International investing

What Is International Investing?

International investing involves purchasing securities issued by companies or governments outside an investor's home country. This investment strategy extends a portfolio's reach beyond domestic borders, allowing access to a wider range of global markets and economies. The primary objectives of international investing are often to enhance portfolio diversification and capture growth opportunities not readily available in local markets. By including assets from various countries, investors can potentially spread investment risk across different economic cycles and political environments.

History and Origin

The concept of cross-border capital flows is not new, with foreign investments occurring throughout history, often tied to colonial expansion and trade³⁰, ³¹. Early forms of international investment were driven by the pursuit of resources and the establishment of trade routes, such as the Silk Road, and later, trans-oceanic commerce²⁹. In the early 20th century, foreign direct investments were mainly motivated by exploiting natural resources, with the United Kingdom being a significant source of global investment²⁸.

Modern international investing, particularly for individual investors, gained significant traction with the rise of globalization in the latter half of the 20th century. Technological advancements in communication and financial markets simplified the process of overseas investing, making it more accessible. The International Monetary Fund (IMF), established in 1944 at the Bretton Woods Conference, played a crucial role in fostering international monetary cooperation and financial stability, indirectly facilitating cross-border capital movement²⁷. As capital markets became more interconnected, the benefits of global portfolio management became increasingly apparent, leading to a broader adoption of international investing strategies by institutional and individual investors alike.

Key Takeaways

• International investing means buying securities in countries other than an investor's home country to expand investment opportunities and manage risk.
• Key motivations include diversifying a portfolio across different economies and capitalizing on growth in foreign markets, especially emerging markets.
• It exposes investors to unique considerations like currency risk, political instability, and differing regulatory environments.
• International investing can be accessed through various instruments such as foreign stocks, bonds, mutual funds, and Exchange-Traded Funds (ETFs).

Interpreting International Investing

International investing is interpreted as a strategic approach to optimize a portfolio's risk-adjusted returns. By allocating capital across different national economies, investors can potentially reduce the overall market volatility of their holdings. This is because various countries often experience different economic cycles and market conditions that do not always move in sync²⁶. For example, a downturn in a domestic market might coincide with growth in an overseas market, helping to balance the portfolio's performance²⁵. Evaluating international investing involves considering factors such as the economic growth prospects of foreign nations, the stability of their political and regulatory systems, and the potential impact of exchange rates on returns. Investors look for countries or regions that offer uncorrelated growth patterns or sectors not well-represented in their home market.

Hypothetical Example

Consider an investor, Sarah, based in the United States, who initially holds a portfolio entirely composed of U.S. domestic stocks. Sarah decides to implement international investing to diversify her holdings.

1. Initial Portfolio: Sarah has $100,000 invested solely in U.S. large-cap equities.
2. Research and Allocation: After researching, Sarah decides to allocate 20% of her portfolio to international markets. She identifies opportunities in a developed market like Germany and an emerging market like India.
3. Investment Vehicles: Instead of buying individual foreign stocks, which could be complex and expensive, Sarah opts for a German equity ETF and an India-focused mutual fund. She invests $10,000 in each.
4. Scenario 1 (Domestic Downturn): In a given year, the U.S. stock market experiences a decline of 10%. However, the German market, due to strong industrial performance, rises by 5%, and the Indian market, driven by consumer growth, surges by 15%.
   • U.S. Holdings: $80,000 * (1 - 0.10) = $72,000
   • German ETF: $10,000 * (1 + 0.05) = $10,500
   • India Mutual Fund: $10,000 * (1 + 0.15) = $11,500
   • New Portfolio Value: $72,000 + $10,500 + $11,500 = $94,000.
   • Without international investing, Sarah's portfolio would be $90,000. Her international exposure helped cushion the domestic downturn, resulting in a less severe overall loss.
5. Scenario 2 (Currency Impact): Suppose the U.S. dollar strengthens against the Euro, making the Euro-denominated German assets worth less when converted back to dollars. Even if the German market rose, the unfavorable foreign currency exchange rate could reduce or negate gains in U.S. dollar terms. This illustrates a common risk of international investing.

Practical Applications

International investing is a widely adopted practice in investment and asset allocation to achieve a variety of strategic goals. Fund managers of large institutional portfolios, such as pension funds and endowments, routinely incorporate international assets to enhance Modern Portfolio Theory (MPT) principles by diversifying across global markets²³, ²⁴. Retail investors can access international markets through U.S.-registered mutual funds, exchange-traded funds (ETFs), or American Depositary Receipts (ADRs)²¹, ²².

Beyond individual portfolios, international investing also appears in governmental and economic policy. Nations actively seek and encourage foreign direct investment (FDI) and foreign portfolio investment (FPI) to stimulate economic growth, create jobs, and facilitate technology transfer. For instance, countries in the Gulf region are actively pursuing economic diversification efforts, reducing dependence on oil revenues by encouraging tourism and expanding other sectors, which can attract further international investment²⁰. The Securities and Exchange Commission (SEC) provides investor bulletins to educate the public on the various aspects and considerations of international investing, highlighting its relevance for individual investors in the U.S. and the special factors to consider when engaging in such investments¹⁹.

Limitations and Criticisms

Despite its benefits, international investing carries inherent limitations and criticisms. One significant drawback is exposure to currency fluctuations, which can significantly impact returns when converting foreign earnings back to the domestic currency¹⁸. A strong domestic currency can diminish gains from overseas investments, while a weak one can amplify them¹⁷.

Additionally, international investing involves elevated transaction costs and higher fees for U.S.-registered funds that invest abroad, due to the complexities of trading in foreign markets¹⁶. Investors also face different levels of liquidity in foreign markets, particularly in emerging economies, where trading volumes might be lower and restrictions on foreign ownership more prevalent¹⁵.

Furthermore, international investing exposes investors to unique political, economic, and social risks that are less common in domestic markets¹³, ¹⁴. These can include political instability, changes in government policy, regulatory shifts, expropriation, and even geopolitical events¹¹, ¹². Information access and transparency can also be challenging, as foreign companies may not provide the same level or type of financial disclosure as domestic public companies, and information may not always be available in English¹⁰. Critics also note that with increasing globalization, markets are becoming more intertwined, potentially reducing the diversification benefits that international investing traditionally offered, especially during periods of systematic risk like global financial crises⁸, ⁹.

International Investing vs. Global Investing

While often used interchangeably, "international investing" and "global investing" have a distinct difference in the financial world, particularly when referring to investment funds.

International Investing typically refers to investments made exclusively in securities outside of an investor's home country. For example, a U.S.-based international fund would invest only in non-U.S. companies and markets⁷. This approach allows investors to maintain precise control over their domestic-to-international asset allocation, ensuring that their foreign exposure complements their existing domestic holdings without overlap⁶.

Global Investing, on the other hand, involves investments in securities from all over the world, including the investor's home country⁵. A global fund might invest in U.S. stocks alongside non-U.S. stocks, giving the fund manager the flexibility to shift investments between domestic and foreign markets based on perceived opportunities⁴. The key difference is that a global fund provides exposure to both domestic and foreign markets, whereas an international fund specifically excludes the investor's home market. Investors choose between the two based on their existing domestic exposure and their desired level of control over the balance between domestic and international assets within their overall portfolio.

FAQs

Why should I consider international investing?

International investing can provide important benefits such as greater diversification and access to growth opportunities in foreign economies that may not be present in your home country. It can help reduce your overall portfolio risk by ensuring your investments are not solely dependent on a single market's performance.

What are the main risks of international investing?

Key risks include currency risk (changes in exchange rates affecting returns), political and economic instability in foreign countries, different regulatory environments, potentially lower market liquidity, and higher transaction costs compared to domestic investments³.

How can individual investors engage in international investing?

Individual investors can access international markets through various channels. The most common methods include investing in U.S.-registered mutual funds and ETFs that focus on international or global securities. These funds often hold a diversified basket of foreign stocks and bonds, simplifying the process for the investor¹, ². You can also invest directly in foreign stocks via American Depositary Receipts (ADRs) or directly on foreign exchanges through a broker.

Is international investing suitable for all investors?

While international investing offers significant benefits, its suitability depends on an individual's financial goals, risk tolerance, and existing portfolio. Due to the added complexities and risks, investors should conduct thorough research or consult a financial professional before committing to international investments.