Academic journal article Multinational Business Review

International Diversification for Individuals

Academic journal article Multinational Business Review

International Diversification for Individuals

Article excerpt

INTRODUCTION

Individuals and investment advisors have shown fresh interest in the potential gains from diversification into international common stocks during the past five years. Publications targeted to experienced investors and advisors, such as Barron's, The Financial Analysis Journal, Financial Planning, Personal Financial Planning, and The Journal of Portfolio Management, routinely publish articles extolling the merits of diversifying beyond the United States' capital markets. Even mass market publications--AAII Journal, Business Week, Kiplinger's Personal Finance Magazine, Money, and The Wall Street Journal--have broadened their coverage of international investments. Their usual conclusion is that individual investors should reduce their emphasis on domestic markets and adopt a global investment approach.

As individual investors have become more aware of these opportunities, they have invested more in the international arena. Between 1988 and 1992, individuals more than doubled the amount they invested in international common stock mutual funds, though investment started from a low base. The amount invested in foreign common stock mutual funds in 1992 was still less than nine percent of the total for all U.S.-based stock funds.

In the past, individuals were most comfortable investing in the domestic common stock market, and they continue to feel that way today. The emphasis on domestic investment in the United States is quite different from the more global approach taken by investors in Europe's developed countries. Modest local equity markets and the realization that investment opportunities do not stop at national boundaries have encouraged European investors to diversify aggressively so that a larger fraction of their portfolio is invested outside their domestic markets.

Opportunities for investing outside the United States are now much more extensive than they were a few years ago. Between 1988 and 1992 the number of international common stock mutual funds increased more than 2-1/2 times; domestic, growth-oriented mutual funds rose only 40 percent during the same period. International funds now make up more than 16 percent of all common stock mutual funds.

Not only have the numbers of these funds grown, so has their variety. Ten years ago the investor's choice was limited: most international funds concentrated on the common stocks of large companies that could be bought and sold in the developed equity exchanges of Europe and Asia. Not so today. Though the majority of international funds continue to focus on the stocks of large firms trading on established exchanges, the introduction of specialized funds has made the investor's range of choice far more diverse. New entrants include common stock funds that focus on firms within a geographic region, companies with small to moderate market capitalization, and--most recently--companies traded on the emerging equity markets of the world's developing countries.

As a result, investors can construct a more diversified international portfolio than ever before. One or more traditional large-company international funds can provide the foundation, and this core can be complemented with specialized regional, small-gap growth, or emerging equity market international funds.

U.S. investors appear to be more aware of, and more willing to invest in, international investment alternatives. That raises several questions: How have they fared with their international mutual fund investments? Have rates of return been superior to those for domestic common stock mutual funds? Has risk exposure been higher or lower than with domestic counterparts? When risk levels are substantial, have returns been sufficiently high to compensate for the added risk?

This study addresses these questions by examining the gains investors could have achieved by adding international equity mutual funds to their portfolios. We begin by reviewing the potential gains from diversifying outside the domestic U. …

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