Many investors tend to forget about one important aspect of diversification when building their investment portfolios: geographic diversity.
Keeping an otherwise well-diversified selection of stocks, bonds, commodities and other asset classes limited to just one country means that local economic changes can impact your portfolio in unexpected ways.
Overseas markets aren’t always at the same point in the business cycle as domestic markets. While the overall global economy influences markets regardless of where they are located, it doesn’t always have an equal effect everywhere. A sudden spike in oil prices can give a market like Canada a boost while negatively impacting another part of the world such as South Korea.
Let’s take a look at the implications of investing in international markets.
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Risks to Consider
Investing overseas reduces some local economic risk factors, but this diversity is a double-edged sword. It also means being exposed to additional risks that don’t come up for a portfolio composed entirely of domestic stock holdings.
Foreign exchange risk is usually the biggest risk to investors. Profits earned from an international company are usually cited in the currency of where it is headquartered. That means that the exchange rate between the local currency and the U.S. dollar is an additional factor that plays into the total profit realized by investors. If the U.S. dollar gains relative to the local currency, the company’s actual realized gain is reduced as the local currency is now worth less than before.
Another major risk factor for international holdings is geopolitical risks. In emerging market economies particularly, rapid changes in government policies or political parties can drastically affect the local market. India is a prime example of how changes in government impact investments along with China. Recently, there has been easing of trade tensions between the U.S. and China, helping companies like Alibaba (BABA) mount a turnaround in its stock price.
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Choosing International Mutual Funds
Choosing to invest in a mutual fund that specializes in international stocks is a great way to start diversifying outside of the U.S. There are countless funds that offer investors everything from broad global exposure (which contain stock selections from every part of the world) to regional or even country-specific funds.
The biggest advantage that mutual funds offer to investors is their expertise in foreign markets. The average investor likely doesn’t have specialized knowledge of another country’s economic or political climate, nor would they be familiar with their local companies and brands. A portfolio management team is armed with knowledge about the economies and stocks listed on foreign exchanges so that they know how to construct a successful portfolio that benefits investors.
Here’s a brief rundown of some of the popular international mutual funds:
| Name | Ticker | YTD Performance * |
| Vanguard Total International Stock Index | VTIAX | 8.30% |
| Fidelity Total Emerging Markets A | FTEDX | -0.30% |
| Matthews Emerging Markets Small Companies Fund | MSMLX | 24.10% |
| Wasatch International Opportunities | WAIOX | 1.20% |
* Fund returns as of October 25, 2021
Getting Exposure to Foreign ETFs
One of the biggest benefits of ETFs (exchange-traded funds) is that they trade like any other stock, making them highly liquid investment options. The basket of international stocks offered by ETFs is nearly as diverse as it is for mutual funds, giving investors multiple options for how they want to structure their overseas exposure.
Most ETFs are passively managed, which means that fees are kept very low compared to mutual funds of the same investment type – typically less than 0.50%. Investors who may want more control over their investments, but don’t have the insider acumen for global stock exchanges, may prefer ETFs over mutual funds as well.
Below is a list of the popular international ETFs:
| Name | Ticker | Fund Type | YTD Performance * |
| Franklin FTSE China ETF | FLCH | China-specific ETF | -9.80% |
| Invesco BLDRS Emerging Markets 50 ADR | ADRE | Diversified emerging markets ETF | -8.30% |
| ProShares MSCI EAFE Dividend Growers | EFAD | International growth stocks ETF | 8.20% |
| IQ 500 International ETF | IQIN | International value stocks ETF | 13.80% |
| SPDR S&P Emerging Asia-Pacific ETF | GMF | Emerging Asian markets ex-Japan ETF | 1.80% |
* Fund returns as of October 25, 2021
ADRs
One of the easiest ways to gain exposure to international stocks is through ADRs (American Depositary Receipts). To the uninitiated investor, these companies are listed no differently than domestic companies on the exchanges. There are a few popular stocks on Wall Street that are actually classified as ADRs, such as Alibaba (BABA) and Novartis AG (NVS).
In order to qualify to be listed on a U.S. exchange, foreign companies must meet certain regulatory guidelines. Typically ADRs have 3 levels, with each one having a more verified and secure rating from U.S. regulatory agencies. Only level 2 and level 3 ADRs are allowed to trade on U.S. exchanges – you should use extreme caution when considering a level 1 ADR as there is little-to-no information made available for investors.
Level 2 ADRs are listed like any other stock on U.S. exchanges and are subject to SEC guidelines. Level 3 ADRs have the highest rating and come with the additional benefit of being able to raise capital from U.S. investors through new stock offerings.
Check out the different levels of ADRs here.
The Bottom Line
One often overlooked choice for international investing is simply selecting an American company that has broad global sales exposure. Large-cap companies like Caterpillar (CAT) have operations around the world and derive their income from multiple regions. While these companies are headquartered in the U.S., they might generate a sizable portion of their earnings from foreign operations.
If you’re looking to expand your portfolio into the international space, there are a number of good options to choose from. Whether you want to select a general, broad exposure for diversification purposes or a single country to take advantage of a specific market condition or insight you have, there is a way to invest in international markets.
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