International Diversification: Opportunities, Risks, Tax Consequences

Many Swiss investors focus on domestic securities, but the Swiss equity market only represents three percent of the global capital market. Investing exclusively in Switzerland means foregoing 97 percent of global investment opportunities. International diversification means spreading your assets across different countries and currency areas.

But this strategy raises questions: What currency risks arise? What is the impact of taxation on foreign income? And is hedging worthwhile?

The most important facts at a glance

• Spreading risk across borders significantly reduces your portfolio risk and gives you access to different economic cycles
• Currency fluctuations of 10 to 20 percent within a few years are normal - they can increase or decrease your returns
• Hedging strategies come at a price: you have to weigh up costs, security and flexibility
• Tax reporting is mandatory for all foreign assets, withholding tax is offset against Swiss taxes
• Professional asset management with a systematic approach significantly simplifies access to global markets

Why internal diversification is essential

Do you know the biggest mistake private investors make? They invest disproportionately in their home market. This so-called home bias costs returns and unnecessarily increases risks.

Switzerland does have first-class companies such as Nestlé, Novartis and Roche. But even these global players cannot replace the asset diversification offered by genuine geographical diversification. Why? Because different regions go through different economic cycles.

While the European market stagnates, Asian markets can boom. American technology stocks often perform independently of Swiss bank stocks. This low correlation between markets is your greatest ally in building wealth.

A look at the figures is convincing: the MSCI World Index, which tracks around 1,500 companies from 23 industrialized countries, shows more stable long-term returns than many regional indices. In 2020, for example, the MSCI World (in USD) rose by around 16%, while the DAX - after heavy losses in the meantime - only ended the year with a slight gain of around 3%. This resilience is the result of global diversification across different markets and currencies, which mitigates the risks of individual regions

Those who wish to invest their assets internationally also benefit from yield differentials. Different interest rate levels, different valuations and regional growth opportunities open up opportunities that do not exist in the domestic market.

Reading tip : Diversification as the key to minimizing risks in the portfolio

Understanding and classifying currency risks

Foreign currency investments bring an additional dimension to the portfolio: exchange rate risk. But what does this mean for you in concrete terms?

Example : Imagine you invest CHF 100,000 in American equities. The exchange rate is 1.00 USD/CHF. You therefore receive securities worth the equivalent of USD 100,000. After one year, your shares rise by ten percent - a pleasing gain. At the same time, however, the Swiss franc appreciates to 0.90 USD/CHF. Due to the unfavorable exchange rate, your equity gain of USD 10,000 dwindles to a real gain of just CHF 1,000.

Currency fluctuations of ten to twenty percent within a few years are not uncommon. They are influenced by numerous factors: economic developments, central bank policy, geopolitical events and market sentiment.

The Swiss franc is traditionally regarded as a safe haven. In times of crisis, investors flee to the stability of Switzerland - the franc appreciates. This appreciation reduces the return on your foreign investments. Conversely, you often benefit from a weakening franc in calm market phases.

You should be aware ofthree types of currency risk :

• Transaction risk arises with specific payment flows. You buy a bond today that matures in two years. The repayment amount is fixed - but not the exchange rate at the time of repayment.
• Translation risk relates to balance sheet valuation. If you own shares in international funds or companies with foreign subsidiaries, their value on your balance sheet fluctuates with the exchange rates.
• Competition risk has an indirect effect. If the Swiss franc appreciates sharply, Swiss companies become less competitive in exports - their share prices suffer.

Currency hedging - when does it make sense, when not?

Should you hedge currency risks? As is so often the case, the answer is: it depends. Three factors determine your decision, the so-called magic triangle:

• Hedging effectiveness describes how completely you protect yourself against exchange rate fluctuations. Full hedging almost completely eliminates currency risks, but also prevents currency gains.
• Costs are incurred for every hedging strategy. These can be between 0.5 and three percent per year, a considerable burden on your return.
• Flexibility means that you can react to changing market conditions. Some instruments lock you in for the long term, others allow you to make adjustments.

You cannot maximize all three goals at the same time. If you want maximum security, you pay higher costs and sacrifice flexibility.

There arethree hedging strategies to choose from:

1. The unhedged strategy forgoes hedging. You participate fully in currency opportunities, but also bear the entire risk. This strategy is suitable for long-term investments over ten years, as currency fluctuations tend to even out over time.
2. Partial hedging , for example, hedges 50 percent of your foreign currency positions. You balance opportunities and risks. Many professional asset managers use this middle way.
3. Full hedging protects your entire currency risk. You get planning security, but pay the highest costs and forgo currency gains.

Hedging instruments for private investors include currency-hedged ETFs. These take care of the complex hedging work for you. Institutional investors use currency forwards or currency options, instruments that are usually too complex and cost-intensive for private investors.

Rule of thumb: If you have an investment horizon of more than ten years, do without expensive hedging. Short-term positions or high individual exposures in volatile currencies, on the other hand, should be hedged.

Reading tip : Private equity: an asset class for private investors too?

Tax consequences for Swiss investors

Cross-border investments entail tax obligations. Transparency is not an option here, but a requirement.

Reporting obligation: You must list all foreign securities and accounts in the list of securities and assets on your tax return. The automatic exchange of information (AEOI) ensures that the Swiss tax authorities are aware of your foreign investments anyway.

Capital gains such as interest and dividends are subject to income tax. Many countries levy a withholding tax directly at source - often between 15 and 35 percent. But don’t worry: double taxation agreements (DTAs) between Switzerland and most countries prevent double taxation.

This is how offsetting works: the foreign tax office deducts 15 percent withholding tax on your dividend, for example. In Switzerland, you declare the gross income. The withholding tax already paid is offset against your Swiss tax liability. The bottom line is that you only pay the difference.

Currency gains are tax-free for private investors with private assets. If you sell your American shares at a profit and benefit from a favorable exchange rate, this currency gain remains untaxed. Conversely, you cannot deduct currency losses for tax purposes.

Withholding tax of 35 percent applies to Swiss capital gains - not to foreign capital gains. However, you can reclaim this in full, provided you declare your income correctly.

Stamp duty is payable on the purchase of foreign securities: 0.15 percent of the transaction volume. For a purchase volume of CHF 100,000, this is CHF 150. This tax does not apply to purchases via foreign brokers, provided they are not based in Switzerland.

The tax complexity should not put you off. Professional asset managers prepare detailed tax reports that make your declaration much easier.

Practical implementation of international diversification

How do you implement international diversification in practice? A systematic approach is crucial. Spread your assets across at least three to four regions.

• An example allocation could be: 40 percent North America, 30 percent Europe, 20 percent Asia-Pacific, ten percent emerging markets. This weighting is based on global market capitalization and offers broad diversification.
• Developed markets such as the USA, Europe and Japan offer stability and liquidity. The USA dominates with over 60 percent of global market capitalization. American technology companies are drivers of innovation and are indispensable in many portfolios.
• Emerging markets in Asia, Latin America and Eastern Europe offer greater growth potential with higher risks. An addition of ten to 20 percent can increase your returns in the long term.

Diversification across several levels maximizes your risk spread:

We have already discussed geography. But you also need to diversify across sectors. Technology, healthcare, finance, industry and consumer goods develop differently. What is lost in one sector can be made up for in another.

• Asset classes complement each other: equities for growth, bonds for stability, real estate for inflation protection, commodities as crisis protection. This mix significantly reduces fluctuations.
• Company size plays a role. Large caps offer stability, small and mid caps higher growth potential. A balanced mix makes use of both worlds.
• ETFs have proven their worthas an implementation tool. A single MSCI World ETF invests you in over 1,500 companies from 23 countries - instant diversification with a single security. The costs are often less than 0.2 percent annually.

Regularrebalancing is mandatory. At least once a year, you check whether your original allocation is still correct. If American shares have outperformed European shares, they will be given a disproportionate weighting. When rebalancing, you sell winners and buy losers - a disciplined strategy that brings long-term returns.

Reading tip : Private markets: New opportunities in the asset class for exclusive investments

Everon as a partner for international asset management

Investing globally requires expertise, time and discipline. This is exactly where Everon comes in.

As a FINMA-regulatedasset management company, we are subject to strict Swiss standards. This regulation protects your interests and guarantees professional risk management. Our investment strategies are developed and monitored in accordance with the highest regulatory requirements.

Systematic approach instead of gut feeling: Many investors make emotional decisions. Our quantitative approach eliminates this source of error. The in-house Everon Portfolio Engine analyzes thousands of securities worldwide and calculates their attractiveness based on scientifically sound factors. In this way, we avoid home bias and other behavioral investment errors.

There arethree international strategies to choose from:

1. The Smart Global Markets strategy cost-effectively tracks global market trends. We use ETFs and index funds with a focus on quality and momentum. From defensive (20 percent equities) to dynamic (100 percent equities), we adapt the strategy to your risk profile.
2. The multifactor strategy systematically invests in international equities, bonds, real estate and commodities. Our multifactor model evaluates each security according to several criteria and aggregates these into an overall score. The strategy exploits market inefficiencies worldwide and offers true diversification across asset classes and regions.
3. Private Markets provides access to international private equity, private debt and private real estate investments. These alternative investments were previously reserved for institutional investors. We work with reputable providers and only use semi-liquid products.

Currency management is one of our core competencies. We adjust hedging ratios depending on the market situation and your risk appetite. You don’t have to worry about complex foreign exchange transactions - we take care of this professionally for you.

Transparent cost structure with no hidden fees. You always know what you are paying and what service you are receiving. Our tax reporting provides all the information you need for your tax return in a clear format.

The Everon app and web platform allow you to monitor your internationally diversified portfolio at any time. Smooth onboarding, risk profiling and portfolio monitoring - all in one user-friendly solution.