Most of us have heard the advice that we need to employ diversification within our broader investment portfolios. This includes diversification of asset classes, but also within classes. One of these classes is stocks.
Within each of our stock portfolios, many of us tend to have a home country bias when investing. As we discussed in a previous article, we can alleviate this by purchasing international stock funds to diversify our risk exposure.
However, we have to ask: Just how much diversification are we really getting when we invest internationally?
An interesting article in Money magazine (at CNN Money) highlights the notion that diversification isn’t as easy as it might seem, particularly due to the following factors:
- Some stock markets around the world track the U.S. relatively closely
- Some international stock funds are very geographically concentrated.
In terms of tracking the U.S. closely, non-North American markets rate as follows:
- India: Least like the U.S.
- Russia: Least like the U.S.
- Japan: Least like the U.S.
- East Asia: Somewhat like the U.S.
- Latin America: Somewhat like the U.S.
- Europe: Most like the U.S.
Interestingly, taking that into account, here are the average holdings by region in large cap foreign funds:
- Europe: 61%
- Japan: 15%
- Latin America: 3.7%
- Asia (excluding Japan): 3.2%
- India: 1.1%
- Russia: 0.6%
Connecting the dots, Europe correlates highest with the U.S., and represents a significant percentage of large international funds.
The article lists its own lessons. For me personally, I think the biggest takeaway is to revisit the composition of my international exposure to stocks.
I do have an individual fund in which I’m currently invested, but I haven’t checked the makeup of this fund. My previous efforts in evaluating funds focused primarily on historical performance, not it’s specific investments and source countries.
Clearly, I should take a closer look at this.
Are you have investments in international stock funds? If so, have you researched the holdings of the funds – such as geographic concentration, size of the companies, etc?
I must confess I am not as on top of my mutual funds as I need to be. I am pretty good about small/mid/large cap balancing within the US, but I have not tracked my international funds as closely.
Thanks for the reminder.
Everyday Tips – I think you’re probably in the majority with this one. It’s easy for most of us to just invest in international funds and check that box. In reality, there might be more correlation than we think with U.S. markets!
Squirrelers, that is a good point, and completely agree. If you drill down into the individual holdings of these funds, many of the top holdings of these funds will be large European or Japanese corporations that derive a substantial portion of their income from the US economy. For example, some of the top holdings in the international index fund offered in my company’s 401k plan include Nestle (Switzerland), HSBC (UK), Toyota, Roche Holding (Switzerland), BP (UK), Shell (UK) and Total (France).
Andrew – that fund you describe may technically be “international”, but it might be doing a good imitation of a U.S. fund! Going through this article and writing mine, I have gained an appreciation for peeling back the layers and paying closer attention to the composition of such funds.
I do invest in an international fund that is primarily concentrated in Europe. Although this isn’t the only international investment that I own, you are right that it is highly correlated with the US market. It makes sense.
Good Point.
One of my goals this year was to do more international funds as a way to diversify.
To do this, I bought a vanguard total market fund, total international market fund VGTSX. This is supposed to represent the global economy, but when I look at it, it’s heavily weighted towards Japan and UK. So, Japan may actually diversify me some, but my UK holdings according to your analysis are not that different from investing state-side. My husband already has an emerging market fund, so I stayed away from more of that. That fund has been extremely volatile over the last 10 years.
Very interesting indeed.
Sandy – it really is interesting how these funds are commonly viewed as ways for U.S. to diversify, but they just might be correlated too much with U.S. stocks to serve that purpose. Another example of how it’s good to examine things further than the surface level, particularly when it comes to using our money.
I’ve got a developing/emerging market mutual fund from American Century. (This was from back before I took over my own money management from my father.) It bounces around a LOT in value. I’ve kept it even though I don’t like that much bouncing precisely because of the diversification aspect. My solution is to only look at it once a year. My DH didn’t have any international, so we added a vanguard fund to his IRA this past year, but it’s probably the same one as Sandy L so we might have to look into that at some point.
Check out Morningstar “Portfolio X Ray.” It’s a fabulous tool for identifying areas of overlap within your holdings.
Barb – thank you for the tip, I’ll check it out!