International equity funds are funds that purchase only stocks in non-U.S. companies. They represent an opportunity for investors to diversify their portfolios but do carry more risks than some other investments.
A report by Vanguard states that non-U.S. companies represent almost half of the global market capitalization. If you don't invest internationally, you are missing out on investing in a lot of important companies. But, before you start putting your money in investments outside the U.S., it's important to understand the risks and how to manage them.
What Are International Equity Funds?
Like other mutual funds, international equity funds are companies that purchase a variety of stocks based on a specific investing strategy, then sell that blend of shares to investors. The difference with an international fund is that all of its stocks are in companies based outside the U.S.
International funds offer investors an opportunity to diversify their portfolios and capitalize on growth in markets throughout the globe. But they carry greater risk than most domestic investments, due to factors such as exchange rates, political unrest, and different levels of liquidity.
- Alternate name: International mutual funds, international stock funds
How International Equity Funds Work
Owning international equities may help boost your returns. Historically, international stock markets have actually tended to outperform U.S. markets, leading many advisors to recommend investing between 30% and 50% of your portfolio internationally. Because U.S. markets and international markets don't always move in the same way, owning international stocks can help reduce a portfolio's overall risk.
When one part of the world's markets is underperforming, another may be performing well. Owning both helps to bring balance to a portfolio.
International Equity Funds vs. Global Equity Funds
International equity funds are not to be confused with global equity funds. Global equity funds are made up of stocks of companies anywhere, meaning both U.S. and non-U.S. companies.
If you invest in a global fund to get international exposure, you may find that the majority of the fund's holdings are in U.S. companies. You may even already own those companies in another equity fund. If you want diversification, you should be looking for international equity funds.
Types of International Equities
There are two types of international funds: those that invest in developed countries, and those that invest in emerging markets. Emerging markets are countries or regions that have less developed economies but a lot of potential for growth. But because most of these countries, or their markets, are not highly regulated, there can be risks involved with investing there. With greater risk, however, often comes a greater potential return. Long-term growth potential for emerging markets is over 10%, compared to 6% for the S&P 500.
Typically the international equity funds that are included in a 401(k) plan are large-cap equity funds that invest in developed countries, such as Japan, Germany, and the United Kingdom. If a plan does offer emerging markets equities, it will probably be in a separate fund.
Financial advisors often recommend that investors who choose to own emerging market equities should limit exposure to no more than 12% of an overall portfolio—and that's for aggressive investors. The less aggressive you are, the more you should limit your investment in emerging markets.
Risks of Investing in International Equities
There are several types of risks associated with investing internationally:
- Currency risk: The value of the dollar will differ from the value of the fund's underlying currencies. This can help to boost your returns when the dollar is weaker, regardless of how the investments are performing. But when the dollar is strong, it can have the opposite effect.
- Political risk: The stability and oversight of local governments matter to the markets. Anytime you are investing in a foreign country (or even your own), there is a risk that the economy or government may face unforeseen troubles.
- Liquidity risk: The U.S. stock market is fairly liquid, meaning that a large volume of stocks is bought and sold on it every day. So when the average investor wants to sell a stock, there's usually a willing buyer. What if there were no buyers and you had no choice but to hold onto it until one came along? That's an illiquid market. Many foreign markets have a lower trading volume than U.S. markets.
There are other risks to consider with international funds. Are the accounting and reporting standards as high as those in the United States? Are the fees for investing in these stocks greater than those charged to invest in U.S. stocks? A well-managed fund will anticipate and understand these risks to some extent.
- International equity funds purchase stock only in non-U.S. companies.
- They offer a great option for diversifying your portfolio, but you should be aware of the risks.
- International funds are different from global funds, which invest in a mixture of U.S. and non-U.S. companies.
- Emerging international markets are riskier than developed ones but come with higher return potential.