How Closed-End Funds 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.
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.
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.
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.