International and Emerging Market Funds Explained: Risks, Costs and Taxes
Funds that own stocks outside the United States add exposure to other economies, but also to currency swings, different accounting and political risk. This explainer covers developed versus emerging markets, how international funds are built, what they cost, how the foreign tax credit works, and how investors weigh home bias.
A fund that owns only U.S. stocks still earns a large share of its revenue overseas, but its shares trade in dollars, follow U.S. accounting and respond mainly to U.S. conditions. International funds hold companies listed in other countries, and that changes the sources of risk and return. This article explains how those funds are built, how they differ and what to check before comparing them. It is educational and not advice to buy or sell anything.
What counts as "international"
Fund companies and index providers use three common labels:
- Developed markets ex-US. Companies in wealthy, established markets outside the United States, such as those in Europe, Japan, Canada and Australia.
- Emerging markets. Companies in countries classified as emerging by an index provider, typically markets that are growing but smaller, less liquid or less open to foreign investors.
- Total international or all-world ex-US. A blend of both, weighted by market size.
The line between developed and emerging is set by index providers using their own criteria, such as market size, liquidity and access for foreign investors. Two providers can classify the same country differently, and countries can be reclassified over time. This means two emerging market funds may not hold identical countries.
How these funds are built
Most international funds track a market-capitalization-weighted index, meaning bigger companies get bigger weights. Some points follow from that:
- Country concentration. A few countries can account for a large share of a broad index. Check the fund's country breakdown rather than assuming an even spread.
- Sector tilts. International indexes can have a different mix of industries from the U.S. market. Financials, industrials and consumer staples may weigh more, and large technology companies may weigh less, depending on the index.
- Large versus small. Some funds include small companies; others stop at large and mid-sized ones. The fund's fact sheet should say.
- Active alternatives. Some funds are actively managed to pick countries or companies. They usually cost more, and whether they beat an index after fees varies by manager and period. Our guide to index funds, ETFs and mutual funds explains the structural differences behind these choices.
The risks that are different
Currency. If you buy a fund holding euro- or yen-denominated stocks, your return in dollars depends on both the stocks and the exchange rate. A stronger dollar can reduce returns from foreign holdings, and a weaker one can add to them. Some funds hedge currency; most plain index funds do not. Hedging has its own costs and can reduce or add volatility depending on the period.
Political and regulatory risk. Changes in government, capital controls, sanctions or ownership rules can affect holdings. These risks are generally larger in emerging markets.
Accounting and governance differences. Disclosure standards, auditing and minority-shareholder protections vary by country. Index funds spread this risk across many companies but cannot eliminate it.
Liquidity and trading. Smaller markets can have wider spreads and less trading, which can affect fund pricing and costs, especially in stressed markets. Funds trading on U.S. exchanges can also trade at different prices from the underlying holdings when overseas markets are closed.
Concentration in a few state-linked firms. In some emerging markets, large government-linked companies make up a significant part of the index. Whether that matters to you depends on your view of those companies.
Developed versus emerging at a glance
| Feature | Developed ex-US | Emerging markets |
|---|---|---|
| Typical market size | Large and mature | Smaller overall, varied |
| Currency risk | Meaningful | Often higher |
| Political and legal risk | Generally lower | Generally higher |
| Typical fund cost | Often low for index funds | Often higher than developed funds |
| Role in a portfolio | Broad diversification beyond U.S. | Additional growth and cycle diversification, with larger swings |
What international funds cost
Expense ratios are the annual fee as a percentage of assets, and they are only part of the picture. Because overseas markets are harder to trade, international funds can have higher trading costs and, in some cases, taxes withheld at the source. Compare:
- Expense ratio. Broad index funds are generally cheaper than actively managed ones, and emerging market funds tend to cost more than developed market funds.
- Tracking difference. How closely the fund follows its index after costs.
- Bid-ask spread for ETFs, and any transaction fees or minimums for mutual funds.
Our explainer on fund fees breaks down the different cost types in detail.
Taxes on international funds
Many foreign countries withhold tax on dividends before they reach a U.S. fund. The fund passes that cost through to shareholders, and in a taxable brokerage account you may be able to claim a foreign tax credit or a deduction on your federal return. The fund's year-end tax documents show the foreign taxes paid. In retirement accounts such as IRAs and 401(k)s, the credit is generally not available, which is one reason investors sometimes think carefully about where in their accounts to hold international funds. The IRS publishes guidance on the credit, and a tax professional can explain how it applies to your situation.
Qualified dividend treatment can also differ for foreign companies, depending on factors such as the country's tax treaty with the United States.
The home-bias question
U.S. investors tend to hold most of their stocks in the U.S. This is called home bias. Arguments for holding some international exposure usually include:
- Diversification. Markets do not always move together, and leadership between U.S. and non-U.S. stocks has rotated over long periods.
- Opportunity set. A large share of the world's listed companies are outside the United States.
- Currency diversification. Spending power is in dollars, but holdings in other currencies can behave differently.
Arguments for holding less include:
- U.S. companies already earn revenue globally.
- Costs and taxes are often higher for international funds.
- Past U.S. outperformance over long periods, which may or may not continue.
There is no universally correct allocation, and reasonable investors disagree. Some use a market-weighted split of world stocks; others hold a smaller international slice, and some hold none. Anyone deciding should consider their time horizon and the rest of their portfolio, and may want a licensed adviser's view.
Scenarios, not predictions
How international funds behave relative to U.S. funds depends on conditions nobody can forecast reliably:
- A weaker dollar would tend to help dollar returns from foreign holdings, while a stronger dollar would tend to hurt them.
- A global slowdown can hit emerging markets and cyclical sectors harder.
- A leadership rotation away from U.S. large-company technology would change the relative performance of the two groups.
- Policy surprises, such as trade changes or sanctions, can affect specific countries and sectors.
These are illustrations of how risk can show up, not forecasts.
Questions to ask before comparing funds
- Which index does it track, and how does that index define "emerging"?
- What are the top countries and sectors?
- Does it hedge currency?
- What is the total cost, including spreads?
- Is it a single fund or part of a bundle, such as a target-date fund that already holds international stocks?
- Does the fund already overlap with something I own?
- Where will I hold it, taxable or retirement account?
A broad U.S. stock fund is only part of the market. International funds can add a different mix of countries, currencies and risks, at a price in costs and complexity, and the fund fact sheet is where to confirm what you would actually own.
Frequently asked questions
What is the difference between international and global funds?
An international fund, sometimes called ex-US, holds companies outside the United States. A global or world fund holds both U.S. and non-U.S. companies, usually weighted by market size. If you already own a U.S.-only fund, an international fund fills the gap, while adding a global fund can duplicate the U.S. exposure you already hold.
Are emerging market funds riskier than developed international funds?
Historically they have tended to swing more, because the economies are smaller, currencies can be more volatile and political, legal and accounting risks are often higher. Emerging markets can also grow faster or follow different cycles. Whether that trade-off suits an investor depends on their time horizon and tolerance for large declines.
Do international funds create extra taxes?
Foreign governments often withhold tax on dividends paid by overseas companies, and funds pass that cost through. In a taxable account, investors may be able to claim a credit or deduction for those foreign taxes on their U.S. return, and the fund's year-end tax statement reports the amount. In IRAs and 401(k)s that credit is generally not available. IRS guidance explains the rules.
