What is International Investing?

It’s hard to believe that roughly 25 years ago, the concept of “international” investing was foreign to a large percentage of the US investing public.

I remember the time well: In 1986 I was assigned to the Tokyo office of a large US investment bank, a move that had my New York colleagues shaking their heads, wondering what value I could possibly gain from working in such an “exotic” outpost, so far from the pulsating heartbeat of the world financial system in downtown New York.

How times have changed. These days, it is not possible to wade too far into the market without confronting a staggering variety of ways to obtain exposure to virtually any region, country, investment sector or theme anywhere in the world. International investing is no longer exotic: it is required.

But what are you actually buying when you “invest internationally?” And how do you put together an international investment strategy that makes sense in light of the dynamic pace of the market’s evolution?

The purpose of this post is to take a step back and look at the broader picture. We’ll explain some of the terminology and outline the global markets and the risk.

What is International Investing? The Basics.

The traditional nomenclature is divided into four parts: domestic, international, emerging, and frontier markets.

Domestic markets are the US equities and debt markets.

International markets are the developed markets of Western Europe, Japan and a couple Asia-Pacific spots like Australia and Hong Kong.

Emerging markets are those up-and-coming dynamos like China, India, Brazil, Malaysia and Chile.

Frontier markets are the “very new frontiers,” such as Ghana, Ukraine, Tunisia and Vietnam.

In the old style of thinking, a diversified investment portfolio might have an allocation of something like:

• 65% domestic
• 30% international (i.e. developed)
• 5% emerging markets.

This reflects the trade-offs between expected return, risk and the level of correlation between the different asset classes. (Frontier markets are for more aggressive portfolios).

There are some problems with this approach. We’ll dive into that below.

What is International Investing in a Globalized World?

Twenty years ago, it was possible to obtain meaningful diversification benefits from investing in non-US assets. The correlation between stock markets in Great Britain or Germany and those of the US were low.

That is not the case anymore. The world has become much more globalized. Look at the composition of the US S&P 500 index, a broad market indicator containing 500 of the largest companies domiciled in the US. These companies (like Coca-Cola) are doing global business — deriving up to 50% or even more of their revenue from non-US sources, having exposure to multiple foreign currencies in multiple economic environments.

The same is true for the largest companies in Germany, the Netherlands or Hong Kong – large companies like Siemens, Hitachi or Toyota conduct business all around the globe.

Making some arbitrary division between the percentage of US and developed international assets for a portfolio is a bit simplistic.

To better diversify, do more analysis. For example, concentrate certain exposures in small-cap stocks (which tend to command less of a global presence due to their size), or in real estate (such as REITs), which remains the ultimate “local” business.

What Are Emerging Markets and Frontier Markets?

Then we come to emerging markets. Here is where the world really has changed.

China has overtaken Japan as the second-largest economy in the world. Brazil has rapidly moved up the value chain as a sophisticated and globally important economy. The so-called “emerging Asia” region is on course to become the fastest-growing and most influential economic region in the world.

Maintaining a traditional cap of 5% or so to your emerging markets exposure is simply out of step with the percentage of global wealth that exists in these markets (and continues to expand).

Let’s take a moment to look at frontier markets.

Frontier markets are today what emerging markets like Taiwan and Malaysia were 20 years ago – a wild ride of potentially outsize returns and, commensurately, outsize risks.

These are countries like Ghana, Ukraine, Bulgaria and Vietnam – exhibiting great potential for growth but still young with relatively undeveloped legal, market and political infrastructures. They really do not belong in the same tier of risk/return positioning as global engines like China and Brazil.

And they certainly can’t be lumped together with “developed” markets like Chile or Malaysia, which in many ways are indistinguishable from middle-tier Western European countries like Sweden or Belgium when you look at risk-return performance over recent years.

How Much International Investing Exposure Should I Have?

As a very general rule of thumb, something along these lines might make sense:

• 50% allocated among US and other mature markets in Western Europe and the Pacific Rim
• 35% allocated among the growth markets formerly known as emerging markets
• 15% spread among a diversified pool of the “frontier” markets

Those percentages are highly elastic – and any investor needs to consider his or her own return objectives, risk tolerance and special circumstances very carefully before making any portfolio allocation decisions. To get an asset allocation that is right for your situation and goals, you can use Jemstep.com. It will ask you about your situation and preferences and then based on your profile, recommends the ideal combination of assets for you.

Do you participate in international investing? Tell us about it in the comments below.