Help Explain Currency Risk in Intl Stocks

[rhymenocerous]

I was thinking about this issue the other day and thought I'd ask for some more clarification.  My understanding is that a US international stock mutual fund buys shares of foreign companies listed on different stock exchanges.  The shares for these companies are denominated in different currencies.  Thus, when the fund uses cash inflows to buy shares and outflows to sell shares, movements in exchange rates can either add to or detract from the movements in share price.  This only comes into play when the fund is actually buying and selling the shares, correct?

Another issue is that any global company will have issues with exchange rates that affect their earnings, and thus their share price, correct?  Why then do we recommend to invest only in US stock funds rather than international stock funds?  Is it because international stock funds have an extra "layer" of currency risk compared to US funds? Wouldn't currency movements that would hurt the returns of international funds also adversely affect global companies headquartered in the US as well?  Is this mostly time dependent as to when the buying and selling of shares occurs?

[melveyr]

A lot of the US companies that do business abroad hedge their foreign revenues back into dollars. Whereas a foreign company that does business in the US might be hedging their US business out of dollars back into the local currency.

[Ad Orientem]

Of the four economic conditions generally recognized as possible by PPers, "prosperity" is the only one that is not closely tied to a currency related event. So while there is some risk involved in owning foreign equities, I don't think it is huge. And in fact there is an argument that some foreign diversification in equities can add a level of protection against an extremely adverse currency event. Consider Japan's brutal drawdown in their stock market over the course of 20 years of deflationary depression. An all Japanese PP only barely broke even and by some calculations may have actually suffered slight losses. By contrast putting 10% of a Japanese PP's stock portion in a global index fund would have kept it in the black.

And of course holding a little foreign stock adds a hedge against severe inflation as well. I have long been of the view that a good strategy is to keep either 10% of your PP in international stocks or maybe just do 90% conventional HBPP and 10% VP consisting of a foreign index fund. Craig has also suggested that there is nothing inherently wrong with just using a cap weighted global index fund/ETF like VT for the stock part of your permanent portfolio.

But yes, there is an added level of risk. In a period of strong economic prosperity coupled with a strong dollar, a global index is likely to underperform an all US index. Hence my suggestion for going 90% HBPP and 10% VP (foreign index).

[smurff]

What global or international index fund/ETF do you recommend?

[Ad Orientem]

What global or international index fund/ETF do you recommend?

VT or VEU. Both are good and reasonably priced in their ER.