An international portfolio is a grouping of investment assets that focuses on securities from foreign markets rather than domestic ones. An international portfolio is designed to give the investor exposure to growth in emerging and developed markets and provide diversification.
Breaking Down International Portfolio
An International portfolio allows investors to further diversify their assets by moving away from a domestic-only portfolio. This type of portfolio can carry an increased risk due to potential economic and political instability present in certain emerging markets, but can also bring increased stability through investments in industrialized and more stable foreign markets. The most cost-effective way for investors to hold an international portfolio is to buy an exchange-traded fund (ETF) that focuses on foreign equities, such as the Vanguard FTSE Developed Markets ETF.
International Portfolio Advantages
- Helps Reduce Risk: Having an international portfolio can be used to reduce investment risk. If U.S. stocks underperform, gains in the investor’s international portfolio can smooth out returns. For example, an investor’s domestic portfolio may have declined by 10%. Meanwhile, their international portfolio could have advanced 20%, leaving the investor with a net investment return of 10%. Risk can be reduced further by holding a selection of stocks from developed and emerging markets in an international portfolio.
- Diversifies Currency Exposure: When investors buy stocks for their international portfolios, they are also effectively buying the currencies in which the stocks are quoted. For example, if an investor purchases a stock on the London Stock Exchange, he is also buying the British pound. If the U.S. dollar falls, the investor's international portfolio helps to neutralize currency fluctuations. (To learn how to hedge an international portfolio with a currency ETF, see: Hedge Against Exchange Rate Risk With Currency ETFs.)
- Market Cycle Timing: An investor with an international portfolio can take advantage of the market cycles of different nations. For instance, an investor may believe U.S. stocks and the U.S. dollar are overvalued and may look for investment opportunities in developing countries, such as Latin America and China, that are believed to benefit from capital inflow and demand for commodities.
International Portfolio Limitations
- Political and Economic Risk: Many developing countries do not have the same level of political and economic stability that the United States does. This may increase volatility to a level that risk-averse investors don't feel they can tolerate. For example, a political coup in a developing country may result in its stock market declining by 40%.
- Increased Transaction Costs: Investors typically pay more in commission and brokerage charges when they buy and sell international stocks, which reduces their international portfolio’s overall returns. Taxes, stamp duties, levies, and exchange fees may also need to be paid, which dilute gains further. Many of these costs can be significantly reduced or eliminated by gaining exposure to an international portfolio using ETFs or mutual funds.