International investments provide valuable opportunities for an investor to diversify their portfolio and cast a broader net in the search for returns. Yet many are intimidated by the perceived risk and recent underperformance of investments outside of the United States.
In this Insight, I’ll explain how thoughtful international investments can help mitigate extreme outcomes in the domestic economy, reduce sectoral concentration, and play a valuable role in an investor’s portfolio.
International Investments Helps Avoid Extreme Outcomes
Because investors in the United States feel like they have an incredibly diverse array of domestic investment opportunities, many US investors don’t feel the need to invest anywhere else. The financial press tends to focus on domestic markets, and when we see daily headlines on the S&P 500, it can be all too easy to forget about international opportunities.
Most investors in the United States have a portfolio that is heavily weighted toward domestic stocks, bonds, and real estate. Diversifying internationally can help avoid extreme outcomes and mitigate the impact of extended downturns in the domestic economy, as the “lost decade” for US equity markets vividly illustrated. During this period, from 2000 to 2009, the S&P 500 Index had one of its worst 10-year performances in history, with a total cumulative return of -9.1%. By comparison, international indexes excluding the US performed well in the same period.
Source: “Why You Should Diversify,” Dimensional
How Can International Investments Help Diversify Your Portfolio?
Even though the global economy is more interconnected than ever, different markets still rise and fall at different times, and international investments can leverage this fact to reduce portfolio volatility.
International investments provide a number of different benefits for diversification, including the ability to reduce sector concentration compared to US markets. The Russell 3000 (a broad index representing over 95% of the US public equity market) is made up of over 30% of technology companies by market capitalization.
Source: FTSE Russell
By comparison, the MSCI ACWI ex-US index (representing a variety of large and mid-cap companies outside the US) consists of only 13% technology companies, which is a reason for underperformance versus “US stocks” over the past several years. Given this shift in sector selection, you could argue the international market is more diverse than the US because it is less concentrated in any one given sector.
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Source: MSCI
Within the broad category of international investments, investors still have the flexibility to diversify their portfolios across different regions and risk profiles. Developed markets (like the UK, France, Germany, South Korea, and Japan) offer comparatively secure investments, while emerging markets (examples include South Africa, India, China, and Mexico) offer greater risk, but the potential for greater returns due to rapid economic growth and potential undervaluation. Data compiled by Bloomberg suggest that developing market stocks are trading at a discount of over 40% compared to US companies, one of the largest valuation gaps on record between these categories.
International investment funds may focus on either of these categories, or provide coverage of a specific region like Asia-Pacific, Europe, Latin America, or Africa. Funds may also be “global,” mixing both US and international assets according to specified criteria.
Align International Investments with Your Personal Financial Plans
International investments come with distinct risks including exchange rate fluctuations and geopolitical uncertainty, and it is important to balance these risks as part of your overall investment strategy.
Like any investment, the best options for balancing risk and reward depend on your personal financial goals. For many individuals, international investments will have a valuable role to play in securing a share of global growth while further diversifying their portfolios.
A financial advisor can help you understand how to best incorporate international investments into a balanced portfolio tailored to your long-term goals. Don’t hesitate to contact our team to discuss the right approach for your needs.
