Wednesday, December 5, 2007

International Investing

Question: Do you have any international investments in your covered calls portfolio?

If you're like many investors, the answer is "No". This article presents a case for not only including exposure to international equities, but also for making them a significant portion of your covered call assets.

The primary basis for including non-U.S. (i.e. International) equities relates to the concept of portfolio diversification. To put diversification in context, here are some related comments from a prior blog post:
"There are three primary components related to diversification: Asset Allocation, Sector Diversification, and Position Sizing -- Each of these will be discussed in greater depth in future postings. For now, this advisor will simply present my own guidelines for diversification:
(a) Asset Allocation
Domestic Equities – 70% (roughly 40% large cap and 30% mid/small cap)
International Equities – 25%
Fixed Income – 0%
Cash – 5%
Note: This advisor maintains an aggressive investing approach. You might be more conservative in your own portfolio with a lower percentage of equities and a higher percentage of fixed income and cash.
(b) Sector Diversification - Invest in at least five of the six sectors listed below:
Consumer (includes both Consumer Staples and Consumer Discretionary)
Energy (including Materials)
Health Care
Industrial (including Telecom and Utilities)
Information Technology
(c) Position Sizing – No single position more than 20% of total. This is the same guideline used by this advisor’s broker, Charles Schwab & Co."

As you notice above, this advisor previously recommended that approximately 25% of ones portfolio be committed to international equities. This may seem somewhat high to some of you; however, the international component in my current asset allocation recommendation is actually higher, namely:
U.S.-based equities -- 69%
International equities -- 31%

Further breakdown by region:
U.S. Large Cap (>$5 billion market cap) -- 44%
U.S. Small & Mid Cap (<$5 billion) -- 25%
Europe -- 16%
Japan -- 5%
Emerging Markets(primarily Asia/Pacific ex-Japan & Latin America) -- 7%
Canada -- 2%
Australia -- 1%

It is very important to understand that the percentages above are by no means rigid percentages. Rather they are simply a baseline from which adjustments are made based on regional and country-specific valuation judgments. For example, my current asset allocation preferences are:
U.S. Large Cap -- Overweight
U.S. Mid/Small Cap -- Marketweight
Europe -- Underweight
Japan -- Overweight
Emerging Markets -- Overweight
Canada -- Underweight
Australia -- Underweight

Hence, my current target allocations might approximate:
U.S. Large Cap -- 50%
U.S. Mid/Small Cap -- 25%
Europe -- 8%
Japan -- 7%
Emerging Markets -- 10%

The asset allocations in the Covered Calls Advisor Portfolio (CCAP) at the current time are as follows:
U.S. Large Cap -- 70%
U.S. Mid/Small Cap -- 9%
Europe -- 0%
Japan -- 0%
Emerging Markets -- 21%
As you can readily see, there is a large discrepancy between plan and actual allocations in current CCAP holdings. Going forward, I intend to do a much better job of practicing what I preach as far as asset allocation is concerned.

Unfortunately, the options market in international equities is much less liquid than for U.S.-based equities. In addition, the availability of financial information as well as financial analysts' assessments are also much more scarce for most international equities -- but valuable information and analysis is now growing rapidly. Also, regional and single-country ETFs can often be a viable alternative to individual companies in making international investments in our covered calls portfolios.

I would like to re-iterate and expand on this comment from a prior post: "This advisor maintains an aggressive investing approach."
You might be more conservative in your approach to covered calls investing and that is fine. But being more conservative does not imply that international equities should be excluded from ones portfolio. To the contrary, including a generous international investing exposure is a desirable reflection of our increasingly global economy and may actually help to reduce overall portfolio risk.

Finally, if you would like a country-by-country percentage breakdown for Europe and Emerging Markets, email me at and I will be happy to forward it to you.

Regards and Godspeed

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