Top 4 Asset Allocation Tips for International Investors

Asset Allocation Strategies to Maximize Risk-Adjusted Returns

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Most financial professionals would agree that asset allocation is one of the most important decisions facing individual investors. In fact, choosing the right mix of asset classes can be much more impactful that picking the right assets themselves. Asset allocation becomes even more complex when investing beyond the United States, since there are significant differences between countries and regions around the world.

In this article, we will take a look at four asset allocation tips for international investors to help them improve their overall risk-adjusted returns.

#1. Stocks vs. Bonds

Conventional asset allocation is focused on optimizing a portfolio’s mix of stocks, bonds, and cash. Younger investors are encouraged to buy stocks since they tend to produce higher returns over the long run, while older investors are told to hold bonds for a safe and predictable income over time. Certain levels of cash are also recommended in some cases in order to meet any near-term needs or have capital ready in case an opportunity arises.

International investors must make a similar decision in their portfolios, but there are some important distinctions from domestic financial markets. For example, international bonds may be significantly riskier than U.S. Treasuries or investment grade U.S. corporate bonds, which means they may not be appropriate for investors seeking a safe source of income.

Many emerging market bonds offer stock-like returns with a bond-like structure.

Investors should carefully consider their risk tolerance and seek out assets that meet those requirements rather than generalizing asset classes.

#2. Mind the Currency

Most domestic investors don’t think too much about currencies, since most U.S. companies convert their foreign earnings back into U.S. dollars before reporting income.

Of course, this means that these investors risk losing money when the U.S. dollar loses value relative to other currencies. Most U.S. investors are comfortable taking this risk because they calculate returns in U.S. dollars, which means gains and losses tend to go unnoticed.

International investors must carefully manage their currency exposure based on their risk tolerance and diversification goals. On one hand, investors may decide to hedge exposure to foreign currencies with currency-hedged exchange-traded funds (ETFs) in order to keep consistent results. On the other hand, investors may actively seek out currency exposure in order to enhance a portfolio’s overall diversification.

Investors should decide how much diversification they’d like to incorporate into their portfolios, as well as potential risks with unstable foreign currencies.

#3. Diversify Geography

Most domestic investors don’t worry too much about location, since S&P 500 companies tend to be well diversified in the U.S. and even beyond. The percentage of S&P 500 sales from international sources actually increased from 24.6% to 35% between 2000 and 2010, which means that U.S. investors are already diversified to some extent.

There’s also little concern that these companies are overly exposed to risky markets due to their large size.

International investors must decide where in the world they’re going to allocate capital to maximize risk-adjusted returns. For example, investors may want to allocate a certain percentage of assets to developed markets, emerging markets, and frontier markets depending on their target returns and the level of risk that they’re comfortable assuming. The asset class and market capitalizations may be similar, but the risk profiles of these markets differ greatly.

Many financial advisors recommend limiting emerging markets exposure to 10-15% of a portfolio since they involve a high level of risk.

#4. Track Industry Exposure

Most domestic investors can achieve broad industry exposure through an investment in the S&P 500 or similar large indexes.

After all, the U.S. economy is one of the largest and most diversified economies in the world with a very stable equities market.

International investors must be careful to avoid investing in countries or regions that have concentrated industries. For instance, the Middle East has a concentration of energy-related companies and South America tends to have resource-heavy economies. Investors that are overweight in these areas may experience significant declines if the energy or commodities sectors experience a downturn – even though they are diversified between countries.

Investors should take a close look at what drives a country or regional economy before investing in the assets and ensure any risks are properly diversified.

The Bottom Line

Asset allocation is one of the most important concepts for international investors to understand when building their portfolios. While domestic investors may be find with an S&P 500 index ETF and some bonds, international investors must deal with more complicated assets, currency risks, geographical diversification, and industry exposures. Keeping these asset allocation tips in mind can help improve risk-adjusted returns and avoid unexpected downturns.