International investing has become vital for our portfolios as we take part in the global growth story.
Adding international stocks to a portfolio offers diversification and may provide higher returns. However, there are both benefits and risks associated with global investing.
Benefits of International Equity
Diversification is the most obvious yet the most crucial benefit of global investing. A diversified portfolio acts as a source of stability during market volatility.
When you spread out your investments across geographies, there is a low correlation between them. This means that the volatility in one market is likely not to affect your other assets.
Many of the US-listed companies have global revenues. Over 40% of the revenues of the S&P500 companies come from outside the US. By investing in the US itself, you can build a globally diversified portfolio.
b. Wide range of investment options
Global investing enables you to access investment opportunities that are not present domestically. Developed markets like the US are home to some of the world’s largest tech companies – something you cannot access by investing in India.
You may even choose a theme or a combination of multiple sectors. For example, you can prefer the US market for technology, Europe for engineering, and Australia for commodities.
If you are interested in healthcare or pharmaceuticals, there are several options in the US and Europe.
You can access multiple geographies through ETFs. For example, you can invest in German equities through the US-listed EWG ETF or in the Brazilian market through the EWZ ETF.
c. Investment Protection
Another significant benefit of global investing is the protection of investments against fraud and liquidations.
Developed market companies generally have strong regulations that ensure sound corporate governance and severe penalties for market abuse. This protects retail investors from potential scams and insider trading losses.
Remember, capital is always at risk, but many foreign financial institutions, offer protection from seizures and other threats such as liquidation of the broker-dealer. For instance, in the US, SIPC protects investments up to $500,000 if your broker-dealer faces liquidation.
d. Currency Diversification
Investing overseas exposes you to currency appreciation (or depreciation). For example, the USD has been appreciating, on average, between 3-5 percent versus the INR over the last few years.
Emerging markets’ currencies depreciate over the longer term. Interest rates in domestic savings accounts are at a low of 3-4 percent on average.
By investing globally, portfolios have generally had the dual benefit of better markets and appreciating currencies.
Risks of International Equity
a. Higher Transaction Costs
The most significant barrier to investing in global markets is the added transaction cost, which varies depending on the foreign market you want to invest in. For the US markets, for many other markets, access may not be as inexpensive.
There may be additional costs like FX conversion charges, transfer fees, and annual maintenance fees that you should know on top of the brokerage commissions.
b. Currency Volatility
When investing directly in foreign markets, you first have to convert your Indian rupees into a foreign currency at the current exchange rate. Let’s assume you own a foreign stock for a year and then sell it.
You then convert the foreign currency back into the Indian rupee. That could help or hurt your return, depending on which way the domestic currency is moving.
c. Political Risk
While investing, you should also consider the geopolitical environment of the country. Political events affect the domestic markets of the country and may lead to volatility.
In developing markets, government and policy decisions could hurt even the most prominent companies. We have seen this frequently in countries like Brazil and Argentina.
International investing has become the need of the hour to achieve strong portfolio diversification. While the benefits are lucrative, you must pay attention to the risks as well. There is a lot of information available online to measure the risks and ensure your portfolio’s right mix.