Global investments are increasingly important as U.S. companies represent a smaller and smaller percentage of global revenues and profits. As of April 2022, domestic stocks in U.S. exchanges accounted for about 42% of the global market capitalization. Leading mutual fund providers recommend allocating about 40% to non-U.S. stocks.
What are the Risks of Global Investment?
Global investment risk is an umbrella term that encompasses various types of international investment risks, including currency risk, political risk, and interest rate risk. International investors should carefully consider these risk factors before investing in global equities.
Currency Risks
This risk is associated with fluctuations in foreign currency relative to the U.S. dollar. For example, a foreign company might announce a 25% growth in profits, but if the local currency depreciates by 10% against the U.S. dollar, the real growth rate is only 15% when converted to U.S. dollars.
Political Risks
This type of risk relates to governments and foreign politics. For example, Brazil’s Petrobras was involved in a corruption scandal that led to prison sentences for several company officials and prominent politicians, including popular former president Luiz Inácio Lula da Silva. The scandal contributed to catastrophic losses for the company from 2014 to 2016, including losses of $10 billion in 2015 alone.
Interest Rate Risks
This risk consists of unfavorable changes in monetary policy. For instance, a fast-growing emerging market economy might decide to take action to contain inflation by raising interest rates. Such dynamics can negatively affect the value of financial assets that are priced based on those rates.
The best way to mitigate global investment risks is through diversifying global portfolios. For instance, world funds provide exposure to a range of countries and asset classes around the globe, reducing the risks associated with any single country.
Measuring Global Investment Risks
There are many different ways to measure global investment risks, including quantitative and qualitative measures. International investors should consider a mix of these approaches when assessing global investment risks.
Quantitative Measures for Measuring Global Investment Risks
The most common quantitative measures include:
Beta
Beta measures the volatility of an investment relative to a benchmark index. For example, U.S. investors can gauge the volatility of foreign stocks by comparing them to the S&P 500 index via the beta coefficient. A higher beta indicates greater volatility.
Sharpe Ratio
The Sharpe ratio measures the risk-adjusted return of a particular fund over time. The ratio is calculated by dividing the fund’s average return minus the risk-free rate by the standard deviation. A higher Sharpe ratio indicates a better risk-adjusted return.
Qualitative Assessment of Global Investment Risks
Global investment risks can also be qualitatively evaluated using methods such as:
Credit Ratings
Credit ratings provide insight into the creditworthiness of a country. For instance, a country with a low credit rating may lack the flexibility needed to stimulate growth, which could lead to declining stock values.
Analyst Ratings
Analyst ratings can offer specific insights into individual international securities. Often, these ratings include price targets and other factors to consider, although sell-side analyst ratings should be approached with caution.
Investors should consider how these factors affect their portfolios. Retirement portfolios might prefer to stick with less volatile stocks, while younger investors may want to consider adding volatility as it might provide greater long-term return potential.
Are
Is Global Investment Worth the Risk?
Global diversification helps reduce the volatility of portfolios over the long term. In the short term, investors can also participate in any regional market that is performing better. The United States may lead the world during certain periods, but there are definitely times when another country or market delivers better returns. For example, exposure to diverse foreign equities during the mid-1980s would have been better than solely local portfolios.
Currency movements may also help enhance diversification as they are not correlated with stock performance. The lesser correlation with U.S. stocks means investors may achieve more balanced returns over time.
Conclusion
Global investment has become increasingly essential over time, but investors must carefully consider the risks associated with global investing. The good news is that there are various tools available to measure these risks and ensure the right mix for any portfolio. Vanguard recommends investing about 40% of the equity allocation in a portfolio to international stocks, and 30% of the bond allocation in international bonds. For instance, if 30% of the portfolio’s assets are invested in stocks, then 40% of 30% would be an allocation to international stocks, which amounts to about 12% of the portfolio, and so on.
The Balance does not provide tax, investment, or financial advice. The information is presented without regard to the investment objectives or risk tolerance or financial circumstances of any specific investor and may not be suitable for all investors. Past performance is not indicative of future results. Investing involves risks, including the risk of loss of principal.
Source: https://www.thebalancemoney.com/what-is-global-investment-risk-4148455
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