by Karin Maloney Stifler and Sarah Hannibal

Important changes occurred this month in Ohio’s College Advantage 529 Direct Sold Savings Plan.

As of September 9, 2016, Vanguard increased the allocations to international stock and bond holdings in the Vanguard Ready Made Risk-Based and Age-Based Portfolios. On first hearing about this, it seemed like a bold move for a relatively conservative company. Yet, these changes mirror Vanguard’s recent history of increasing allocation to international stock and bond funds in their target date retirement funds.

In Ohio’s 529 Plan, Vanguard changed the allocation from domestic to international by 10%, summarized in the table below:

Old Allocation New Allocation
Stocks: 70% US / 30% Int’l 60% US / 40% Int’l
Bonds: 80% US / 20% Int’l 70% US / 30% Int’l

The Case for Global Investing

Vanguard’s rationale for higher international allocation is grounded in the fact that diversification reduces risk and enhances returns over time. Vanguard argues that investing in US companies alone disregards more than half of the world’s investment opportunities. US-based public companies represented 49% of the world’s market capitalization as of December 31, 2014.

“Home country bias” is common, but not necessarily less risky contrary to popular thinking. Research shows that globally diversified investment portfolios have the lowest average volatility. A broadly diversified portfolio consists of all major asset classes around the globe. Volatility is reduced through diversification because equity and bond markets of other countries behave differently than in the US.

What is a Reasonable International Allocation?

Vanguard tested the diversification impact of various combinations of US and non-US investments over time. The research showed that the maximum historical diversification benefit would have been achieved by allocating 30% to 40% non-US, achieving a net reduction in volatility of 71 basis points. Allocating 20% to non-US would have captured 60 basis points, or about 85% of the maximum possible benefit.

The optimization analysis is instructive, but is backward looking and not a guarantee of future results. Results can vary based on the time periods under review. For example, recent performance of international stocks has been lackluster and has not reduced volatility at any allocation. This is reflective of higher average correlations among global equity markets. Whether this will persist is debatable.

Considering the evidence, Vanguard adopted a long-term commitment to the increased international allocation, albeit less than the market proportions, creating enhanced opportunity to participate in whichever regional market is outperforming.

Are US Based Multinationals Enough?

Some argue that owning US based multinationals provides adequate international exposure. This perspective has merit, but fails to capture many leading international companies, such as Samsung, Toyota and Nestle and emerging companies in other regions. In addition, a portfolio of solely US-domiciled firms is likely to have less industry diversification and misses the impact of local currency exposure, which can help reduce correlations.

Bottom Line

If you’re invested in Ohio 529 Plan Vanguard’s Age-Based or Risk-Based Portfolios, stay the course. We will be monitoring results. For all investors, it is important to invest globally based on evidence that US-based investors reap long-term benefits from controlled investment allocations outside of our own borders. We cannot predict returns, but it seems reasonable to anticipate that returns for US and international markets will differ and offer diversification benefits.

For investors in the Illinois Bright Start Savings Plan, Vanguard has not made these changes to their Age Based Index Portfolios. We will actively be watching this and other plans for any changes.