International Equity Funds: Smart Investment Or Risky Business?

International equity funds are an increasingly popular way to diversify your portfolio and discover new opportunities. These funds can help investors access stocks from outside their domestic market, such as the US, Europe, China, India and Brazil. They can also provide exposure to sectors that may not be available in an investor's home country, such as agriculture, mining and technology.

International funds are typically riskier than domestic investments, but they can also offer higher returns. For example, while the US stock market posted an annual growth rate of just 1.7% between 1999 and 2009, international developed markets yielded a more robust 4.1% return during the same period.

There are a few things to consider before investing in international equity funds. Firstly, it's important to understand your risk tolerance and investment goals. Additionally, international funds often come with higher fees and costs, so it's essential to factor these into your decision-making.

Geographical diversification

International equity funds also allow investors to access markets outside of their home country that may be performing better. For example, between 1999 and 2009, the US stock market posted a compound annual growth rate of just 1.7%, while international developed markets yielded a more robust 4.1% annualised return. Even more impressive were the returns from emerging markets like China, India, Brazil, Russia and South Africa, which delivered a stellar annualised return of 13.7%.

> "Adding international stocks to your portfolio can dampen volatility and improve returns, since the US economy and market may face challenges at different times compared to international regions."

However, it is important to note that investing in international equity funds also comes with additional risks. These include uncertainty around currency exposure, tax benefits and the perceived risk associated with investing in unfamiliar companies and markets. It is also important for fund managers to constantly monitor foreign market fluctuations and understand how economic changes in other countries will impact fund investments.

Currency exposure

It is also important to consider the impact of currency fluctuations on the companies in which you are investing. A change in exchange rates can affect a company's profitability and competitive position. For example, a strengthening domestic currency can make a company's exports more expensive and less competitive in the global market. Therefore, it is crucial to assess the currency exposure of the underlying assets in your international equity fund and understand how changes in exchange rates may impact their performance.

While currency exposure comes with risks, it can also provide diversification benefits. By investing in multiple currencies, you can reduce the impact of fluctuations in any single currency on your overall portfolio. Additionally, investing in international equity funds can provide access to countries with stronger economic growth and more stable currencies, which can be a hedge against weakness in your domestic economy and currency. Therefore, currency exposure in international equity funds should be carefully evaluated and managed as part of your overall investment strategy.

Risk and return

International equity funds can be a great way to diversify your portfolio and access global markets. However, there are certain risks and potential returns that you should be aware of before investing.

Risks

Higher Transaction Costs

Brokerage commissions and other fees tend to be higher for international markets. These can include stamp duties, levies, taxes, clearing fees, and exchange fees.

Currency Volatility

Currency fluctuations can impact the value of your investments. If you invest in a foreign market, you will need to exchange your domestic currency, and when you sell your investment, you will need to convert the foreign currency back. These exchange rates may hurt your returns.

Liquidity Risk

Liquidity can be a problem, especially in emerging markets. This is the risk that you won't be able to sell your investment quickly without incurring substantial losses due to political or economic crises.

Country Risk

Country risk refers to the uncertainty associated with investing in a particular country, which could lead to unexpected investment losses. This includes economic, political, and sovereign default risk.

Returns

Diversification

International equity funds offer access to hundreds or thousands of foreign securities, reducing the volatility of your portfolio. Markets outside your home country don't always rise and fall simultaneously with the domestic market, so owning both international and domestic securities can spread out your portfolio's risk.

Long-Term Growth

There is a higher probability of long-term growth in global markets. By investing in international equity funds, you can take advantage of the market cycles of other countries' economies and benefit from their growth.

Professional Management

International mutual funds are often managed by professionals with expertise and technical knowledge of investing in foreign markets. This can be beneficial for new investors who are unsure of how to navigate foreign markets.

Recommendations

Financial advisors generally recommend that investors can allocate up to 5-10% of their portfolio to international mutual funds. It's important to consider your risk tolerance and investment goals when making this decision. Diversification is key, and investing in a single country is not prudent.

Long-term growth

International equity funds can be a great option for long-term growth, especially if you want to diversify your portfolio. By investing in these funds, you can gain exposure to stocks from outside your domestic market, such as the US, Europe, Japan, China, and emerging markets. This type of investment can help buffer against potential stagnation in your domestic market and potentially provide above-average returns.

One of the key advantages of international equity funds is geographical diversification. For example, during the "lost decade" for US equities from 1999 to 2009, international developed markets yielded a more robust annualised return of 4.1%, while emerging markets delivered an impressive 13.7%. This highlights the benefits of having exposure to different economies and reducing the concentration risk by investing in a broader range of sectors and regions.

When considering international equity funds, it's important to keep in mind the associated risks. These funds can be more volatile than domestic funds and expose investors to currency risk and political risks. Additionally, there may be liquidity and due diligence concerns for retail investors. However, the potential rewards can be significant, especially in emerging markets, which are projected to become major drivers of global growth in the coming years.

When deciding whether to invest in international equity funds, it's crucial to assess your investment goals, strategies, and capital pool. These funds may be more suitable for high-net-worth individuals who can tolerate higher risk and have a long investment horizon. It's also important to consider the tax implications, as the tax treatment of international funds may differ from domestic funds.

Overall, international equity funds offer a compelling opportunity for long-term growth, particularly for investors seeking to diversify their portfolios and access global growth opportunities. By investing in these funds, you can gain exposure to some of the world's largest and most innovative companies, potentially enhancing your portfolio's performance over the long term.

Market movement

International markets do not always rise and fall simultaneously with the domestic market. Therefore, investing in both international and domestic securities can stabilise your portfolio's volatility. This can spread out your portfolio's risk more than if you owned just domestic securities.

However, markets outside the United States can be more volatile, and you should be aware of the risks involved. For example, currency fluctuations can impact the performance of international funds. To mitigate this risk, consider international investments hedged in US dollars.

Additionally, it is important to understand the economic cycles of different countries. Simultaneous investment in different economies can minimise losses and potentially smooth out returns. For instance, during the "lost decade" for US equities from 1999 to 2009, international developed markets yielded a more robust annualised return of 4.1%. Even more impressive were the emerging markets, which delivered a stellar annualised return of 13.7%.

International funds also provide exposure to companies and brands that you may not be familiar with, and it is important to research these thoroughly before investing.

Frequently asked questions