Question

Given a diversified international bond portfolio, does inter-national (specific currencies/countries) or intra-national (specific bonds/durations within a country/currency) capital allocation/weights matter more? Why or why not?

Answer 1

The goal of diversification is not necessarily to boost performance—it won't ensure gains or guarantee against losses. Diversification does, however, have the potential to improve returns for whatever level of risk you choose to target. This way, even if a portion of your portfolio is declining, the rest of your portfolio is more likely to be growing, or at least not declining as much.

When it comes to your bond investments, consider varying maturities, credit qualities, and durations, which measure sensitivity to interest-rate changes.

An international portfolio is a selection of stocks and other assets that focuses on foreign markets rather than domestic ones. If well designed, an international portfolio gives the investor exposure to emerging and developed markets and provides diversification. This type of portfolio can carry increased risks due to potential economic and political instability in some emerging markets, There also is the risk that a foreign market's currency will slip in value against the U.S. dollar.

International Portfolio Advantages:-
1).May Reduce Risk:- Having an international portfolio can be used to reduce investment risk. If U.S. stocks underperform, gains in the investor’s international holdings can smooth out returns. For example, an investor may split a portfolio evenly between foreign and domestic holdings. The domestic portfolio may decline by 10% while the international portfolio could advance 20%, leaving the investor with an overall net return of 10%. Risk can be reduced further by holding a selection of stocks from developed and emerging markets in the international portfolio.
2).Diversifies Currency Exposure:- When investors buy stocks for an international portfolio, they are also effectively buying the currencies in which the stocks are quoted. For example, if an investor purchases a stock that is listed on the London Stock Exchange, the value of that stock may rise and fall with the British pound. If the U.S. dollar falls, the investor's international portfolio helps to neutralize currency fluctuations.   
3).Market Cycle Timing:- An investor with an international portfolio can take advantage of the market cycles of different nations. For instance, an investor may believe U.S. stocks and the U.S. dollar are overvalued and may look for investment opportunities in developing regions, such as Latin America and Asia, that are believed to benefit from capital inflow and demand for commodities.

International Portfolio Limitations:-
1).Political and Economic Risk:- Many developing countries do not have the same level of political and economic stability that the United States does. This increases risk to a level that many investors don't feel they can tolerate. For example, a political coup in a developing country may result in its stock market declining by 40%.
2).Increased Transaction Costs: Investors typically pay more in commission and brokerage charges when they buy and sell international stocks, which reduces their overall returns. Taxes, stamp duties, levies, and exchange fees may also need to be paid, which dilute gains further. Many of these costs can be significantly reduced or eliminated by gaining exposure to an international portfolio using ETFs or mutual funds.