Beginning with the creation of the European Union through the Maastricht and Lisbon Treaties, a generation of investors no longer worried about European country risk. German bonds and Greek bonds traded within a few basis points of each other up to late 2007/early 2008. Economic historians will point to the periods between 1946 and 1999 as being very challenging. Deciding which European countries to invest in and how was tough. You had the Club Med countries experiencing several periods of currency devaluation. The markets provided guidance on the risk between these European countries with credit spread differentials on corporate and government debt. Since the creation of the European Union, German and Greek bonds traded based on interest rate differentials. No longer. They now trade based on credit differences. Risk and return eventually come back into balance. The only question is when.
One great aspect of capitalism is that it allows a society to get richer (source: Schumpeter). Capitalism also brings about creative destruction. The global stock and bond markets are in this current phase. I experienced such a phase in Canada during the late 1980s through the mid-1990s (family businesses and investments). There is opportunity in a crisis. There is also the need to ensure one’s assets are intact at the end of the crisis or the creative destruction phase.
Money managers will need to avoid the pressure thrust upon them from pension consultants and the like over the last 25 years to base their country weightings on the EAFE Index. Sometimes it makes sense to have a zero weighting to Japan (currently a 23.5% weighting in the MSCI EAFE Index).
Bottom line: Stock picking, not country allocation, has historically provided a balanced risk/return trade off. Policy/political risk during a creative destructive phase is very real (US is especially included in this category).
Always Asking, Never Assuming™
Christopher Holtby
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