According to Charles Schwab, 85% of U.S. investors have “home country” bias in their portfolios, meaning the vast majority of their stocks and bonds are from U.S.-based companies.
Why? Because we tend to invest in what we know. After all, our own markets are easy to understand.
Yet, this bias narrows the investment opportunity set. U.S. equities represent 60% of the global equity market value. That leaves a significant portion of investment allocations—and opportunities—in other countries!
Before diving into international investments, it’s essential to understand the three main categories along with their benefits and risks. Read on for a breakdown of developed, emerging, and frontier markets.
Developed Markets
Developed markets include the U.S., Canada, Western European countries, Australia, and Japan. They are characterized by:
- Mature economies
- Strong regulatory systems
- Open capital markets
- Freely exchanged currency
What is freely exchanged currency? Freely exchanged currency can be bought and sold without restrictions in the foreign exchange market. Its value is based on market supply and demand, impacted by economic factors, geopolitical events, interest rates, and other market influences. Governments or central banks usually have limited direct intervention in determining the currency’s exchange rate.
Developed countries also typically have a higher per capita income, although this alone isn’t necessarily enough to deem a nation as developed. Take Qatar, for example: While it has one of the highest per-capita GDP in the world (about $62,000), the United Nations considers it an emerging economy due to the severe income inequality, weak infrastructure, and poor access to education for non-affluent citizens.
While investments in developed markets typically offer lower risk, they also yield potentially lower returns than emerging or frontier markets.
Emerging Markets
Emerging or developing markets include countries like China, Poland, Brazil, and India. These nations:
- Tend to be faster growing (their GDP starts at a smaller base)
- Use currency that does not always trade freely (e.g., China’s Yuan)
- Have an equity market concentrated into two or three sectors
For example, Brazil is focused on agricultural commodities and fossil fuels. However, its service sector is rapidly expanding, with industries like finance and tourism contributing to this growth.
As emerging markets are in transition, they have more volatility and risk than developed economies but offer higher growth potential.
Frontier Markets
Finally, there’s the Wild West of international investments: frontier markets. Vietnam, Indonesia, and Nigeria are all examples of these less established markets, which typically have:
- High volatility (i.e., significant currency fluctuations)
- Weak institutional stability and regulation
- Low liquidity
Frontier markets can offer high growth potential but pose significant risks for investors due to instability.
What Types of International Investments Should I Consider?
Here at Carlson Investments, we invest in developed and emerging markets. We believe that emerging markets have their place in a portfolio, but not a large portion. Portfolio construction and diversification is more than investing in different sectors in the U.S. Emerging markets provide access to:
- Rapidly growing populations
- Expanding business sectors (especially financials and consumer discretionary)
- Accelerating income per capita
What is consumer discretionary? This is an economic sector classification of non-essential products and services consumers purchase when they have sufficient disposable income. Examples include luxury goods and clothing, entertainment, and electronics.
We favor exchange-traded funds (ETFs) in this space to provide clients with adequate diversification and liquidity. An ETF works similarly to a mutual fund and can track a specific index, commodity, bond, or basket of securities. They also offer lower expense ratios than some mutual funds and can be traded like individual stocks.
Are you considering international investments but need help determining where to start? There’s a lot to assess, from the state of the market to the risks it poses to how much risk you can afford to take on. We’ll gladly guide you in diversifying your portfolio while keeping it balanced and protected. Speak with a Carlson advisor today!
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