The TSP I Fund, which focuses on foreign developed market equities, has been a poor-performer since its inception in 2001.
This is because Japan’s stock market has been in a 30-year bear market, and Europe’s stock market has been in a 20-year bear market, as they both fell from very high valuations to rather low valuations, and their economic growth rates slowed.
The United States has had similar lengthy bear markets in the past, and overall the multi-decade long run these indices tend to all perform similarly, but lately we’ve been in a big cycle of U.S. equity outperformance.
I’ve been rather bearish on the I Fund since 2016, and indeed my first article on FEDweek from late that year was about the problems associated with the I Fund. However, I’ve been more favorable to emerging markets during that time frame, and in the past year or so, I’ve warmed up to the I Fund as well, due to such a long stretch of underperformance and therefore, improving valuation.
In 2020, the I Fund has yet again been in a slump, as the worst-performing TSP fund.
Part of this differential is from Europe’s relative lack of technology exposure, and thus slower earnings growth rates.
If we look at Vanguard’s three major equity funds, we can see the growth rates and valuations of different equity regions. In the chart below, the first column is the total U.S. stock market, which roughly corresponds to the C Fund and S Fund combined. The second column is the international developed equity market, which roughly corresponds to the I Fund except it also has Canada and South Korean exposure for about 13% of its allocation, whereas the I Fund doesn’t invest in those countries. The third column is the set of companies throughout emerging markets, which heavily includes China but also includes many other countries:
U.S. stocks are by far the most expensive, but they have come with decent growth rates. Foreign developed markets offer lower growth rates, but also much lower valuations. Emerging markets have growth rates that are about as high as U.S. markets, but have valuations that are about as low as foreign developed markets, and also have overall technology sector exposure that is similar to U.S. markets.
Performance tends to go in cycles, although there’s no guarantee. In the 1980’s, foreign developed markets were the best performers in terms of equity returns. In the 1990’s, the United States was the best. In the 2000’s, emerging markets were the best. And in the 2010’s, the United States was the best again. Who will be the best in the 2020’s decade? Based on valuations and growth, my guess would be emerging markets, but of course we can’t know until we look back in nearly ten years. 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. markets and foreign developed markets, but in exchange they generally have high earnings growth, lower valuations, and sometimes lower debt. For most people, it would be a bad idea to go all-in on emerging markets, and yet having a slice of them in a portfolio and rebalancing occasionally, historically improves long-term returns.
The TSP unfortunately doesn’t have any emerging markets exposure, but federal investors can of course choose to buy one of the common emerging markets index funds or ETFs in an IRA or other investment account alongside their TSP holdings, if they decide that they want that exposure within the context of a diversified portfolio.
TSP: Tech Rout Sends Shares Lower (Sept 8)