In a global economy, hosting international investments in your retirement and other investing portfolios is paramount.
It may be something you hear financial professionals communicate. Why is this international exposure important? What benefits do international holdings provide?
A Better Balance
If your investment portfolio only includes U.S. equities, you are missing out on a majority of the world’s economic exposure and are limiting your opportunities for long-term growth. The U.S. accounts for roughly 57 percent of the world’s total stock market capitalization1. The other 43 percent is represented by companies in Asia, Europe, Latin America, and other areas of the globe. These economies play an important role in the construction of a diversified portfolio.
How do we Define International?
The lines of domestic and international investments are somewhat blurred in today’s global economy, and it’s important to define what international means in this context. More than 25 percent of the revenue generated by U.S. S&P 500 index constituents comes from outside the United States, with China, Japan, and the UK accounting for the lion’s share of this geographic exposure2. For example, Coca-Cola is defined as a U.S. holding, but more than 65 percent of the company’s 2020 revenue was generated outside the U.S3. Owning a broad market index appears to give some international exposure in a portfolio. This is true; however, just as U.S.-based company performance is used as a gauge for the health of the U.S. economy, a foreign-based company is a purer reflection of foreign economic health. Companies whose headquarters lie outside the U.S., therefore, represent the purest form of international investment.
Types of International Investments
There are two main types of international investment: emerging markets and developed markets.
Emerging markets are classified as economies that are experiencing rapid growth. These regions are typically transitioning from a less prosperous development stage to a more industrial, global modern economy. Emerging market investors may face heightened volatility due to less governmental stability when compared to other regions. In exchange for this uncertainty, investors may expect higher returns. China, Brazil, and Russia are a few examples of emerging economies.
Developed markets combine elevated living standards with high levels of political stability and industrialization. Investors with exposure to developed countries often expect these markets to exhibit comparatively less extremes in investment pricing and liquidity. Countries such as the UK, Germany, and France are developed international economies.
Investors considering international holdings must carefully consider which type of international exposure will be added to a portfolio. The flavor of international investments can greatly enhance or detract from the benefits of international diversification.
Portfolio Stability with International Investments
The type of international investment is only one consideration for investors. Investing outside the United States can bring added benefits, including diversification. Roughly 25 percent of the U.S. S&P 500 Index is comprised of stocks in the technology sector4. Return contributions from technology companies made up over half of the domestic markets return in 2020. Contrast this with the much lower proportion of technology, just 13 percent, that makes up the broad international markets5. Many foreign economies have a much greater reliance on cyclical sectors such as energy, materials, and financials. Adding international holdings to a portfolio can help spread out overall sector exposure.
Dividends are also worth considering. The S&P 500 dividend yield is approximately 1.2 percent6, but investors can get additional yield by including international holdings in a portfolio. The average dividend yield of the international markets is roughly 2.3 percent6. This dividend yield can be attractive, adding cash into the portfolio while helping to offset stock return volatility.
Cycles in Markets
International exposure can also offer investors an opportunity to capture differences in value. Overseas investments have often performed well when domestic markets have not. This counter-cyclicality is particularly important during periods of domestic market strength, when overseas investments are at their lowest valuations. The large financial and cyclical stock exposure of foreign investment contributes to this pattern. For example, exiting the COVID-19 pandemic international stock price/earnings expectations were more than 25 percent below domestic valuations, providing investors with an opportunity for future growth7. The financial markets ebb and flow, so having exposure to various global stocks and economies can help protect your portfolio in times of market stress.
International investing remains an important tool for portfolio construction long term investing. If you’re unsure of the level of international investing in your current portfolio, or would like to explore how to expand this possibility to help strengthen your investment accounts for your future, we’re always available to start a conversation.