Investors largely target markets they know, and for U.S. investors, most focus on domestic stocks. However, you may be missing out by avoiding international stocks and exchange traded funds.
“Looking beyond our borders to international equities can have benefits for U.S.-based investors,” according to a Deutsche Asset Management white paper.
By excluding international exposure, investors may lose out on access to almost half of the global equity opportunity set, along with the potential diversification benefits to a U.S.-centric investment portfolio.
To get a sense of how a truly diversified international investment portfolio works, investors can take a look at the MSCI All Country World Index, which includes a split of around 53% U.S. exposure, 10% to emerging markets and the remainder to ex-U.S. developed market equities.
“We found that, for equities, a mix somewhere in line with global market capitalization is a pretty strong starting point – that’s around 50% in the U.S., about 40% in international developed markets, and around 10% in emerging markets,” Robert Bush, ETF Strategist for Deutsche Asset Management, said in a note. “As an investor shifts from having 100% invested in the U.S., adding international equities starts to lower volatility.”
While some may argue that they have enough international exposure through U.S.-based multinationals with large global revenue streams, the economic exposure of U.S. companies and international companies still vary and provide drastically different performances.
Moreover, international exposure helps prevent investors from becoming overweight in certain market sectors. For instance, the U.S. is concentrated in technology and health care sectors while other developed markets may have larger tilts toward financials, consumer staples and industrials.
“In our opinion, the most compelling argument for international investment is the advantage of diversification,” according to Deutsche Asset Management.
Due to the varying economic and sector exposures of international equities, many foreign stock markets have historically exhibited relatively low correlation to U.S. equities, with Japanese and Australian markets reflecting the lowest correlation to U.S. stocks.
[related_stories]Some investors may be wary of incorporating the emerging markets into their portfolios as these less developed economies are seen as a large source of uncertainty and risk. However, the broad developing markets may actually be less risky than U.S. markets. Since 2002, the one year rolling standard deviation of returns for the emerging markets has been lower than that of the MSCI U.S. index over 75% of the time. The lower risk may be associated with the diverse nature of the emerging market category.
“We think the explanation comes when one considers the uncorrelated nature of the markets included in the index,” according to Deutsche Asset Management. “Unlike in Europe, for example, the countries that make up the emerging markets baskets in the well-known indexes are particularly geographically and economically diverse.”
For instance, the average correlation between between Brazilian stocks and those of the other seven larges MSCI EM Index components is only 0.35 – a 1 reading means perfect correlation while a 0 reading reflects zero correlation.
Investors interested in international exposure have a number of ETF options available to them. For developed market exposure, the iShares MSCI EAFE ETF (NYSEArca: EFA) and Vanguard FTSE Developed Markets ETF (NYSEArca: VEA) are two largest ETFs that target developed Europe, Australia and Asian economies.
Additionally, Deutsche also offers the Deutsche X-trackers FTSE Developed ex US Comprehensive Factor ETF (NYSEArca: DEEF), which includes developed foreign market exposure but selects components based on a broad set of five factors, including quality, value, momentum, low volatility and size.
For emerging market exposure, the popular Vanguard FTSE Emerging Markets ETF (NYSEArca: VWO) tracks the FTSE Emerging Index and the iShares MSCI Emerging Markets ETF (NYSEArca: EEM) follows the MSCI Emerging Markets Index.
Additionally, the Deutsche X-trackers FTSE Emerging Comprehensive Factor ETF (NYSEArca: DEMG) also provides emerging market exposure and selects components based on the same set of five factors as DEEF.
When constructing a investment portfolio, investors should not forget the diversification benefits of including international exposure.