Why might an investor choose to hold foreign assets?

Question

BlackTom AI · Accepted Answer

The question asks why an investor might choose to hold foreign assets, which generally relates to expectations about returns and exchange-rate movements as part of the investment rationale.

Option analysis cannot proceed with full rigor because the provided answer choices are not listed. However, the lone listed answer suggests: 'Because the expected rate of return, including the expected appreciation of the foreign currency, is higher.' This aligns with a common investment logic: foreign-asset holdings can offer higher nominal returns and the potential for currency appreciation, which together contribute to greater total expected return when measured in the investor’s home currency.

From a conceptual standpoint, holding foreign assets serves multiple purposes:
- Return potential: Exposure to foreign markets can provide higher average returns than domestic options, especially if foreign equities or bonds are undervalued or growth faster than domestic equivalents.
- Currency appreciation: If the foreign currency strengthens against the investor’s home currency, the value of foreign-denominated investments rises even without changes in local prices, boosting the realized return when converted back home.
- Diversification: Including assets from other countries reduces portfolio concentration risk and may improve risk-adjusted returns if correlations with domestic assets are not perfect.
- Inflation and real returns: Some investors seek foreign assets to hedge against domestic inflation or to access sectors not readily available domestically.

Nevertheless, there are important caveats that temper this rationale:
- Currency risk: If the foreign currency depreciates, it can offset or even reverse gains from higher foreign returns, reducing overall performance.
- Political and macro risk: Foreign markets may present different regulatory, political, and economic risks that affect performance.
- Costs and frictions: Exchange rate fees, taxes, and transaction costs can erode expected extra returns.

If we were to consider possible alternative options (though not provided here), typical incorrect choices might assert that foreign assets are only about speculation, or that diversification never warrants taking on currency risk, or that domestic factors alone determine return. These would be incomplete because they ignore currency effects, global growth opportunities, and the role of currency movements in total return.

In summary, prioritizing foreign assets on the basis of a higher expected total return (which includes potential currency gains) captures the core motivation for international investing, while remaining aware of currency risk and other accompanying considerations.

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Why might an investor choose to hold foreign assets?

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