How closed-end funds and international diversification can enhance your portfolio
“Home bias” can sizably limit an investor’s portfolio by reducing its ability to capture additional sources of return.
International investments can add more sources of returns, reduce volatility and mitigate risk to portfolios that are skewed toward domestic assets.
Investors can diversify internationally through a variety of investment vehicles, but each of them has different advantages and risks of which investors should be aware of.
Region- and country-specific closed-end funds can help investors tailor exposure to certain markets based on individual risk/return objectives.
The expanding investment universe
Leaving bias at home
The benefits of investing internationally have been well documented, and yet investors have continued to invest a disproportionate amount in stocks listed on their home market. This phenomenon, known as home bias, is still prevalent with investors today.
In fact, recent data show that although non-U.S. equities comprised 51% of the global equity market, U.S. investors invested only 27% of their portfolios, on average, in international stocks.1 Clearly, many American investors have been overlooking opportunities abroad.
Portfolios with diversified assets may be able to withstand a greater variety of market conditions because risk is spread among different markets with different market cycles. This can potentially stabilize portfolio returns over the long term.
In addition, diversifying internationally is a way for investors to be early movers in emerging economies that may be more volatile but could experience faster growth than developed economies.
Targeting countries and regions
Investors may be trepid when adding international investments to a portfolio because deciding where to start is not an easy feat. One of the ways closed-end funds can help in this area is the availability of country and region-specific funds. This enables investors to customize their portfolio to meet their goals.
Country-specific funds give investors the ability to customize their international portfolios based on convictions about individual countries. Regional closed-end funds make it possible to gain exposure in areas where a country-specific fund may not be available. Either way, closed-end funds can be a flexible and practical way for investors to enter international markets and diversify their portfolio with global assets.
In a recent Aberdeen Asset Management survey, 52% of those polled said they would recommend a closed-end fund in order to gain exposure to a certain asset class, sector or country.2
Knowing where to go
Reaping the benefits of international diversification first requires investors to look beyond their comfort zone to opportunities outside of their domestic market. The next important step requires an understanding of what is happening abroad.
The world has changed dramatically over the past few decades. The Morgan Stanley Capital International (MSCI) indices provide an example of how investable global opportunities have greatly expanded over the last 40 years. In 1970, when MSCI was beginning to establish its global stock indices, its global universe comprised 16 countries in only the main developed markets.
Economies such as China and India have been growing at a faster pace than the U.S., a decoupling which has created new investment opportunities plus new demand for products and services. Even through the global financial crisis of 2007-2009, both China and India continued to experience significantly positive growth, while the economies of the U.S. and most of the developed world contracted.
History of GDP annual growth (%) in the U.S. compared to China and India
Source: World Bank April 30, 2015. For illustrative purposes only.
Drilling down, the U.S. has also been surpassed in growth in the corporate sectors by some global countries. Despite the U.S. being relatively overweight in information technology (IT), some of the most innovative and disruptive IT companies have come from Europe, Japan and Korea. Even with the U.S.’s dominance, the IT sector outside of the U.S. market is substantial, and long-term opportunities still exist.
U.S. share of world: sector breakdown
Source: MSCI, April 30, 2015. For illustrative purposes only.
Different regions around the globe have different sector concentrations, and having investments that center around just one country or region can result in a portfolio that is overweight to one or more sectors. For example, although the MSCI U.S. All Cap Index accounts for a significant proportion of the global equity investment opportunity set, it is not evenly spread across all sectors. While the U.S. All Cap Index accounts for over 70% of the global IT sector, it accounts for much smaller proportion in areas such as telecommunications and materials.
Even through the global financial crisis of 2007-2009, both China and India continued to experience significantly positive growth, while the economies of the U.S. and most of the developed world contracted.
Investing internationally gives investors the opportunity to take active positions in sectors of the world economy where the U.S. may be relatively underweight or overweight. For example, Australia is rich in natural resources and has benefited from the seemingly insatiable demand from emerging markets. U.S. investors can therefore access the materials sector far more easily if they widen their horizons to include countries with more exposure to materials.
Entering these countries through a closed-end fund is one way investors can take advantage of growing sector exposure and growth abroad.
Expanding your horizons with Closed-End Funds
Anatomy of a closed-end fund
When looking for ways to invest internationally, the amount of choices can be daunting. Closed-end funds can be an efficient way to gain exposure to international regions.
Because closed-end funds issue a fixed number of shares, closed-end fund managers have a stable pool of capital to use when investing for the long term. With a stable level of assets to work with, closed-end funds can remain fully invested in less liquid markets over market cycles.
Another appealing feature of closed-end funds is their ability to trade either at a premium or a discount to net asset value (NAV) or their underlying portfolio. If trading at a discount, investors can buy shares at a lower price while granting them access to international investments and actively managed strategies.
If trading at a discount, investors can buy shares at a lower price while granting them access to international investments and actively managed strategies.
Premiums and discounts tend to vary throughout the year (see Figure 3) because prices are established by the competitive markets. This reflects buying demand and selling supply of shares as it exists in real-time in the real world. These variations in price are influenced by investor perceptions, fears and needs for specific types of investments, among other factors, according to the Closed-end Fund Association.
Average monthly premiums and discounts for closed-end fund peer group*, August 2012-August 2015
Source: Morningstar, August 31, 2015. For illustrative purposes only. *Peer group is Morningstar US Closed-End Funds
The world we live in today is complex, but investing internationally doesn’t have to be.
At Aberdeen Asset Management, our teams of highly experienced Financial Explorers are on a relentless quest around the globe for long-term growth opportunities. They live in the countries in which they invest and pair global perspective with regional focus.
From the Far East to the Middle East, we believe that opportunity knows no boundaries— so why should your portfolio?
Download the full white paper to learn more about how Aberdeen Closed-End Funds can open your world to new investment opportunities.
1 “Global equities: Balancing home bias and diversification.” Vanguard, February 2014.
2 Aberdeen Asset Management survey of more than 100 financial advisors and investors at a closed-end fund conference, October 12, 2015.
Closed-end funds are traded on the secondary market through one of the stock exchanges. The Fund’s investment return and principal value will fluctuate so that an investor’s shares may be worth more or less than the original cost. Shares of closed-end funds may trade above (a premium) or below (a discount) the net asset value (NAV) of the fund’s portfolio. There is no assurance that the Fund will achieve its investment objective. Past performance does not guarantee future results.
International investing entails special risk considerations, including currency fluctuations, lower liquidity, economic and political risks, and differences in accounting methods; these risks are generally heightened for emerging market investments. Equity stocks of small-cap companies carry greater risk, and more volatility than equity stocks of larger, more established companies. There are also risks associated with investing in a single country or single region fund.
Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).
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