International investing: A world of diversification

The case for diversifying internationally is clear: In 1990, the United States had 60% of the world’s capital. At the end of 2008, the United States had only 30% of the world’s capital. To ignore this is to forgo significant opportunities. Diversified international exposure should be part of a prudent equity portfolio. 

Background: Foreign stocks come in two varieties. Those from “developed” markets come from Western Europe, Japan, Australia and Canada. “Emerging” markets include Mexico, Brazil, Chile, Eastern Europe, South Africa, India, China and the other, smaller economies of the Far East. What small and micro-cap stocks are to the U.S. stock market, emerging-market stocks are to international investing.  

Why invest in international markets? There are two main reasons to invest in international markets. One is diversification—the spreading of risk among a variety of investments that do not gain and lose value at the same time. The other is growth—participating in the potential for growth in foreign economies.  

What are the risks? Investing in international markets—especially emerging markets—involves special risks. These include: Currency exchange rate risk: If the foreign currency is weak against the U.S. dollar when you sell the stock or receive dividends, that translates into fewer dollars in your pocket. Event risk: Political, economic and social events might drastically affect stock values. Lack of transparency: Many foreign companies do not provide as much disclosure as U.S. companies are required to do, and the information available might not be in English. Different rules and practices: Some markets don’t report stock trades as quickly. Custodian banks and depositories might operate under different rules that leave investors less protected. Transaction and tax costs might be higher. Liquidity risk: It might be more difficult to buy and sell stocks in foreign markets that have lower trading volume, fewer hours of operation and fewer listed companies. Legal risk: You might have to rely on the courts of the company’s host country. 

Given all these risks, shouldn’t I avoid international investing? No. Remember that all investment involves risk. The key is to balance risk and reward according to your individual asset allocation strategy. In the long run, the additional diversification provided by international investing can actually lower total portfolio risk.

How much of my portfolio should be in international investments? Our recommendation is that U.S. investors should consider allocating 25% to 40% of their stock portfolios to international investments. Mutual funds, American Depositary Receipts, exchange-traded funds, U.S.-traded foreign stocks and direct investments in foreign markets are all possible ways to invest in foreign markets. 

How does Karpus Investment Management invest internationally? For many years, KIM has believed that investors should allocate 25% to 40% of their equity assets to foreign markets using conservative, highly diversified strategies. We have invested internationally at these levels since the mid-1990s, producing outstanding returns for our clients. Investors with $1 million or more to invest should consider professional money management with KIM.