A little over 400 years ago, in 1580, Francis Drake returned to London from his circumnavigation of the globe in the Golden Hind. He brought back with him a large cargo of gold, silver, diamonds, emeralds, and spices, mostly plundered from Spanish colonies and treasure ships. His backers, including Her Majesty Queen Elizabeth I, constituted probably the most successful investment syndicate in British financial history, earning a return of 4,700 percent.
The impact of that voyage was tremendous, changing the balance of power in Europe and laying the foundation for England's global empire. It had a significant effect on the suffering English economy and boosted the fledgling capitalist system in the country. And just as important, the success of the voyage ensured that England's financial direction for most of the next four centuries would be outward, based on foreign investment.
International financial diversification is not new, and in many parts of the world it is taken for granted in planning an investment portfolio. It is perhaps a peculiarly American phenomenon that the topic is even considered suitable for debate. Author John Pugsley calls Americans' typical reluctance to look abroad a "natural consequence of their heritage." Partially, this arises from a certain provincialism among Americans (by which I mean citizens of the United States) and a belief that everything American is better—certainly bigger—than all things foreign. And until very recent times, Americans' conviction in their economic supremacy, military might, and moral right was very strong and still pervades every aspect of American life. In part, the feeling was correct.
This supremacist attitude also rolled over into the investment field. International stock market advisor Dennis Hardaker notes that until very recently the feeling among Americans was that "the investment world begins in New York and ends in California." But the mood among US investors is slowly changing. Cautious steps in the direction of international diversification have been taken, with the increasing use of Swiss or Bahamian or Cayman bank accounts, a more ready acceptance of South African gold stocks or a Mexican stock fund, and more and more frequent discussions of foreign investment in newsletters and periodicals. Often, however, this discussion emphasizes the decline in US economic superiority and the inability of the US stock and bond markets to keep up with inflation, as well as the possibilities of US exchange controls or a deep economic crisis.
However appropriate such motives may be for investing on an international scale, any US decline is by no account the sole or even prime proper motivation for such investment. Indeed, it is important to realize that, in advocating investment across national borders, one is not knocking America. Diego Veitia, president of International Assets Advisory Corporation, prefers to talk of "international diversification" and eschews the phrase "foreign investment," stating quite correctly that proper international diversification includes investment within the United States. The true international investor simply looks at the entire world as if from some imaginary spot outside it, rather than from the restricted vantage point of a citizen of a single nation.
To be sure, many people invest abroad because of what they perceive as the present and potential decline of the United States. And the motive may have some validity in that it is certainly only sensible at all times to have some capital outside the country in which one is living and of which, presumably, one is also a citizen. It's a form of insurance, if you will. But for the greater part of our investment portfolio, there should be other reasons; and prime among them is the greater profit potential that is available through a properly diversified portfolio. What causes that greater potential?
Greater opportunity. You can take advantage of the ebb and flow, the ups and downs, of the world investment cycle. If you invest in the stock market, you may have to wait several years to get real profits out of the US market, unless you select your stocks very carefully. But if you allow yourself the opportunity to invest among all the stock markets of the world—more than 50—you will always have the opportunity to catch rising markets. It's simple arithmetic: if a boom-bust cycle lasts four or five years, you must wait that long to catch the next bottom in the home market; but with 50 or so markets around the world, each with similar though not coincidental cycles, there will always be a market somewhere bottoming out, providing the opportunity of greatest profits.
There will indeed be periods when the US stock market is the place to be. In 1961–62, it appreciated by more than any other market in the world. But do you really want to wait 20 years before the US market is again the world leader? The respected International Bank Credit Analyst has prepared a "potential international performance" chart, comparing an international portfolio with a purely domestic one. In 20 years, beginning in 1960, the US portfolio, as measured by Standard & Poor's 500, rose from 55.78 to just over 100. The international investor, simply by investing in the leading market and making only 10 shifts over the 20-year period, could have seen the same 55.78 appreciate to nearly 4,500.
The top-forming markets change, of course, but you are missing out on a lot of potential if you wait for the US market to turn around. In the last year, for example, the US market ranked 10th out of 18 major stock markets around the world, losing 9.3 percent of its value. But it was not a dismal year for all stock markets: Sweden was up 66 percent, Denmark up 45 percent, and Japan up 23 percent (all in local currency terms).
You don't have to be a short-term investor to take advantage of these rising markets, either. During the decade of the 1970s, US stocks increased in nominal value by 16.3 percent. During the same period, the Hong Kong market grew by 644 percent, Singapore stocks rose by 370 percent, and the Canadian and Japanese markets each more than doubled. If you restrict your investing to the United States, you are virtually bound to do badly compared with the international investor.
Better bargains. An extension of the same notion is that by looking at the entire world, one will almost always be able to find a better bargain abroad. After all, the United States is only one of the more than 200 countries in the world. Many advisors are advocating a heavy position in the US equity markets now because "stocks are cheap." But cheap compared with what? With what they were a year or two ago? Irrelevant. With what they might be in a year or two? Well, maybe. But certainly, they cannot mean cheap compared with other stock markets.
As of March of this year, the US stock market sold at a price-earnings ratio of 7.7, moderately low by historic standards. But at the same time, other markets sold at considerably less. Dutch stocks, for example, were selling at only 5.4 times earnings, while Mexican stocks averaged only 4 times earnings. And in many smaller stock markets, the ratio is even less.
More availability. Many investments are available abroad that simply are not available domestically, because of the law or for some other reason. Gold-denominated annuities, for example, are not available in the United States or in many other countries, including Switzerland, because of legal restrictions. They are, however, readily obtainable from reputable Swiss and British companies based in Bermuda and the Bahamas, among other places, and the US resident is freely permitted to purchase them.
We have been hearing a lot lately about the enormous potential of strategic metals—exotic metals like indium, tantalum, and rhodium. These metals are traded only in London, mostly on the London Metal Exchange. And if you want to invest in them with confidence that you are dealing with someone with years of metals experience, you have to deal through London.
Higher quality. A better version of a domestic item may be available abroad. It may be less expensive, more flexible, or otherwise of superior quality. British life insurance, for example, is approximately half the cost of similar US coverage, again because of the tight restrictions on US insurance-company investments. It is not necessary to be British or even to go to Britain to obtain such coverage. It can be done quite easily by mail from the United States.
Similarly, there are scores of mutual funds based overseas that are invested in a single foreign market, in many foreign markets, or even in the US market. Many of these funds are not normally available in the United States because of archaic laws to "protect" the naive investor. The law actually prohibits funds that are not registered with the Securities and Exchange Commission from promoting or soliciting in the United States. As an American citizen, you are permitted to buy into these funds if you make the approaches.
Though there are some fine mutual funds in the United States, there are many others based abroad with records superior to those of most US-based funds. Indeed, the best foreign-based funds tend to have better records than the best US-based funds. Why? Many reasons, one of which may be the very receptiveness toward international diversification. That foreign funds are free of high US taxes is another factor.
Offshore mutual funds have a bad reputation—a hangover from the IOS-Cornfield-Vesco scandal of the 1960s. But when we discuss offshore mutual funds, we are discussing not only US funds based abroad but also highly reputable foreign companies based in their home countries. Companies such as Barclays, Britannia, Swiss Bank Corporation, and Union Bank of Switzerland have a wide range of mutual funds with different investment objectives and philosophies. Again, among the US companies that have mutual funds offshore are some highly reputable firms, such as Dreyfus and Drexel Burnham Lambert.
New technology. There are opportunities to invest abroad in new technologies that are often unavailable in the United States. Revolutions in home computers and industrial robotry are taking place in Japan. That country is the present world leader in technological innovation in many spheres and an aggressive exporter as well. In the areas of videotape recorders and videodiscs, for example, Japanese companies hold a worldwide 90-percent market share. Such products, and many others, have only scratched the surface of the great US consumer and industrial markets. There will surely be a tremendous boom in the stock of such companies, but the only way to take advantage of it is to buy foreign stock.
Developing markets. If you missed out on buying IBM in 1954, don't worry. You have another chance. Just as there are new technologies being developed outside the United States yet to truly take hold here, so there are things we take for granted in the United States that are only now beginning to become commonplace abroad.
The market for washing machines in many Latin American countries is an example. Within the next few years, such consumer products will probably become just as common as they are in the United States, but you can take advantage of the coming booms by investing in the companies that manufacture, import, or distribute these items in those regions.
Tax advantages. Although the US taxpayer is supposed to pay US taxes on all foreign investment income in just the same manner as taxes are paid on US income—with only few exceptions—many investors are under the mistaken impression that they do not have to pay US taxes on foreign income until they repatriate it to the United States. It is the case that, as with many other types of income (real estate gains, gold sales, etc.), it is up to the taxpayers themselves to report income from funds invested abroad. All manner of interest and dividend income is routinely reported to the Treasury, but not if the bank certificate of deposit is with a Swiss bank or if the company whose stock you own is a Japanese one!
I have mentioned diversification as an important reason for internationalizing one's investment portfolio, but it needs emphasizing that diversification must not just be for its own sake. One should never have all one's eggs in one basket, but it is also important that one does not overdiversify and risk losing profits. The approach should be to make carefully selected individual investments, but from the widest possible base. And that, of course, means looking at the entire world, not just the United States.
One aspect of international investing that frightens some people is that, on its face, it is more complicated than investing purely in one's domestic economy. The reason? The currency factor. Currencies are the key to international investing and can turn a poor investment into a profitable one and an otherwise sound investment into a poor one. Again, this is both a short- and long-term phenomenon. During the 1970s, for example, the Swiss stock market lost 12 percent in Swiss-franc terms. But in US-dollar terms, it appreciated by 86 percent. Similarly, the German market lost 10 percent of its nominal value, but a US-dollar investor would have seen a 37-percent appreciation. In the same manner, an investment in Argentinian real estate, appreciating at more than 50 percent a year, may not be such a sound investment, since the peso has been declining by more than that.
So currencies add yet another level to investment decision-making for the international investor, one which the purely domestic investor does not contend with. But he is only fooling himself. By blinding himself to the currency factor and investing only in the domestic economy and currency, the parochial investor, just as surely as if he were investing in that currency from abroad, is losing purchasing power if his own currency is declining.
So there is no advantage—not even one of simplicity—in avoiding international diversification. On the contrary, by opening one's eyes to the whole world, one sees more—and better—opportunities. I am certainly not suggesting that every investment abroad is better than its US counterpart, but, simply, that an international investor, who includes the United States as well as other countries among the base from which to select investments, will usually be more successful.
Adrian Day, a British citizen living in Washington, D.C., is executive editor of Personal Finance newsletter and editor of two investment newsletters on the Caribbean region. This article is adapted from his book Investing without Borders.