What Are International Equity Funds?

Definition and Example of International Equity Funds

Like other mutual funds, international equity funds are companies that purchase a variety of stocks based on a specific investing strategy, and then sell that blend of shares to investors. The difference with an international fund is that all of its stocks are in companies based outside the U.S.

• Alternate name: International mutual funds, international stock funds

A report by Vanguard states that non-U.S. companies represent around half of the global market capitalization. International funds offer investors opportunities to diversify their portfolios and capitalize on growth in markets throughout the globe. However, they carry greater risk than most domestic investments, due to factors such as exchange rates, political unrest, and different levels of liquidity.

How International Equity Funds Work

Owning international equities may help boost your returns. Historically, international stock markets have actually tended to outperform U.S. markets, leading many advisors to recommend investing between 30% and 50% of a portfolio internationally. Because U.S. markets and international markets don't always move in the same way, owning international stocks can help reduce a portfolio's overall risk.

International Equity Funds vs. Global Equity Funds

International equity funds are not to be confused with global equity funds, which are made up of stocks of companies anywhere, meaning both U.S. and non-U.S. companies.

If you invest in a global fund to get international exposure, you may find that the majority of the fund's holdings are actually in U.S. companies. You may even already own those companies in another equity fund. If you want true diversification, you should be looking for international equity funds.

Types of International Equity Funds

There are two types of international funds: those that invest in developed countries, and those that invest in emerging markets. Emerging markets are countries or regions that have less-developed economies but a lot of potential for growth. But because most of these countries, or their markets, are not highly regulated, there can be risks involved with investing there. With greater risk, however, often comes a greater potential return. Long-term growth potential for emerging markets is over 10%, compared to 6% for the S&P 500.

Typically, the international equity funds that are available in a 401(k) plan are large-cap equity funds that invest in developed countries, such as Japan, Germany, and the United Kingdom. If a plan does offer emerging markets equities exposure, it will probably be in a separate fund.

Are International Equity Funds Worth It?

While international equities can help you diversify your portfolio, and come with a high return potential, as with any investment there are important issues to be aware of before you invest. For instance, there are several types of risks associated with investing internationally:

• Currency risk: The value of the dollar will differ from the values of the fund's underlying currencies. That can help to boost your returns when the dollar is weaker, regardless of how the investments are performing, but when the dollar is strong, it can have the opposite effect.
• Political risk: The stability and oversight of governments matter to the markets. Anytime you are investing in a foreign country (or even your own), there is a risk that the economy or government may face unforeseen troubles.
• Liquidity risk: The U.S. stock market is fairly liquid, meaning that a large volume of stocks is bought and sold every day. When the average investor wants to sell a stock, there's usually a willing buyer. What if there were no buyers, and you had no choice but to hold on until one came along? That's an illiquid market. Many foreign markets have lower trading volumes than U.S. markets.

There are other risks to consider with international funds. Are the accounting and reporting standards as high as those in the United States? Are the fees for investing in those stocks greater than those charged to invest in U.S.-based stocks? A well-managed fund will anticipate and understand those risks to some extent.