Investing internationally has grown rapidly in recent years. The bias for investing only within our national borders is diminishing, as an increasing number of individual and institutional investors boost their international exposure to pursue their investment goals. Behind the trend toward international investing are the realizations that the global market can offer attractive opportunities for investment and that diversification abroad can help reduce risk.
The Investment World Grows Larger
In 2015 foreign markets represented 58% of the world’s investment opportunities. It is estimated that by 2030 the U.S. stock market will represent just 38% of the world market.1
Diversification and Higher Returns
The quest for diversification and higher returns are driving forces behind the internationalization process. When U.S. investors began to invest in foreign equities, a key reason for the move was increased diversification. Because international markets do not always move in sync — some may zig while the others zag — diversification on a global scale may help offset the effect of a downturn in the U.S. market. Investors in international securities may face additional risks, such as higher taxation, less liquidity, political problems, and currency fluctuations, that do not affect domestic investors. But despite these risks, the potential for higher returns and diversification makes these markets attractive to many investors.
As investors around the world become more sophisticated and aggressively explore investment opportunities, they find that the global arena can offer competitive returns. The MSCI Europe, Australasia, Far East (EAFE) index, which tracks 23 major world markets, posted a 5.95% annualized rate of return for the 30 years ended December 31, 2016, compared with the 10.16% annualized return of Standard & Poor’s Composite Index of 500 Stocks (S&P 500).1 Past performance does not guarantee future results.
This difference in returns is due in part to differences in economic and market environments in countries around the world. For example, the Japanese market throughout the 1990s was depressed due to the country’s economic recession. Many Japanese stocks became undervalued. In 1999 the Japanese stock market bounced back, producing a gain of more than 60%.2
How to Invest in Foreign Equities
One way you can include international exposure in your portfolio is to invest in stocks of U.S. companies that derive a large portion of their annual revenue from overseas markets. Examples of such companies are Coca-Cola and McDonald’s.
You can also buy stocks of foreign companies through American Depositary Receipts (ADRs) — traded on the New York Stock Exchange — and through mutual funds that invest in foreign companies. ADRs are negotiable certificates that represent the shares of a publicly traded foreign company. ADRs are issued in the United States and their underlying shares are held in U.S. banks.
But familiarizing yourself with international markets (including the regulatory, political, and economic environments) is time consuming, and access to company information can be difficult to obtain. An easier way to invest internationally is to buy shares of broadly diversified international mutual funds or exchange-traded funds, which invest exclusively overseas, or global funds, which may buy a mix of foreign and U.S. stocks. These types of funds offer instant diversification through an array of foreign market stocks.
For more experienced and more aggressive investors wishing to target stocks in particular regions or countries, regional or country funds are also available. These funds are designed to take advantage of specific opportunities in the world’s developed and emerging markets, but they do carry an increased risk of volatility.
International investing does present unique risks and considerations. A U.S. investor’s foreign-investment return depends on both the local currency’s exchange value against the U.S. dollar and the stock price in the local currency. For example, falling currency values and plummeting stock prices in Asian nations in 1998 not only drove down stock prices for international investors in Asia, but also in the U.S., because many American companies depend on Asia for customers. For U.S. investors, currency losses could also stem from a rise in the dollar’s value against the currency of the foreign country they are investing in. In the past, currency fluctuations have tended to balance out over extended periods of time, although there are no guarantees this will always be the case. Maintaining a long-term perspective and diversifying international investments can help minimize these risks.
Securities offered through LPL Financial, member FINRA/SIPC. Investment advice offered through Barnes Capital Group, a Registered Investment Advisor. Barnes Capital Group is a separate entity from LPL Financial.