The Secrets Behind International Stock Portfolio Allocation

Recently I discussed with a friend how little coverage and focus there was on international investing. Research and even brokerages are hard to come by if you want to invest on your own.

What there is no shortage of is ETFs and money managers offering investment products and offering to do it for you. It’s also common for advisors to say you need to invest a portion of your portfolio in international funds and stocks. But, just how much of your portfolio should you allocate to international stocks?

30% of a stock portfolio should be allocated to international funds or stocks. It can range from 15-50% if you are a bottom up individual stock investor. Retirement portfolios should only invest in international funds, not stocks, for tax benefits from dividends.

There is no easy answer to how much international allocation you should have in your portfolio and it can depend on a myriad of factors. As an individual small cap stock investor my percentage fluctuates wildly over time.

If you are curious about the secrets to international individual stock investing, follow along as I lay out strategies and reasoning behind why you should invest internationally and how much to allocate.

Why You Should Invest Internationally

A common argument for investing internationally is that it decreases volatility. This is a strange way to explain it, but essentially it lowers your portfolio swings. While this may be true it is also true that investing in value wherever it is in the world will protect your portfolio’s downside.

International company’s also account for more than 50% of the worlds capitalization according to sites like MarketWatch.

This leaves an entire world of stocks that are largely undiscovered and provides ample opportunities for value investors to profit. Famous investors like John Templeton and Peter Cundill found amazing deals as international investors and analysts are not as savvy as those in the United States.

International investing remains very nuanced as very few brokers allow access to specific markets. One of the few that has a wide array of international offerings is Interactive Brokers. By clicking the aforementioned affiliate link you can open an account and earn free stocks.

Small Cap Stocks Provide Zero International Diversification

John Bogle over at Vanguard sees international investing as unnecessary, since large multinational corporations take care of the international diversification for you. The problem with this is I’m strictly a small cap investor so I don’t have the luxury of this type of diversification.

John Bogle’s words leave a lot to be misinterpreted.

Relying on multinationals for true international diversification sidesteps smaller cottage industries that do very well in their local markets. Imagine missing out on Nintendo or Anime related stocks, soft culture that has gone global originating in Japan or luxury brands that originate in Europe.

Bottom Up Individual Stock Investing

Bottom up investing looks at specific company’s and their situation rather than the overall economy.

This style of investing I believe is the best way to beat the market. It takes advantage of limited knowledge and delves deeper in the differences between companies. Looking for edges certain company’s have against their competition.

These edges may include:

  • Valuable hidden assets.
  • Better manufacturing processes.
  • Happier workforce.
  • Efficient management.
  • Divergent diversification. (Companies don’t often fit perfectly in specific sectors).

Because bottom up investors generally don’t take the overall macro-economic picture into account but rather look at the value of individual company’s they really have no interest in specifically hitting international portfolio allocation targets.

Rather as is the case with my investments I am currently over 50% invested in international companies. While I wouldn’t suggest this for every investor between 40-50% is a good international allocation based on the overvaluation of many US stocks.

Venture Capital Hurts Small Cap Investments in America

Venture capital is how small ideas are funded in the United States. Specifically in silicon valley. Private investors often get in on the small companies and drive up their valuations to extreme levels before they ever make it to public markets.

Venture capital bars many smaller investors from investing in these company’s as you have to be an accredited investor to take part.

An accredited investor needs to have over a million dollars in liquid capital. This does not include your primary residence.

Because there is so much wealth in these private venture capital companies, when they decide to go public their valuations are already sky high. They blow past small cap status straight to mid cap. This is limiting the number of investable small caps in the tech space.

According to the world economic forum venture capital is acutely allocated to the United States with Europe and China trailing behind. Interestingly enough Japan is not even on the map! The third largest capital market on the planet!

The rankings are in this order:

  1. United States
  2. Europe
  3. China
  4. India
  5. Israel
  6. Canada

This leaves Japanese startups with little option besides listing their company on Japanese markets allowing investors to profit where venture capital is absent.

If you are more interested in Europe, it’s still a fraction of what the United States commands and there may be many more opportunities for small cap investment than at home.

Individual International Dividend Stocks and Retirement Accounts

If you decide you want to invest internationally in your retirement portfolio it’s best not to invest in individual dividend paying stocks.

The reason behind this strategy is countries will automatically take a portion of the dividend paid out to allocate to taxes. There are a few ways to recoup these costs outside of a retirement portfolio:

  • Get a tax deduction for foreign dividends.
  • Get a tax credit for foreign dividends.

This only applies to countries that have a tax treatise with the United States. Make sure you check to see if the country your investing in has one before investing. Generally, most G7 countries have this treaty so its beneficial to stay focused on developed markets.

International Funds and Management Fees

International funds are the way to go in order to retain your taxes from dividends paid to foreign governments. This is because the ETF or fund can deduct the tax themselves and write it off as a business expense.

This is beneficial for those who don’t want the headache it may not always be the best option. If a Fund is charging a hefty management fee, it may cut into those tax savings.

International funds typically charge higher fees because of the difficulty of investing overseas. Not to mention foreign exchange worries. Many funds attempt to hedge a currency in order smooth out the returns for investors and charge a higher fee as a result. Although the benefits to the investors are nearly non existent.

How Do Famous Investors Invest Internationally

I find it odd how many famous investors have home country bias. It may just be the familiarity or that by the time they are ready to invest internationally they have too much money to find the bargains.

Nonetheless there are many famous investors who invested internationally.

  • Peter Cundill
  • Warren Buffett
  • Peter Lynch
  • John Templeton

While their main focus obviously was never to invest internationally their bottom up investing approaches found them investing where the bargains were.

Warren Buffett most recently invested in Japanese trading companies because of their extreme valuation, and has often been quoted, “I would certainly not be a seller of Japanese stocks.”

ETF International Diversification

For many it may make sense to just invest in a basket of international ETFs. This can be done very simply by investing in an emerging market ETF and a developed market ETF. Alternatively you can just invest in a world market fund.

Some funds include:

  • Vanguard emerging market VWO
  • iShares emerging market EEM
  • Vanguard total international stock VEU
  • Vanguard developed market VEA
  • iShares total international IXUS

While these will get you international exposure to larger companies on the international landscape they tend to fall short on short caps. The only way to invest in small caps in international funds is to buy country or regional specific ETFs.

I talked about DFJ my favorite Japanese small cap ETF on Seeking Alpha

Unlocking the Mystery on International Investing

International investing may seem mysterious, but it is a major part of a developing global economy. Many industrials have been offshored to other countries leaving few options for domestic investors.

It can be difficult traversing the waters and wading into international stocks but it’s becoming easier every day. If you want to learn more about international investing and bottom up style investing you can follow my stock analysis and net net portfolio reports.

Bryan Shealy

Bryan Shealy is an active value investor. He currently focuses on the small and micro cap stock market looking for bargains. He has written content for Seeking Alpha, Net Net Hunter and Broken Leg Investing.

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