How Much International Exposure In Portfolio: Exploring Types Of Exposure In International Finance
by Arnab Dey Finance 17 May 2023
As the world becomes more interconnected, investors are increasingly seeking ways to diversify their portfolios by investing in global markets.
One of the questions that arise in this context is, how much international exposure should an investor have in their portfolio? This article aims to explore various types of exposure in international finance and provide insights on the optimal level of international exposure an investor should consider.
Why International Exposure Matters
International exposure can help investors achieve better risk-adjusted returns by diversifying their portfolios across different countries, industries, and currencies.
By investing in foreign assets, investors can potentially benefit from growth opportunities in emerging markets and reduce their reliance on a single country’s economic performance. The following sections delve into the different types of international exposure in finance.
Types of Exposure in International Finance
1. Equity Exposure
Equity exposure refers to investing in foreign stocks, either directly or through mutual funds, exchange-traded funds (ETFs), or American Depositary Receipts (ADRs). Investors can gain access to various sectors and regions, helping them achieve broader diversification in their portfolios.
2. Fixed Income Exposure
Fixed income exposure involves investing in bonds issued by foreign governments or corporations. By investing in international bonds, investors can diversify their interest rate risk and tap into different credit profiles.
3. Currency Exposure
Currency exposure, or foreign exchange exposure, refers to the potential change in the value of an investment due to fluctuations in exchange rates. Currency exposure can be managed through various strategies, including currency-hedged investments or holding assets in different currencies.
4. Commodity Exposure
Commodity exposure involves investing in commodities or related assets that are traded on international markets, such as gold, oil, and agricultural products. These investments can serve as a hedge against inflation and provide diversification benefits.
5. Real Estate Exposure
Real estate exposure includes investing in foreign properties or real estate investment trusts (REITs) that own properties in different countries. This type of exposure can offer diversification and income generation through rental yields.
Determining the Optimal Level of International Exposure
The optimal level of international exposure in a portfolio depends on several factors, including an investor’s risk tolerance, investment horizon, and financial goals.
Here are some key considerations:
A. Risk Tolerance
Investors with a higher risk tolerance might allocate a more significant portion of their portfolio to international investments, as they can potentially offer higher returns but may also involve higher volatility and currency risk.
B. Investment Horizon
Investors with a longer investment horizon might benefit more from international exposure, as they can potentially ride out short-term market fluctuations and currency movements.
C. Financial Goals
Investors aiming to achieve specific financial goals, such as funding retirement or saving for college, might need to carefully consider the appropriate level of international exposure based on their target return and risk tolerance.
D. Home Bias
Investors should be cautious about over-concentrating their portfolio on domestic assets due to home bias, which can lead to insufficient diversification and increased vulnerability to local economic downturns.
Strategies for Achieving International Exposure
1. Passive Investing
Passive investing has emerged as a popular and effective strategy for achieving international exposure in one’s investment portfolio. By utilizing low-cost, diversified index funds or exchange-traded funds (ETFs) that track the performance of international markets, investors can gain exposure to a wide array of global equities without the need for active management.
This approach allows investors to participate in the growth and returns of international economies, benefiting from potential currency diversification and reduced home-country bias. Passive investing can be a cost-effective and efficient way to tap into the opportunities presented by global markets, ultimately helping investors build a more resilient and well-rounded portfolio.
2. Active Investing
Active investing is a hands-on approach to achieving international exposure in an investment portfolio, relying on the expertise of professional fund managers to select and manage individual stocks or bonds from various global markets. This strategy aims to outperform benchmark indices by identifying and capitalizing on market inefficiencies and trends in international equities.
Through in-depth research and analysis, active managers seek to uncover high-potential investment opportunities, providing investors with access to unique and potentially lucrative positions in foreign markets. While active investing typically involves higher fees compared to passive strategies, it offers the possibility of generating alpha, or excess returns, by leveraging the skills and knowledge of experienced investment professionals navigating the complexities of international markets.
3. Thematic Investing
Thematic investing is a forward-looking approach to achieving international exposure by focusing on investment opportunities tied to global trends and transformative forces, such as technological innovation, demographic shifts, or environmental sustainability. This strategy aims to capture the growth potential of companies and industries that stand to benefit from these long-term themes, regardless of their geographical location.
By concentrating on specific themes that transcend national boundaries, investors can access a diversified set of assets with the potential for strong performance across various international markets. Thematic investing allows investors to align their portfolios with their convictions and capitalize on the interconnected nature of the global economy while gaining exposure to emerging sectors and industries poised for growth in the years to come.
Determining how much international exposure an investor should have in their portfolio is a complex process that depends on their individual risk tolerance, investment horizon, and financial goals. By understanding the different types of exposure in international finance and carefully considering their specific circumstances, investors can make more informed decisions about the optimal level of international exposure for their portfolios.
To achieve international exposure, investors can choose from various investment vehicles and strategies, including passive investing through index funds or ETFs, active investing with mutual funds or individual stock and bond selection, and thematic investing focused on global trends. By incorporating a well-balanced mix of international assets, investors can potentially benefit from enhanced portfolio diversification and improved risk-adjusted returns.