In an increasingly integrated world, there is no denying the need to invest internationally. Fortunately, investment tools to include international mutual funds now make this a lot easier.
There are different types of mutual funds to suit the style, needs and goals of international investors.
- Regional mutual funds: These funds invest in certain regions of the world. For example, an investor who sees good potential for growth in the Asian Pacific region can invest in a fund which specializes in that area.
- International mutual funds: This is a fund invested only outside of the country of residence of the person buying shares. For example, investors in the US who put money into international mutual funds with have all their money invested outside of the US.
- Global mutual funds: These funds invest globally without irrespective of the country. Therefore, those who put money into these funds will likely be investing partially in their home countries.
- Global sector funds: This type of fund invests solely in a particular industry or economic sector. Those expecting good returns in an industry such as biotechnology can use these funds to get a part of these returns wherever they may occur.
Reasons to invest internationally in mutual funds
Even though financial and other markets are increasingly integrated, rates of growth between different countries can be huge. Investing internationally allows investors to take advantage of growth and profits outside their home countries. For example, emerging markets (which have a lot of catching up to do) often have growth rates much greater than those of more mature markets (albeit greater risk too).
In addition, when economies move in opposite directions, international investing can help make returns steadier. Besides, economic activity is increasingly spread across the world, and it is not wise to limit oneself to any one country.
Drawbacks of international investing
The fluctuations of equity and other markets is enough to make all but the most hardened investors weary. With international investing, there are also currency fluctuations that will likely add more volatility to investing. Furthermore, with the world economic integration growing, economies increasingly move in tauten. Therefore, the steadying effect on returns that international mutual funds once offered has diminished.
In addition, particularly when invested in emerging markets, there may be political uncertainties, conflicts and other problems that could have an effect.
Understanding how currency fluctuations can affect returns
Currency fluctuations are the greatest single factor separating international investing from its domestic variety and need to be understood. Unless two nations use the same currency, mutual funds invested overseas will have to convert the investment money they receive into another currency. This can either help or hurt returns depending on the way the currency moves.
For example, $100 is invested in Japanese stock at 100 yen to the dollar and 10,000 yen worth of stock is purchased. If the value of the dollar drops to 80 yen to the dollar, that 10,000 yen of stock will now be worth $125 if sold. If the dollar rises in value to 120 yen to the dollar, the $100 in stock purchased will not only be worth $83 dollars (everything else remaining constant in both these examples).
While this obviously makes it best to invest in international mutual funds when a home currency is strong and sell when it is weak, the direction currency markets will take can be as hard to predict as stock markets. Some funds using hedging to mitigate this risk, but it is generally a risk that simply must be factored in.
Depending on the tax laws, money invested in overseas funds may be subject to taxes in the country it is invested in. While foreign taxes on investments are usually not high, they will automatically be deducted from the fund’s returns. Generally, these taxes paid abroad can count as a tax credit for domestic taxes if the countries have a tax treaty.
With the extra transaction and other fees involved in global investing, one can expect higher costs with international mutual funds. However, a good fund should have the economies of scale to keep these expenses reasonable.
One way to control the costs involved in international investing is through ETFs which always have lower fees (see ETFs vs. mutual funds). However, some may want more actively managed investments for their overseas portfolios.
Top international mutual funds
T. Rowe Price, Vanguard, Laudus and others all offer a lot of good mutual funds. Those looking to buy a mutual fund should do extensive research and choose carefully with factors to include long-term performance and expenses ranking high in any decision.