Globalization has become such a fact of life that we forget how recent a phenomenon it really is. While today’s investors don’t think twice about investing in foreign markets, not all that long ago it was far less common. For much of history, investors have tended to stay in their home markets, building portfolios of domestic securities denominated in their local currency.
There are a number of reasons. Even had they desired it, before globalization access to foreign investments was difficult and expensive. More importantly, people tended not to see the need. This has changed. Today we know that diversifying abroad is one of the best ways to protect and even enhance portfolio returns.
Spreading risk, increasing opportunity
Well first of all, it helps avoid the pitfalls of “home bias” (defined as the overreliance on domestic investments in a portfolio).
“Home bias” has many pitfalls. It over-exposes investors to the economic cycles in their home market. As the macroeconomic situation either improves or deteriorates, so too will many of the country’s securities. It also robs investors of opportunities: whether the opportunity to take advantage of benign economic conditions elsewhere, or the opportunity to access a larger universe of titles (and hence opportunities).
This is mostly common investing sense: concentrating in any one market, domestic or foreign, adds risk. By adding diversification, globally oriented portfolios spread the risk around, reducing it overall. That is why in today's globalized market, where it has become extremely easy to invest in foreign markets, investors are piling on.
There’s an index for that
One of the easiest ways to access the opportunities in foreign markets is through ETFs. With index funds in markets and asset classes all over the world, they offer access to a huge universe of opportunities to cater to almost any investment style, with high liquidity and at a low cost.
Internationally oriented index investors do however have to worry about currency risk. For this reason, ETF investors are increasingly turning to currency-hedged ETFs, which have built-in hedges that shield investors from foreign exchange loss on their positions.
It's like getting the best aspects of travel abroad without leaving the comforts of home.