Portfolio Management in Foreign Assets

An international portfolio is a selection of stocks and other assets that focuses on foreign markets rather than domestic ones. If well designed, an international portfolio gives the investor exposure to emerging and developed markets and provides diversification.

An international portfolio appeals to investors who want to diversify their assets by moving away from a domestic-only portfolio. This type of portfolio can carry increased risks due to potential economic and political instability in some emerging markets, There also is the risk that a foreign market’s currency will slip in value against the U.S. dollar.

Over the recent past, the growth of the economies of China and India greatly exceeded those of the U.S. That created a rush to invest in the stocks of those countries. Both are still growing fast, but an investor in the stocks of either nation now would have to do some research to find stocks that have not already seen their best days.

The search for new fast-growing countries has led to some winners and losers. Not long ago, investors going for fast growth were looking to the CIVETS nations. They were Colombia, Indonesia, Vietnam, Egypt, Turkey, and South Africa. Not all of those countries would still be on any investor’s list of promising economies.

Advantages

Diversifies Currency Exposure: When investors buy stocks for an international portfolio, they are also effectively buying the currencies in which the stocks are quoted. For example, if an investor purchases a stock that is listed on the London Stock Exchange, the value of that stock may rise and fall with the British pound. If the U.S. dollar falls, the investor’s international portfolio helps to neutralize currency fluctuations.

International credit: Investors may be able to access an increased amount of credit in foreign countries, allowing the investor to utilize more leverage and generate a higher return on their equity investment.

May Reduce Risk: Having an international portfolio can be used to reduce investment risk. If U.S. stocks underperform, gains in the investor’s international holdings can smooth out returns. For example, an investor may split a portfolio evenly between foreign and domestic holdings. The domestic portfolio may decline by 10% while the international portfolio could advance 20%, leaving the investor with an overall net return of 10%. Risk can be reduced further by holding a selection of stocks from developed and emerging markets in the international portfolio.

Market Cycle Timing: An investor with an international portfolio can take advantage of the market cycles of different nations. For instance, an investor may believe U.S. stocks and the U.S. dollar are overvalued and may look for investment opportunities in developing regions, such as Latin America and Asia, that are believed to benefit from capital inflow and demand for commodities.

Limitations

Increased Transaction Costs: Investors typically pay more in commission and brokerage charges when they buy and sell international stocks, which reduces their overall returns. Taxes, stamp duties, levies, and exchange fees may also need to be paid, which dilute gains further. Many of these costs can be significantly reduced or eliminated by gaining exposure to an international portfolio using ETFs or mutual funds.

Political and Economic Risk: Many developing countries do not have the same level of political and economic stability that the United States does. This increases risk to a level that many investors don’t feel they can tolerate. For example, a political coup in a developing country may result in its stock market declining by 40%.

Manipulation of Security Prices: Government and powerful brokers can influence the security prices. Governments can heavily influence the prices by modifying their monetary and fiscal policies. Moreover, public sector institutions and banks swallow a big share of securities traded on stock exchanges.

Unequal Access to Information: Wide cross-cultural differences may be a barrier to GPM. It is difficult to disseminate and acquire the information by the international investors beforehand. If information is tough to obtain, it is difficult to act rationally and in a prudent manner.