tr123 wrote:What are the considerations when deciding what percentage of one's stock holdings to allocate to international stocks?
My thoughts (please correct me if I am wrong):
Two reasons to invest internationally:
- you diversify country risk to avoid significant underperformance.
- you increase your opportunity set to earn good returns.
Three methods to construct a portfolio
- naive diversification
- active strategy
- passive strategy
To choose an arbitrary fixed allocation ("30% international stocks") is neither an active nor a passive strategy. It is naive diversification IMO (which isn't necessarily bad).
An active investor picks country markets or international stocks like domestic stocks. (Currency risk is an input variable for both domestic and global investors)
Bloomberg Video, David Herro (Oakmark Funds) on Stocks, Investment Strategy, March 28, 2013
Investors should place money where there is a return calling for it...if international stocks for some reason are more underpriced than domestic stocks than you should be more than 50% international. If they are about the same...maybe 30, 40, 50%...it all depends on relative valuations...
Another active investor could hope that the past predicts the optimal allocation.
We can think of two extreme and presumably unrelistic scenarios:
-If all investors invested globally and if market prices were set by global investors the 'representative investor' (and passive investors) would hold the global cap-weighted market portfolio.
Country risk could disappear, correlations between country markets would tend to be high, and all stocks were priced versus global betas.
-If the market prices were set by domestic investors, country risk would be diversifiable and the correlation between country markets would tend to be low.
You don't need to own all US stocks to diversify away the unsystematic risks of US stocks. And you wouldn't need to own all country markets to diversify away country risks (although it wouldn't be bad).
A "passive" investor could copy the average asset allocation of all domestic global investors who have similar risk profiles.
That's the theory IMO. In practice, the differences may be unpredictable and the results may be similar.