The argument in favour of lower allocations to foreign equity is usually based on the premise that it's inherently more risky to venture abroad than to stay at home. It's true that emerging markets can still fluctuate dramatically. And less-stable political environments and different accounting standards may make international investing a bit trickier, despite improvements on both fronts over the past decade. However, bringing foreign exposure into a broader portfolio can actually decrease your overall level of risk by increasing your diversification.
leAD">
In the end, the real debate isn't over whether you should have international exposure but rather how much and what kind. Below, we'll look at some considerations worth keeping in mind and discuss what you should think about if you decide to increase your international exposure.
Should Your Portfolio Look Like the Global Market?
Some investors heavily weight U.K. stocks out of the mistaken perception that U.K. stocks are less risky, patriotism, or perhaps familiarity (you'll know more about Tesco than you will an Indian or Chinese retailer, for example). But despite its economic might, the U.K. only accounts for approximately 10% of the MSCI All Countries World Index. So, if you've got 80% of your stock holdings invested domestically, you're making an enormous bet in favour of the U.K. market. Finance or economics textbooks might suggest eliminating that bet entirely. But doing so wouldn't be as simple as sounds. Even an all-U.K. stock portfolio would give you some degree of exposure to foreign markets as many U.K. firms earn substantial portions of their revenues abroad.
Moreover, it makes sense to preserve some bias in favour of the U.K. After all, the reason you invest is so that you can spend money in the future. Partly, you'll be buying what economists call "non-tradable goods"--goods and services that must be produced locally. One example is restaurant service, which you'd be hard-pressed to import. Emphasising U.K. stocks is one way to guard against future price fluctuations in non-tradable goods, because their future prices will mostly reflect local conditions. When the price of non-tradable goods rises, presumably the firms offering them will become more profitable and have higher share prices as a result, benefiting the investor with the U.K. bias. It's worth noting, however, that this rationale has waned considerably over the past couple of decades. Increasingly, the U.K. has found new ways to take advantage of more-efficiently produced goods and services abroad. Think about the last time you called a customer-support hotline. You'll often talk to someone in India, but 20 years ago, few would have thought you could locate customer-support operations outside the U.K.
So, if simply mirroring the globe's market-cap allocation isn't the right strategy, what's the right international-stock allocation? It can be helpful to look at what institutions are doing. Fidelity, for example, at its Wealthbuilder Target 2020 fund—which is designed for U.K. investors seeking to meet an investment goal in 2020--recently had 45% of equities allocated to the U.K., and 55% allocated to equities in other countries. Morningstar consultants generally use similar allocations in their work for institutions. There is no one number that is right for every investor, and you may simply be uncomfortable with more than half your equity portfolio invested abroad. However, we think this is at least a reasonable starting point for a discussion with your financial adviser—it gives you ample exposure to the home market and local conditions, whilst diversifying your portfolio globally in a meaningful way.
How Should You Increase Your Foreign Exposure?
If you think your portfolio needs more of an international flavour, you should first start by seeing how much foreign exposure you already have. If you have entered your portfolio on Morningstar.co.uk, you can click the X-Ray tab within Portfolio Manager to find out. You'll be able to see how much of your total portfolio is invested overseas, broken down by world region. Even if you don’t track your portfolio with us, you can obtain a similar view by using our Instant X-Ray tool.
Should you want to boost your foreign stake, keep some things in mind. For one, you want to build your international portfolio using the same principles as you'd construct your domestic holdings, putting steadier large-cap holdings at the core with niche offerings at the periphery. Similarly, you want to keep an eye on expenses (using a fund’s TER as your primary guide) and manager tenure, just as you would if you were buying a domestic holding.
If you've already got a core foreign holding or two, consider branching out into foreign funds that focus on mid-caps and small caps. These stocks have the advantage of being less tied to the global economy, making them better portfolio diversifiers. If you're reducing your domestic holdings to make room for more foreign fare, don't forget the tax consequences of your actions. It might make more sense to cut back first in non-taxable accounts so you don't end up triggering taxable gains. Another alternative is to stop adding to your domestic holdings and use the proceeds to fund your additional international investments.
Finally, keep in mind some areas, especially emerging markets have enjoyed quite a run in recent years. You shouldn't invest expecting the recent past will repeat itself. Instead, focus on creating a sound, long-term plan and stick with it.
