How Much of My Portfolio Should be in International Stocks?

By Jeff A. Christie, February 16, 2010

This is a question that has been under great debate in recent years, and continues to be a hot topic.  Investors are always looking for a rule of thumb to point them in the right direction, but really, the answer lies in your personal goals and in your risk tolerance.

In the last ten years, many believers in Modern Portfolio Theory have generally kept their direct international exposure in an equity portfolio between 10-20%.  But, in the last few years, many investors are moving towards the upper end of this range, if not even higher.  There are a few reasons for this move, better information, more transparent accounting practices, increased globalization, and increased speculation on emerging economies and international markets outpacing the growth of the United States.  But, the question remains, how much makes sense for you?  Well, it depends.

My goal today is to give you food for thought, and allow you to make an educated decision.

For:

Many analysts estimate the United States is no longer going to be economic world power it once was.  We were once the mediator between many emerging trading partners, and this role is quickly diminishing as many international markets are now trading directly with each other.  We were also the major consumer of many countries’ goods & services, which is also changing, but more slowly.  If the last year is any indication, the U.S. is not going to lead the global economic recovery the way many expected, and in fact the emerging markets are fast becoming a hot beds of growth, and beginning to play well with their emerging neighbors.  If the U.S. is no longer their major trading partner or flow-through to their trading partner, this could point to higher growth in comparison to the U.S. markets.

One other thought to consider is prior performance, which as we all know, is not indicative of future performance, but especially so in this case.  Many investment models use past performance in order to try and predict future results, or to at least give a framework to do so.  I do not think that the back-testing of most international markets, especially emerging markets, is going to have much predictive power as we move forward.  They have been become much more stable, are more linked via technology, and in many cases have seen more democratic or flexible leadership emerge.  This makes using historical asset allocation models more difficult to use, as they may overstate the risk taken when investing abroad.

Against:

International investing brings along with it some of its own issues, particularly that of governmental risk, less market regulation and transparency, as well as currency valuation.  That means that although a foreign company’s growth may be fantastic, they may be using different accounting procedures then GAAP (Generally Accepted Accounting Principles), or they may be exploiting some type of corruption in their market, or if they are inside of a dictatorship or communist regime, they may be appropriated by the state.  When it comes to currency devaluation, many people remember the sharp drop of the Mexican Peso, or more recently the huge issues in Greece and Dubai.  These are the types of stories you may hear less and less, but are still a part of investing abroad.

International markets, especially emerging markets, many times do not have the solid and established capital markets that the U.S. enjoys.  Access to capital, and capital and competitive pricing is still an issue.  But beyond the access to it, there is the volatility that comes along with growth.  The “growing pains” of many of these emerging and even more established markets can be a major concern.  With the financial meltdown still fresh in many people’s minds, this has been a double-edged sword for investors.  Some feel the U.S. financial system is so far into ill-repair, that the more simplified capital markets will fare better.  Other’s see the lack of sophistication and derivative markets as evidence that those economies cannot last in their current state and their lending will stall at certain plateaus.

Final Thought:

If you are contemplating adding more international exposure to your portfolio, keep something in mind.  I am a proponent of diversification, but only when it makes sense, and only when it can truly add low or even negative correlation to the rest of the portfolio.   This means that I don’t want to add more international stocks to my portfolio if they are going to perform in a similar manner to U.S. equities.  Many U.S. companies receive much of their sales and revenue from their operations overseas.  It is estimated that nearly 50% of the earnings of the S&P 500 comes from foreign sales.  Many companies, although based in the U.S., have a multi-national or global footprint to consider.  In fact, some investors feel that by simply buying a diverse portfolio of large-cap U.S. companies, they are actually getting international exposure in a de facto manner.

Review your portfolio, your goals, and take into account the thoughts above.  It is important to be as efficient as possible when it comes to risk/reward, and to be sure you are making adjustments in your portfolio as the world changes.

I hope this helps you in creating your own portfolio.  I can tell you that our firm has recently increased our target international exposure in our equity portfolio.  For more information about our philosophies and outlook on the markets, or if you have any questions, please feel free to email me at jchristie@kenstern.com.

Good luck, and good investing.

Jeff A. Christie
Wealth Manager

Ken Stern & Associates
CRD# 4889641
CA Insurance Lic.# 0F01343