markets, but federal investors can of course choose to buy any of the common emerging market index funds or ETFs in an IRA or other investment account alongside their holdings. TSP, if they decide they want that exposure in the context of a diversified portfolio.
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