The world’s economies still dance to different tunes and have different boom and bust cycles that tend to offset each other, even though
differences are getting smaller. As a result, international stocks can provide diversification for a portfolio heavy in U.S. stocks.Between June 1997 and October 1998, for example, Japan’s Nikkei index lost almost 40%, but European markets did well due to continental economic union. U.S.-style corporate restructurings also began to pay off. One region’s success balanced other’s failure to get its financial house in order.
There has been less divergence between regions more recently. Even so, we suggest prudent investor cannot afford to ignore overseas markets. They now represent some 44% of world market capitalization, up from 25% about 30 years ago. International stocks can provide solid diversification for a portfolio heavily invested in U.S. equities.
Exchange rates add an extra flavor to foreign investments. Fluctuations can add to or detract from profits or losses. Institutional investors and others pay significant attention to this factor. When U.S. dollar was appreciating against Japanese yen, billions of dollars flowed out of that country and into U.S. stocks and bonds, worsening economic crisis in Japan. That money started to flow back out when currency valuation began to reverse. Americans saw their investments in Japan appreciate then, even when stocks remained in neutral.
Funds that invest overseas fall into four basic categories: world, international, emerging market and country specific. Diversification is key to containing risk. And, yes, a good fund manager helps, too. Research is scarce and foreign companies, other than some in Canada, are difficult for individual investors to track on their own.
World funds are most diverse of four categories. They are, as name suggests, able to invest anywhere in world, including U.S. As a result, they don’t offer as much diversification as a good international fund. Some have 60% or more of their holdings in U.S.
