Investing abroad

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2. Risk and reward in foreign investment

Many academic studies have shown you can make more money with less risk by including foreign investments in your portfolio. This means that with the right mix of holdings, you can expect your annual returns to increase, while the swings in the value of your portfolio (i.e. its volatility) decrease.

The exact mix has varied over time and will doubtless continue to do so. But historically, it has consisted of around 70% UK stocks to 30% foreign ones. With fewer foreign holdings, returns tend to be lower and volatility higher. With more, returns rise but, once again, so does volatility.

It is often said that the 'emerging markets' of less developed countries are the riskiest of all. This is certainly true of individual markets. A key influence on share prices is the flow of capital around the globe as international investors remove cash from some countries and channel it into others. This sometimes leads to wild gyrations in prices as fashions change.

But again, research clearly indicates you reduce your overall risk by spreading some of your money across these markets. That is because their movements do not closely match those of the UK or other developed markets. To use the jargon, there is a 'low correlation' between the two. So the value of your portfolio will actually tend to move around less if it is partly invested in emerging markets.

One vital caveat applies: a 'low correlation' does not mean emerging markets never move in tandem with developed ones. The evidence suggests they don't generally rise together, but they do tend to fall together. The whole world was shaken by the Crash of '87. You will need to hold your nerve - and your sagging foreign shares - when all about you are losing theirs, to have any chance of banking those higher returns in the long run.

It is hard to define exactly what makes a market 'emerging' as distinct from 'developed'. But here is a rough guide to which countries currently fall into which categories:

Do not be tempted to put too many eggs in one basket, no matter how enticing it may seem. By 1990, Japan had given investors fabulous annual returns of over 30% for the past four years. But if at that point you had decided to send all your money east, you would since have lost more than half of it, while missing out on annual returns of over 17% from the American S&P500 index. So be sure not to lose your sense of balance when venturing abroad!

1. Why invest abroad? 2. Risk and reward in foreign investment 3. Custody risk 4. Currency risk 5. UK companies are foreigners too 6. Foreign unit and investment trusts 7. Picking foreign trusts 8. How to make the most of trusts 9. Tracker funds for foreign markets 10. Foreign companies on the London exchange 11. American Depository Receipts 12. Investing in American companies 13. Investing in European companies 14. Investing in Asian companies 15. Investing in other markets 16. Dividends and withholding taxes 17. Markets go global 18. Conclusion

• Mobius on Emerging Markets