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Why Investors Should Avoid International Equities

·3 min read

- By

Throughout his career, Warren Buffett (Trades, Portfolio) has tended to stay away from international stocks, with a few exceptions.

For example, last decade, he bought a holding in the U.K. retailer Tesco (LSE:TSCO), which he then sold after an accounting scandal. He also purchased a large holding in Chinese electric vehicle manufacturer BYD (HKSE:01211) and, more recently, Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) has acquired multibillion-dollar investments in Japanese holding companies.

While all of these investments have been substantial holdings, which would be significant for other funds and investors, international investments have never formed a significant part of the portfolio for Berkshire.

I do not think they will for as long as the Oracle of Omaha remains at the head of the business.

Buy what you know

Buffett has always tried to stay inside his circle of competence when investing and buying businesses for Berkshire.

He buys what he knows, and if he does not understand something, he moves on and does not look back.

This is the approach he has used when investing in different regions as well.

We got a snapshot of this mentality in 2019 when Buffett spoke with the Financial Times.

When asked about whether or not he would be interested in buying U.K.-based businesses, Buffett replied:

"We welcome the chance to put money out any place where we think we understand and sort of trust the system... We're never going to understand any other culture or the tax laws or the customs as well as the U.S., but we can come awfully close in Britain."

This is an important piece of advice for investors. Buying outside your circle of competence can lead you into owning something you don't understand. And if you buy something you don't understand, the risk of owning that asset goes up exponentially. If one is looking to reduce risk as much as possible, it makes sense to avoid investing in any regions one does not understand.

This brings me on to Chinese equities. I have seen a lot of value investors focusing on Chinese equities after their recent performance. Many investors are acquiring these stocks as they think China is an economic powerhouse, and it will only become stronger over the next few years.

I do not disagree with this view.

However, I have absolutely no idea about the Chinese regulatory or legal system. I also have no idea about the culture.

I only loosely understand why the government is cracking down on tech companies, and I cannot say if they will go further.

As I know very little about the region, it would not make much sense for me to invest in these stocks. Even if I thought I understood a business like Alibaba (NYSE:BABA), I don't understand enough about the Chinese government and culture to have any clear idea about what the future holds for the company.

This is something investors need to consider carefully before making a bet on Chinese equities. Yes, the companies themselves may look cheap compared to their potential and historical valuations, but this gives no regard to the cultural and political environment.

This is important in all economies and is far more critical in China, where the government has the last say on everything.

A better way to invest in Chinese growth, in my opinion, would be to buy the market as a whole. This requires less individual stock knowledge, and as the Chinese economy grows, its stock market should reflect that. This is the approach I am using to invest in the region, and it is something I plan to cover later.

Buffett avoids deploying significant sums of money in regions he does not understand, even though he may be able to find undervalued equities. Other investors may benefit from following the same approach.

This article first appeared on GuruFocus.