International Investment Exposure

With enormous markets emerging across the world and the dollar continuing its decline, the suggestion that investors should increase their international exposure in order to have a balanced portfolio is worth looking at more closely. After all, investing in international equities helps diversify a portfolio by broadening currency risk and exposing the portfolio to new markets.

The dollar has declined over 40% in value compared to the euro since 2002. While this is not necessarily good (especially for those planning a European vacation), it doesn’t mean investors need to run toward international stocks and mutual funds. In fact, there are two significant benefits of the falling dollar for U.S. stocks:

The strength of the euro presents a unique buying opportunity in America for foreigners. I work in an international company. As the holiday shopping season progressed, I heard more and more of my coworkers in Europe and Canada taking shopping trips to the U.S., thus bolstering the profits and stock prices of American companies.
This year, I got a firsthand view of the drastic impact currency exchange has on a company’s income statement. I work in the American division of a European company. In dollars, our annual revenue growth from June 06 to June 07 was slightly positive. That small increase sank to a 3% revenue decline when the profits were transferred across the Atlantic. Each dollar corporate was receiving was worth less than it was a year ago. The exact opposite takes place for U.S companies selling overseas. PPG Industries is a Pittsburgh manufacturer that sells building and automotive paint to China. PPG brought in $350 million exporting its product to China in 2006 (Pittsburgh Tribune). If it experienced 0% revenue growth in Chinese Yuan in this market, its revenue would still grow 6.9% to $374 million due to the strength of the Chinese Yuan compared to the dollar.

As for exposure to foreign markets, we don’t have to look too far. Most major U.S. corporations make a significant portion of their revenue overseas. In fact, 45% of the revenue generated by S&P 500 companies comes from foreign markets (U.S. News). If you invest in the stocks of large American companies, you are investing in foreign markets. Interestingly, due to this same principle, an investment in a foreign market is an investment in America because those companies are likely selling to the U.S. Despite the success of companies like PPG, America still bought $233 billion of goods more from China than it sold to China (Census).

I currently have 13% of my retirement funds invested in international stock funds, about the same as the average 401(k) participant. This ratio is not terrible, especially considering the foreign exposure I get in my S&P 500 Index investments. I plan to increase my international fund holdings to 20% of my portfolio in 2008, but I’m not in any rush to do so. I’ll change my 401(k) investment allocation and let time do the work.

9 Comments

Adfecto
February 8, 2008, 15:44

It is important to remember that if you want to own a full representative equity allocation more than 50% of stocks (based on market cap) are listed internationally.
The MSCI All-World Index (traded under EFA) is a market cap weighted index that tracks all equities in the 23 developed markets. There is also the MSCI All Country World Index that adds the 25 developing markets (for example, China, India, Russia, Brazil). Investing in the developing markets can be achieved through ticker symbol EEM. To own the whole world equity market indexed by market cap mix: 1) 50% – US Total Market (VTI), 2) 45% – Global Developed Markets (EFA), and 3) 5% – Global Developing Markets (EEM).
It is good that these American companies now derive income from outside the US but I’d recommend using an index and buying the entire world equity market. In this way you do not let your proximity bias keep you over-weight in US equities.
P.S. Don’t forget to throw in real estate, short and long bonds, commodities, etc to get a complete asset allocation.
RacerX
February 9, 2008, 13:56

“America still bought $233 billion of goods more from China than it sold to China”
And that is with a really depressed dollar. Scary to think what would happen with a strong dollar policy, that many (incl. Buffett) are up in arms about!
Dough Roller
February 9, 2008, 17:26

My portfolio has benefitted significantly from the decline in the dollar, in part because I put about 40% in non-U.S. equities, bonds and REITs. One thing to keep in mind, though, is that not all international funds or companies that do business outside the U.S. will benefit from a declining dollar. Some use hedging strategies to insulate themselves from currency risk. This is common, for example, in international bond index funds. So make sure you evaluate your international investments to know whether you’ll benefit from a falling dollar.
Pinyo
February 10, 2008, 6:16

@Adfecto – That’s a great way to build a really simple portfolio, I will have to look into these funds and their expense ratio.
@RacerX – And that’s just China.
@Dough Roller – Good input. You’re wise to have that much in international already. I only have about 28% now. But to shift to 45% in international now feels like chasing performance to me — buy low, sell high?
Dan
February 10, 2008, 9:27

Adfecto, good point about diversification. My point was more about the fact that you have exposure to international economies even when you invest solely at home. Likewise, investments in international equities, such as yours through EFA, will derive a portion of their return from the U.S. economy.
RacerX, as long as we can stay on top of technology and information, we can survive being the world’s favorite place to sell. Interestingly, China and other countries are also investing in the U.S. Toyota just built a truck plant in my city that has benefited the local economy.
Dough Roller, your investments would be worth even more if you had first converted your dollars to euros and then invested in foreign stocks through Europe. It would have introduced several new risks, however. I think the important part is to slowly build a portfolio that has exposure to other markets to help smooth the overall fluctuations in the portfolio value.
Pinyo
February 10, 2008, 9:50

“My point was more about the fact that you have exposure to international economies even when you invest solely at home.”
Dan, this is where I have to disagree with you. I think the whole thing is a wash. Remember, most big international companies also have exposure in the U.S. In the end, we should really look at GDP or market capitalization (by both measure the U.S. is about 50%).
Lisa
February 10, 2008, 10:18

I have made a lot of money in international stocks through my 401K in the past year (2007). I’m losing some now, but the profits will definitely outway the losses. My domestic funds have not fared as well.
There’s still a lot of development going on overseas. I think the thing to do is throroughly investigate whatever you are investing in, domestic or international. I am also beginning to explore SRI funds. Seems like the right thing to do. Also, I think the tides is turning, and there will be strong SRI funds down the road.
Dan
February 10, 2008, 16:53

Lisa, thanks for your comment.
Socially Responsible Investing (SRI) Funds have grown huge in recent years. It is estimated that there are close to 200 SRI funds with assets of $2 trillion. I wouldn’t consider investing in an SRI fund as diversification from the stock market because they contain many of the same stocks as other funds. For instance, the Domini Social Equity Fund (DSEFX) holds many S&P 500 stocks, especially techs, so you’d have to account for that in your other holdings to prevent becoming overweight on tech stocks.
Morningstar reports that SRI funds generally have higher expenses than non-SRI funds. With the vast number and variety of funds on the market today, I feel the surest bet is to find a good fund with the lowest expenses.
Make Friends, Earn Money
April 6, 2008, 8:14

Interestingly I’m looking at exactly the opposite scenario. As an englishman in my thrities I still have time to play with and right now US investments look great to me as I can buy in low and providing I’m willing to look for a 5-10 year investment there is every prospect that these will be highy lucrative investments in the future.