In the past several decades there has been a shift from investments in U.S. markets to foreign markets. In 1970, foreign markets represented 34% of the world's investment opportunities and by 2008 foreign markets represented 56% of the world's investment opportunities. It is estimated that by 2030, the U.S. market will only account for 25% of the world market and investments in global markets will increase substantially.
Diversification and Higher Returns
The two main driving factors that can explain the shift toward international investing are the investor's quest for diversification, reduced risk, and higher returns. Initially, when U.S. investors began opening up to foreign equities, it was primarily to increase diversification in their portfolios. Because international markets don't necessarily move in tandem with each other - some may go up while others go down - global diversification may potentially offset the effects of a downturn in the U.S. market. Needless to say, with the benefits investors are still aware that global diversification can bring about additional risks stemming from foreign countries such as political conflicts, currency fluctuations, less liquidity and so on. But despite these risks, the potential for higher returns and reduced overall portfolio risk makes foreign markets extremely attractive to investors.
As investors explore and pursue global investment opportunities, they find that the global markets offer competitive returns. Morgan Stanley's Capital International's Europe, Australia, Far East (EAFE) Index, which tracks the major world markets posted 9.4% average annualized return for the past several decades compared with the 11% average annual return of the S & P 500 Index.
The minor difference in returns can be attributed to many economic and market factors in countries around the world. But as a diversified bunch, the overall risk of any individual international market is reduced. For instance, throughout the 1990s, the Japanese market experienced a market recession. Subsequently, Japanese stocks became heavily undervalued, providing investors with attractive opportunities. Several years after, the Japanese market bounced back producing gains north of 60%.
How to Invest in Foreign Equities
One way to increase international exposure into your portfolio can involve simply a plain investment in an U.S. company that gets most of their revenue from foreign markets. In fact, most of the companies on the S & P 500 Index derive most of their revenues from overseas operations.
Another way to buy stocks is to purchase shares of foreign companies through American Depositary Receipts (ADRs) - traded on the New York Stock Exchange and/or through mutual funds hold foreign equities in their portfolio. ADRs are special certificates that represent shares of a foreign company. ADRs are issued in the U.S. and their underlying shares are held in U.S. banks.
Getting into the international markets space can be daunting for investors especially since they need to consider many factors that don't affect them such as the regulatory, political, and economic environments of those markets. Another way to invest internationally is to buy mutual funds or exchange-traded funds, which invest exclusively in foreign markets. Or consider a global fund which can have a mix of both foreign and U.S. stocks. These funds provide you with more diversification because they invest in an array of foreign equities. An Isakov Planning Group Financial Advisor can position your portfolio in such a way that you can take advantage of added international exposure.
For more sophisticated investors who are looking to uncover specific opportunities in particular regions or sectors, various types of funds such as regional funds are available. These types of funds are designed to bring investors specific opportunities in foreign markets, but they do carry a higher degree of volatility.
Special Risks of International Investing
Investing in foreign markets does carry its own set of risks. A foreign investment's return depends on the currency exchange values between say the U.S. dollar and the local currency of the foreign investment. For instance, for U.S. investors, currency exchange values could come about from a rise in the dollar's value against the foreign currency they are investing in. Nevertheless, investing for the long-term and diversifying with many international investments can help minimize currency exchange and other risks.