The CIA's Guide to International Investing

Bill Byrnes — Tue, 20 Nov 2007 15:00:00 -0600

The world’s second biggest economy is Japan (behind the good ol’ USA). China, India, and Brazil have economies growing at upwards of 10% annually. That’s a lot faster then the roughly 2.5% expected US growth over the next year or so (absent a recession, of course). Together those three economies almost equal the U.S. in GDP. Add in Japan, and the combined GDP of these four countries exceeds the U.S. The CIA’s World Factbook is an excellent source of country information like this.

A good mutual fund investor would be wise to have at least 25% of his or her assets invested outside the US. Global investing makes sense not only to avail oneself of higher growth rates but also because international investments may respond differently to the same event. Global economies is linked and becoming more so. The stock markets of Western Europe, for example, have an 80% correlation with the U.S. markets. Makes sense, doesn’t it? A good portion of BMW’s profits come from the U.S., so if the U.S. economy (and the U.S. stock market) turns down, so does BMWs profits and its stock price on the German exchange. You don’t gain a lot of diversification by investing in Western Europe (although it would be a play on the Euro, if you think the dollar will continue to decline). Something of a surprise is that the Brazilian stock market has a 70% correlation to its U.S. counterpart. Latin America is more closely liked to the U.S. then it would like to believe. As you’d expect, the stock markets of emerging counties, i.e., China (50%), India (40%), Russia (35%), are not as closely correlated with the U.S. market as are the Western European markets. (Of course, they’re also more volatile.)

A second surprise is the uniqueness of the Japanese market. Movements in Japanese stock prices have only a 30% correlation with movements in the U.S. stock market. That’s surprising because Toyota sells so many cars here and we all own at least one Japanese made TV. But it goes to show that the biggest driver of any economy is what’s going on inside a country, not how much it exports. Just like the Japanese culture, there are many unique aspects to the Japanese economy. What’s also nice about Japan is it’s the second largest economy in the world and offers the legal and accounting safeguards of a mature county. Thus, you can diversify without emerging economy risk.

How to decide which regions/countries to invest in? Which counties do you think are attractive investments, i.e., their economies will grow. What are the opportunities in Mexico (domestic demand)? Canada (natural resources)? Germany (banking and automobiles)? Then, like with every other investment decision, consider the riskiness of the investment. Canada and Germany are pretty safe. Russia’s GDP is clipping along at 7% per year and Egypt’s GDP is growing at 6%. Both stock markets reflect this growth but they’re riskier investments.

There are many excellent international mutual funds and ETFs, some invest globally, some focus by region and some by country. International funds invest in all sizes and types of companies and, for the fixed income portion of your portfolio, all classes of debt.

It would be wise to invest 25% of your assets internationally and to diversify beyond Western Europe.

The MUTUALdecision Blog: The CIA's Guide to International Investing

The CIA's Guide to International Investing