Individual investors may reap diversification benefits by investing internationally.
The level of benefit is based on many factors – cross-country correlations, major industries, domestic companies that operate globally, etc. Over time, global diversification benefits have fallen. However, investing outside your home country is still worthwhile.
The question then, how much should you invest abroad?
This question was asked of a panel in The Wall Street Journal. Some good responses. I will comment on a few and include my own view of the world.
My Thoughts (Since No One Asked)
The global market is 100%. Your domestic market is a piece of the pie. The U.S. is the largest financial market with about 33% (plus or minus – you actually may see some claim it as high as 46%, but that is too high) of global market capitalization. Canada has only about 4% of the global market share.
Some experts recommend investing in line with relative global weightings. So roughly 33% in U.S. equities, 4% Canada, etc. Fine by me. An easy way to do this is to simply purchase a global equity fund. For example, the Vanguard Total World Stock ETF (VT) or iShares MSCI All Country World Index (ACWI) ETF (ACWI).
Both are extremely inexpensive and do an excellent job of replicating the global equity markets in reasonable weightings. I use “reasonable” as global equity funds tend to overweight U.S. equities. In this case, both Vanguard and iShares invest about 48% in U.S. equities. The higher weighting in funds versus actual real world weightings has to do with investable assets and a slight U.S. bias. Not a huge issue if you are looking for one single fund to invest in. Canada’s weighting sits at its proper 4%.
Some experts recommend home country bias when investing. If you live in Canada, instead of 4%, you might want to invest between 10 and 20% in Canadian equities.
Why? Your life is tied to your domestic financial markets. If you live in Canada, you are paid salary in Canadian dollars (CAD). Your debt is in CAD. Interest rates, inflation, unemployment, are all tied to Canadian-centric events. What goes on in Canada impacts Canadians disproportionately to world events. As a result, you may want to have greater exposure to Canadian equity markets.
I might add that some experts make the exact counter-arguement. That you should underweight your home market because of all the other impacts.
Me? I do not mind using either relative global weightings or home country bias. I think you need to consider other factors (what is your home market, debt load, other investments, cash flow requirements, etc.) before choosing one or the other. For many individuals who do not want currency and interest rate impact, a home country bias may be preferable. For younger investors, relative global weightings may prove better.
So what do the experts from The Wall Street Journal say? And bear in mind these folks are speaking as U.S. based investors. What might make sense for Americans may not be optimal for Aussies, Channel Islanders, or Malaysians.
Gus Sauter: Keep a Home Country Bias
In my view, investors should have a home-country bias because they face risks that are peculiar to their home country.
So, an investor should invest a significant portion in their home country, but invest enough internationally to take advantage of diversification.
Gus does not provide a suggestion for Aussies. But at 3% global weighting, a home country bias would probably put Australian equities at 10 to 20%. But some would say that more like 30 to 50% is suitable. Too high for me, but just letting you know.
As an aside, I have heard Gus speak a couple of times. Sharp guy.
Manisha Thakor: Don’t Think About Where a Company is Based
As the consumer class around the globe continues to blossom, growth rates in emerging markets continue to eclipse those at home.
Good advice. You need to consider the prospects for your home market versus foreign markets.
Also the region in which you live. If you live in Argentina, what goes on in Chile has more significance in your home market than what is happening in Germany. Conversely, Poles need to monitor the German market very closely given physical proximity and trade partnerships.
So the real question I think is: What is a non-U.S. investment?
To date, corporate domicile has typically been the litmus test for the categorization of an investment as domestic or international. Going forward, I think it’s important to pay attention to the source of revenue and profit generation
So, so true.
Is Apple an American company? Much of its manufacturing is in China. Its customers surround the globe.
Is Nestle a Swiss company? Is Samsung only South Korean? HSBC solely British? Obviously not. These companies operate globally and derive much of their revenue outside their domestic markets. Yet if you look at each country’s main indices, Nestle, Samsung, and HSBC dominate the domestic weightings.
As an aside, you can actually create an internationally diversified portfolio by strategically choosing domestic companies.
Frank Holmes: Anticipate Before You Participate
when you combine non-U.S. stocks, U.S. stocks, real-estate securities and commodity-linked securities, the resulting portfolio historically outpaced any individual asset class with less volatility.
understand the typical price movements of an asset class before you invest.
Not quite sure what Frank’s point is here. Whenever you prepare a portfolio you must consider historic returns and volatility (i.e., risk). That really is the whole point of diversification. Adding non-correlated assets to try and enhance overall portfolio returns while maintaining the risk level. Or reducing portfolio risk while maintaining the existing expected return levels.
Charles Rotblut: No Crystal Ball? Then Best Diversify
unless a person has a working crystal ball, it is impossible to predict where one should invest right now to maximize returns for the next 10 years. By mixing domestic equities with foreign equities, an investor increases the odds of being allocated to the right geographic region at the right time.
Diversification spreads out the risks. Unless you are certain of the future, hedge your bets.
by diversifying internationally, an investor’s wealth won’t solely be dependent on the strength or weakness of the U.S. dollar.
This is a two-edged sword. If your cash needs (living income, debt repayment, etc.) are in your home currency, investments in foreign currency denominated assets might be risky. But if you do not have these concerns, owning assets in a different currency may add value.
The Other Experts
Mostly dross. But you can see that there is no consensus on how much to invest outside your domestic market.
If you have a decent risk appetite and long time horizon, look to higher levels of non-domestic equities. Especially in emergent (and smaller) markets.
If you have substantial liability exposure to your domestic currency or you require income flows in local currency, then focus on a significant home bias.