An international portfolio is a selection of stocks and other assets that focuses on foreign markets rather than domestic ones. If well designed, an international portfolio gives the investor exposure to emerging and developed markets and provides diversification.
Understanding the International Portfolio
An international portfolio appeals to investors who want to diversify their assets by moving away from a domestic-only portfolio. This type of portfolio can carry increased risks due to potential economic and political instability in some emerging markets, There also is the risk that a foreign market's currency will slip in value against the U.S. dollar.
- An international portfolio may appeal to the investor who wants some exposure to the stocks of economies that are growing faster than that of the U.S.
- The risks of such a strategy can be reduced by mixing emerging-market stocks with shares in some of the solid performers of industrialized nations.
- The investor might also take a look at some of the U.S. companies that are experiencing their fastest growth abroad.
The worst of these risks can be reduced by offsetting riskier emerging-market stocks with investments in industrialized and mature foreign markets. Or, the risks can be offset by investing in the stocks of American companies that are showing their best growth in markets abroad.
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 or the Schwab International Equity ETF.
Risky and Less Risky Choices
Over the recent past, the growth of the economies of China and India greatly exceeded those of the U.S. That created a rush to invest in the stocks of those countries. Both are still growing fast, but an investor in the stocks of either nation now would have to do some research to find stocks that have not already seen their best days.
The search for new fast-growing countries has led to some winners and losers. Not long ago, investors going for fast growth were looking to the CIVETS nations. They were Colombia, Indonesia, Vietnam, Egypt, Turkey, and South Africa. Not all of those countries would still be on any investor's list of promising economies.
Currency risk is a factor in international investing. You can gain (or lose) as another nation's currency rate moves.
Meanwhile, in the more industrialized world, there are names that will be familiar to any American investor and they are available, directly or through mutual funds and ETFs. For example, the biggest holdings in Vanguard's Total International Stock Fund Index are China's Alibaba, Switzerland's Nestle, China's Tencent Holdings, South Korea's Samsung, and Taiwan Semiconductor.
It's worth noting that, as of early 2020, only 22.50% of the fund's holdings were invested in emerging markets, with 41.50% in European assets and the rest spread around the globe.
International Portfolio Advantages
- May Reduce Risk: Having an international portfolio can be used to reduce investment risk. If U.S. stocks underperform, gains in the investor’s international holdings can smooth out returns. For example, an investor may split a portfolio evenly between foreign and domestic holdings. The domestic portfolio may decline by 10% while the international portfolio could advance 20%, leaving the investor with an overall net return of 10%. Risk can be reduced further by holding a selection of stocks from developed and emerging markets in the international portfolio.
- Diversifies Currency Exposure: When investors buy stocks for an international portfolio, they are also effectively buying the currencies in which the stocks are quoted. For example, if an investor purchases a stock that is listed on the London Stock Exchange, the value of that stock may rise and fall with the British pound. If the U.S. dollar falls, the investor's international portfolio helps to neutralize currency fluctuations.
- 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 regions, such as Latin America and Asia, 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 increases risk to a level that many 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 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.