In 2022, U.S. stocks made up approximately 55% of the world’s public equity market, with the remaining 45% constituting foreign stocks. Owning both international and domestic securities can help quell portfolio volatility and increase diversification.

Traditionally, non-U.S. markets have not moved in lockstep, reflecting different economic stages and situations. Additionally, investors may choose to fill portfolio gaps by gaining exposure to countries or markets that are growing rapidly due to comparative advantages or long-term secular trends.

Entering Foreign Countries With Mutual Funds and ETFs

Building a globally diversified portfolio using stocks is possible but not easy. Mutual funds and exchange-traded funds (ETFs) offer better and simpler options than buying shares of foreign firms on U.S. exchanges through American depositary receipts (ADRs). International equity mutual funds and ETFs hold shares of companies listed and domiciled in different countries. Combined, this can offer geographical, currency and sector diversification and dampen risks related to a single stock or the instability of a single country.

Choices are bountiful. Screening for international equity with the A+ Investor Mutual Fund and ETF Screeners identified around 3,700 mutual funds and 550 ETFs. This universe represents both indexed and actively managed funds. Large-capitalization international equity funds were highlighted in the April 2022 AAII Journal; these tend to have a majority of their assets in foreign markets.

Here, we cover global, regional and country-specific funds. Global or world funds typically include allocations to both foreign and U.S. equities. Regional funds focus on a continent or geographic area. Per their moniker, single-country funds offer targeted exposure to one nation.

Further carving this out, funds can focus on market capitalization, value or growth, dividends, factors or even a theme such as sustainability. Currency and currency-hedged ETFs exist to mitigate exchange rate risk.

Risks Associated With Crossing Borders

Fluctuating exchange rates will impact the value of an investment in U.S. dollars even if the security’s price remains unchanged in its home currency. If the U.S. dollar’s value falls (rises) relative to other currencies, the returns of an international fund may be enhanced (diminished).

Diversification is the chief reason for investing in international funds. Major stock indexes and economies of different regions and countries are often not highly correlated with each other or with those of the U.S. Correlation measures the degree to which the returns of two different asset classes move together, and it can be helpful in assessing diversification. A correlation of 1.0 means they move perfectly in lockstep in the same direction, and a value of –1.0 means they move in opposite directions to the same degree. From 1970 through 2022, international stocks had a 0.67 correlation with U.S. large-cap stocks and a correlation of 0.53 with small-cap stocks, according to the Stocks, Bonds, Bills, and Inflation (SBBI) Yearbook. Summary statistics from the SBBI Yearbook also show that from 1970 through 2022, the Pacific region was riskiest with a standard deviation of 28.2%, compared to 17.2% for the U.S. The annual geometric return of the Pacific region for this same period was 8.6%, whereas the U.S. had a geometric return of 10.4%. Geometric means are useful when reviewing investment returns because they account for compounding that occurs from period to period.

Country risk can be assuaged by investing in funds that hold securities from many countries or in an assortment of single-country funds. Currency risk can also be dampened by choosing a fund that diversifies among countries.

Political turmoil and government actions that are not investor-friendly can present risks. Events in one nation can have a spillover effect and impact other countries. For example, after Russia invaded Ukraine, western European countries experienced surging inflation. State or governmental ownership in companies is common in many developed and emerging countries and is something for investors to keep in mind.

Developed, emerging and frontier markets are terms that investors will find when researching international funds. Countries in developed markets typically have high incomes, and are open to foreign ownership, free capital movement and efficient market institutions. Emerging and frontier markets are smaller and still developing; they come with great risk but also greater opportunities for economic growth.

Financial markets in some foreign countries are less active, less transparent and less regulated than others, which can make trading more cumbersome and costly. All mutual funds allow investors to buy or sell shares at each business day’s closing net asset value (NAV). Depending on the markets they target, ETFs targeting foreign markets can trade at larger premiums or discounts to their NAV relative to domestically focused ETFs.

U.S. domiciled ETFs with international exposure may have different liquidity characteristics than those with only domestic exposure. This is due to lack of pricing discovery when foreign markets are closed while U.S. markets are open.

Some international ETFs may have low trading volume or there may be low trading volume in the underlying securities held by the ETF. Finally, currency fluctuations may affect the trading and liquidity of ETF shares.

Key Data for Global, Regional and Country-Specific Funds

Tables 1 and 2 show the global, regional and country mutual funds and ETFs with the highest five-year returns. Five years emphasizes intermediate-term performance. Since risk is also a consideration, two risk measures are shown. The total risk index compares the standard deviation of returns for a given fund with that of all funds in the universe—bond, stock, domestic, international, allocation, commodities and alternative. The average risk index is 1.00. A value below 1.00 indicates lower risk relative to the overall universe. The category risk index compares the standard deviation of returns for individual funds with that of peers from the same category. Again, the average risk index value is 1.00. Total and category risk figures are based on monthly returns for the last three years.

Download the Excel spreadsheet of Table 1. 

Download the Excel spreadsheet of Table 2. 

Tax-cost and expense ratios are provided and discussed to give a comprehensive picture. The tax-cost ratio measures how much a fund’s annualized return is reduced by the taxes paid on distributions, assuming the maximum marginal tax rate. For example, a tax-cost ratio of 1.5% means that each year, on average, investors lost 1.5% of their assets to taxes.

Top Mutual Funds in the Group

The global, regional and country mutual funds shown in Table 1 are no-load. Institutional and adviser class funds were excluded.

The actively managed Vanguard Baillie Gifford Global Positive Impact Stock Investor fund (VBPIX) performed the best of this group over the last five years. Its 13.1% annualized return earned it an A+ Investor Grade of A.

Global high-quality growth companies that can deliver positive change in one of four areas is the focus of the fund. Specifically, the fund’s adviser assesses positive changes by considering social inclusion, environment and resource needs, health care and quality of life and the “bottom of the pyramid” (the needs of the world’s poorest populations).

The fund is highly concentrated: Nearly 53% of the portfolio is in its top 10 holdings, with 56.5% of its holdings invested in North America, followed by 22.8% in Europe and 12.6% in emerging markets. MercadoLibre Inc. (MELI), an Argentine online marketplace operator headquartered in Uruguay but incorporated in the U.S., is the fund’s largest holding. ASML Holding N.V. (ASML), a Dutch multinational firm that develops and manufactures machines used to produce computer chips, is the second-largest holding. Other notable holdings are Moderna Inc. (MRNA), Deere & Co. (DE) and Shopify Inc. (SHOP).

Vanguard Baillie Gifford Global Positive Impact’s category risk index of 1.35 ranks it among the 25 highest in the global large-cap growth category. The fund’s total risk index of 1.83 is the highest of all funds included in Table 1. On the other hand, it boasts the lowest expense ratio (0.59%) of all actively managed funds shown in Table 1. The only fund with a lower expense ratio, and the only index fund in Table 1, is the Vanguard Total World Stock Index Admiral fund (VTWAX). Its expense ratio is 0.10%.

T. Rowe Price Global Stock fund (PRGSX) is the second-best performer with a five-year return of 10.0%, earning it an A+ Investor Grade of A. The fund’s category risk index of 0.98 signals slightly below-average risk relative to its category peers. Its expense ratio of 0.82% is also below average and earns the fund a grade of B. (Most active funds in Table 1 have expense ratios greater than 1.00%.) Unfortunately, the fund is not tax-friendly, as its tax-cost ratio is one of the highest of the funds shown at 2.0%.

Note that Table 1 is limited to the top 30 performers over five years. Barely making the cut for this group are the Franklin Global Equity 1 fund (LMPEX) and the Chautauqua International Growth Investor fund (CCWSX) with five-year annual returns of 6.6% (grade of C) and 6.5% (grade of B), respectively. Chautauqua International Growth has the lowest tax-cost ratio, 0.2%, of all funds in Table 1. Both funds are actively managed and have expense ratios greater than 1.00%. As a global blend fund, Franklin Global Equity 1 has 73% of its holdings in North America. Apple Inc. (AAPL) is the largest holding followed by Microsoft Corp. (MSFT), Alphabet Inc. (GOOG) and ExxonMobil Corp. (XOM). Conversely, Chautauqua International Growth invests 88.3% of its portfolio in foreign stocks.

Top ETFs in the Group

The ETFs displayed in Table 2 are categorized as regional, country-specific, global large blend and global large value. Two top performers based on annualized five-year returns are iShares MSCI Denmark ETF (EDEN) and iShares Global 100 ETF (IOO). Both earned A+ Investor Grades of A with returns of 11.6%. Over the most recent three-year period, iShares MSCI Denmark returned 15.0%, nudging out iShares Global 100’s return of 14.5%. However, iShares MSCI Denmark has a higher total risk index of 1.46 compared to 1.18 for iShares Global 100.

Novo Nordisk A/S (NVO), which is a leader in diabetes medications, is iShares MSCI Denmark’s largest holding, at over 20% of the portfolio. [The ETF holds the Danish shares, which trade on the Nasdaq Copenhagen, whereas ADRs of the company trade on the New York Stock Exchange (NYSE) under the ticker symbol NVO.] DSV A/S, a supplier of transport and logistical services, is the second-largest holding at just over 8%. The ETF’s category risk index is 0.86, tax-cost ratio is 0.3% and expense ratio is 0.53%.

In comparison, iShares Global 100’s category risk index is 0.97, tax-cost ratio is 0.6% and expense ratio is 0.40%. Like Franklin Global Equity 1, Apple is the top holding at almost 14% of the portfolio. Apple is followed by Microsoft at 13%, and Amazon.com Inc. (AMZN) and Nvidia Corp. (NVDA), both at around 5%. Domestic stocks account for 73% of this ETF’s portfolio with 53% of the portfolio invested in the top 10 holdings.

For brevity, Table 2 only includes the top 30 five-year performers out of 232 ETFs in this group. The last ETF in the table is the Franklin International Low Volatility High Dividend Index ETF (LVHI). This ETF has a five-year

annualized return of 6.5%, an A+ Investor Grade of A. Franklin International Low Volatility High Dividend’s total risk index and category risk index are 0.76 and 0.64, respectively. Its tax-cost ratio is among the highest of foreign large value ETFs at 2.1%, while its expense ratio of 0.40% equates to an A+ Investor Grade of C.

A few other observations from Table 2 are that the WisdomTree India Earnings ETF (EPI) has the highest expense ratio at 0.84%, while the iShares Currency Hedged MSCI Japan ETF (HEWJ) has the highest tax-cost ratio at 3.8%. The lowest expense ratio is 0.07% for the Vanguard Total World Stock Index ETF (VT); its grade of a D for a 6.7% return over the five-year period reflects below-category-average performance.

Investor Considerations

Investors can conduct further research on individual global, regional and country-specific mutual funds and ETFs on AAII.com by typing the name or ticker symbol into the search. AAII’s Mutual Fund and ETF Guides, which are also available to AAII members, list all global, regional and country-specific funds and data is updated monthly.

Volatility is to be expected in emerging and frontier markets, and foreign investing should be a long-term commitment. No doubt, mutual funds and ETFs can ease the challenges of getting exposure abroad. Understanding a given fund’s specific foreign exposure will help you achieve desired diversification as well as manage risk. 

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