As an investor, it’s natural to have a home country bias – where you rarely or never look for investment opportunities across international borders.
There are several reasons for investors to cling to their home countries. Behavioral finance experts have been studying the phenomena for years now. Many point to the fact that we tend to invest in companies that offer products we use on a day-to-day basis; most of us don’t have to look too hard to find products made by Procter & Gamble, 3M, and others in our household.
Whether you’re conscious of it or not, there are profitable investments to be made that lie outside of your country of domicile. You may be leaving some considerable portfolio benefits on the table by keeping your sights only on domestic opportunities.
This article will highlight:
Before we continue, Financial Professional wants to remind you that this article is educational in nature. Any securities or firms named are for illustrative purposes only and do not constitute financial advice. Always do your due diligence and consider your situation – and the help of a licensed financial professional – when making investment decisions.
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It’s natural to feel uncomfortable exposing yourself to new experiences you’re otherwise unaccustomed to. Perhaps this inherent aversion is why investors express apprehension toward owning foreign investments.
If you can get past this cognitive bias, you are one step closer to adding a great deal of value to your portfolio strategy without too much effort, as investing across international borders offers several benefits in the realm of portfolio construction.
The first thing to consider is the fact that independent economies don’t always move in tandem with one another, even with the advent of globalization. This is why it’s possible for one economy to experience a boom while another falls into recession.
However, it’s also possible for those who reside in a receding economy to participate in the growth of a successful economy.
In essence, by having a global outlook, you can diversify your portfolio not only within sectors and asset classes but within economies as well.
The concept of correlation is discussed heavily in portfolio theory. Many professional investors believe that different parts of your portfolio moving in different directions at different times provides you with better returns in the long run, rather than owning a portfolio of highly correlated investments.
In short, you may be able to capture growth opportunities in other countries that are not available domestically. If the foreign country’s stock market sees a bear market, you will still have domestic exposure which can provide you with some buffer against volatility abroad.
In the case of equities, foreign markets can separate into one of two categories:
Developed economies tend to be more sophisticated and mature. From an American perspective, some developed international markets include:
These markets tend to be highly liquid and are considered more stable than their emerging counterparts. Debt securities originating from these markets tend to carry higher credit ratings since these sovereign governments tend to be less prone to default risk compared to less-developed governments.
Emerging markets (EM) are economies that are not sophisticated enough to be considered “developed” just yet. The risk involved with these markets is usually very high. That said, they tend to carry a great deal of upside for investors that are willing to subject themselves to the increased levels of volatility that emerging markets experience.
Some examples of Emerging Markets include:
Emerging Market fixed income securities tends to offer higher yields because of the inherent higher default risks. This is something to be especially aware of if you are looking to invest in international bonds or bond funds.
Note that there may be some overlap between the two categories depending on the entity that is classifying the market. For example, some agencies consider South Korea to be developed, but others refer to the country as an emerging market.
When investing in either type of international market, an investor should do their due diligence to understand the risks involved with the investment, especially when dealing with less developed countries.
Also, just because an economy falls under the “developed” category, that doesn’t mean it is a risk-free investment opportunity. All economies have risks that investors should understand prior to participating in the growth (or decline) of the said economy.
While owning international equities can provide you with notable investing benefits, there are some risks of which you should be aware.
The first hurdle you may have to overcome is access to information. Certain countries have different standards when it comes to releasing information about their economy. If you are trying to find research on a specific company within a specific country, you may run into a language barrier if the company is not covered by analysts globally.
Political risk is among the largest risks to be concerned with when investing internationally. This can be especially true when dealing with emerging markets. Some regions do not have similar value systems or securities laws compared to developed nations, and countries that are prone to violence can experience higher levels of economic volatility.
It’s also important to be aware of the economic forces, such as inflation, that vary in how pronounced their effects are. In the United States, the inflation rate holds steady at around 2% annually. In violent or developing countries, such as Venezuela, the inflation rate can leap into the thousands.
Currency risk is also something to keep in mind. This simply means that your purchasing power may be reduced if the currency you are using to purchase the foreign investment is devalued relative to the currency of the economy that you are accessing.
Trading costs can also vary by brokerage provider when purchasing international investments. These transactions can be more costly than placing an order to trade domestic securities.
Depending on your needs and preferences, there are several ways to access international markets within your investment portfolio.
For instance, there are plenty of mutual funds available for retail investors that can provide international investing exposure.
Global asset allocation funds (like FNGZX) can provide you with access to economies worldwide. This may be a suitable choice for those who desire maximum exposure to all countries and options. These funds can vary in style, market capitalization focus, and more. Make sure you research every fund’s strategy and costs prior to purchasing it.
There are plenty of mutual funds that invest in specific countries as well. An example would be MCDFX, which invests exclusively in China. If you go that route, it’s critical to be aware of the risks involved with the underlying country.
There are also ETFs that provide you with global exposure (GAL) or country-specific exposure (CHIK).
In the case of individual companies, American investors can own shares of publicly-traded foreign corporations via American Depository Receipts (ADRs). The ADR is traded on an American exchange and will reflect the price movement of the original stock, which is traded on the foreign exchange.
Each investment vehicle has its own unique considerations that you should be aware of prior to purchasing. Some important points of which to have a clear understanding include:
The advent of technology and a global intermingled economy, as well as low-cost online brokerage platforms, has given everyday investors unprecedented access to foreign markets. For the everyday investor, having a global mindset in your asset allocation strategy can uncover investment opportunities that aren’t available domestically, and otherwise would be out of reach. Just make sure the strategy you go with is suitable for your portfolio’s needs, as well as for your personal preferences.
Foreign economies can also provide you with an opportunity to add non-correlated investments to your portfolio, which is a staple and cornerstone in portfolio theory. However, it’s crucial to clearly understand the unique risks involved in each and every foreign market you enter. Remember: volatility does not always beget returns.
Have questions on international investing? Let us know!