Global Investment Risk
Important global risk factors to consider
By
Justin Kuepper
Updated on May 4, 2022
Reviewed by Marguerita Cheng
Fact checked by
Hans Jasperson
In This Article
What Is Global Investment Risk?
Measuring Global Investment Risk
Is Global Investing Worth the Risk?
The Bottom Line
PHOTO:
ERHUI1979 / GETTY IMAGES
Global investing has become increasingly important as American
companies account for a smaller and smaller portion of global
revenue and profit. As of April 2022, domestic equities on U.S.
exchanges accounted for nearly 42% of global market
capitalization.1 The leading mutual fund providers recommend about
40% allocation to non-U.S. stocks.2
In this article, we will look at the risks associated with global
investments and whether the benefits outweigh those risks.
Key Takeaways
Global investment risk encompasses many different
international risk factors, including currency risks, political
risks, and interest rate risks.
Currency risk is associated with fluctuations in a foreign
currency relative to the U.S. dollar.
Political risk is associated with foreign governments and
politics; for instance, political changes may lead to business
losses.
Interest rate risk consists of changes to monetary policy; an
increase in interest rates could have a negative impact on the
value of financial assets.
What Is Global Investment Risk?
Global investment risk is a broad term encompassing many different
types of international risk factors, including currency risks, political
risks, and interest rate risks. International investors should carefully
consider these risk factors before investing in global stocks.
The three major global investment risks include:
Currency Risk
This risk is associated with fluctuations in a foreign currency relative
to the U.S. dollar. For example, a foreign company may report
25% earnings growth, but if its local currency depreciates by 10%
relative to the U.S. dollar, the real growth rate is just 15% when the
profits are converted back into U.S. dollars.
Political Risk
This risk is associated with foreign governments and politics. For
example, Brazil's Petrobras was involved in a corruption scandal that
led to jail time for several company executives and high-profile
politicians, including the popular former President Luiz Inácio Lula da
Silva. The scandal contributed to catastrophic losses for the
company from 2014 to 2016, including $10 billion in losses in 2015
alone.3
Americas Quarterly. "Brazil’s Petrobras: Not Dead After All."
Interest Rate Risk
This risk consists of unfavorable changes to monetary policy. For
instance, an emerging market economy may decide that it is
growing too quickly and act to contain inflation by hiking interest
rates. These dynamics could have a negative impact on the value of
financial assets that are priced based upon those interest rates.
The best way to mitigate global investment risk is through
diversified global portfolios. For example, the all-world ex-US funds
provide exposure to a variety of different countries and asset
classes around the world, which mitigates the risks associated with
any individual country.
Measuring Global Investment Risk
There are many different ways to quantify global investment risk,
including both quantitative and qualitative measures. International
investors should consider a combination of these approaches when
evaluating global investment risk.
The most common quantitative risk measurements include:
Beta
Beta measures an investment’s volatility compared to a benchmark
index. For example, U.S. investors may measure the volatility of
foreign stocks by comparing it to the S&P 500 benchmark index via
a beta coefficient. Higher betas represent more volatility.
The Sharpe Ratio
The Sharpe Ratio measures the risk-adjusted return of a fund over
time. The ratio is calculated by dividing a fund’s average return
minus the risk-free rate of return by the standard deviation. Higher
Sharpe Ratios present a better risk-adjusted return.
Global investment risk may also be qualitatively assessed using
methods like:
Credit Ratings
They provide insights into a country’s credit quality. For example, a
country that has a low credit rating may not have the flexibility
needed to spark growth, which could lead to a decline in equity
valuations.
Analyst Ratings
These may provide specific insights into individual international
equities. Oftentimes, these ratings include price targets and other
factors to consider, although sell-side analyst ratings should be
taken with a grain of salt.
Investors should consider how these factors play into their
portfolios. Retirement portfolios may want to stick to less volatile
stocks, while younger investors may want to consider adding
volatility since they may provide greater long-term return potential.
Is Global Investing Worth the Risk?
Global diversification helps lower average portfolio volatility over the
long term. In the short term, investors can also participate in
whichever regional market is outperforming. The U.S. may lead the
world during some periods, but there are invariably other periods
when another country or market will post the best returns. For
example, exposure to diversified non-U.S. equities during the mid-
1980s would have outperformed domestic-only portfolios. 4
Currency movements may also help enhance diversification since
they aren’t correlated with equity performance. A lower correlation
with U.S. equities means that investors may have more even returns
over time.
The Bottom Line
Global investing has become increasingly necessary over time, but
investors should carefully consider global investment risks. The
good news is that there are many different tools available to
measure these risks and ensure the right mix for any portfolio.
Vanguard recommends investing about 40% of a portfolio's stock
allocation in international stocks, and 30% of the portfolio's bond
allocation to international bonds. For example, if a portfolio has 30%
of its assets invested in stocks, 40% of 30% would equate to an
international stock allocation equaling roughly 12% of the portfolio,
and so on.2
The Balance does not provide tax, investment, or financial services
and advice. The information is presented without consideration of
the investment objectives, risk tolerance, or financial circumstances
of any specific investor and might not be suitable for all investors.
Past performance is not indicative of future results. Investing
involves risk, including the possible loss of principal.
