Including international exposure in your investments

By: ispeculatornew
Date posted: 09.29.2010 (4:43 am) | Write a Comment  (8 Comments)

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If I showed you a portfolio that included only two or three different shares, almost everyone would agree that it’s not an optimal portfolio and exposes the investor is exposed to too much risk if something goes wrong at one of those companies. I could simply mention names like Enron, Lehman Brothers or Bear Sterns and you would know exactly what I mean. Simple enough right?

In my opinion, investing only in US markets is as big of a mistake as putting everything into one or two stocks. There are a lot of questions regarding the US economy and where it is headed. Health care, energy dependence, conflicts in Iraq and Afghanistan and out of control spending are all worries and while we can argue about their importance and impact, I think we’d all agree that no one truly knows what will happen in the next decade. It is almost certain that the United States will be the top economy 10 or 20 years from now and the domination of US capital markets is even more important. We wrote about the emergence of gold and clearly one of the main reasons why it has became so attractive is because of the questions surrounding the future of the US economy and the US dollar, which will have an important impact on the price of all US based and dollar based assets.

Will the US be the top performing market?

It is unlikely. Even the most optimistic economists admit that the US is losing “importance” in the global economy. It’s not happening because the US economy is regressing but simply because emerging countries are growing faster and they investing heavily in education and technology in order to catch up as quickly as possible. Would I bet that emerging markets will do better than US markets? Yes, absolutely.

Under invested

I recently read that US investors were investing less than 10% of their portfolios into international markets even though these markets make up a very significant portion of the total markets capitalization. As years will go by, I imagine that the discrepency will diminish which will certainly push up the valuations of these emerging markets.  It’s not easy to do name picking when you are considering companies that you do not know. It is even more important to use index investing

Investing in China?

Personally, I would not try to guess which market will outperform in a retirement account simply because emerging markets are more volatile. Trying to find out which one will do better is a bit like trying to find the next Google. The truth is that the best performing market will probably not be an obvious pick like China or Brazil but rather less obvious pick. For example, In recent months, Indonesia has been the best performing country. Since we are simply looking at getting better returns with less risk, I would stick to emerging markets as a whole.

How to do it?

There are many ways to gain exposure to emerging markets but readers from our blog would know that we are believers in ETF’s and buying an ETF like VWO or EEM is an efficient and inexpensive way of getting the desired exposure. You could also get mutual funds that will give you the desired exposure or try to buy securities directly into those markets. However, unless you are managing a few millions, you will probably be much better off buying an ETF or mutual fund that will do the selection and maintenance for you.

Counter-argument

One of the main arguments used against international diversification is that in periods of crisis, the assets tend to become more correlated with US assets. That is true and the 2008 market decline provided a good example as almost every type of asset around the globe lost value no matter what the company or location. There is no doubt that the globalization of the economy has increased the importance of relationships and even a crisis in a European country such as Greece has important impacts on investments around the world.

That being said, these assets provide less diversification than 10 or 20 years ago but they do still easily add enough to justify adding them to your portfolio and you will end up on the winning side by adding international assets to your investment portfolio.

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8 Comments

  1. Comment by John — September 29, 2010 @ 7:35 am

    For me diversification is important. I’ve invested in EFA (around 10%) and VWO (5%). I know that EFA is correlated to US markets. How can we find the correlation between the EFA and US markets? But it’s showing great performance.

    What do you think about that ETF? Can you compare this one with other int’l ETFs?

    Thanks again!

  2. Comment by John — September 29, 2010 @ 7:38 am

    hehe not VWO (maybe it’s a lapsus but eventually I’m going to sell EEM to buy VWO), but I’ve invested 5% of my portfolio in EEM… sorry

  3. Comment by IS — September 29, 2010 @ 7:17 pm

    Hi John, glad to hear about your upcoming switch:) I will try to write about this in the near future, very good questions!

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