David Taube of Kalorama Wealth Strategies, LLC has been using international investing in his clients’ portfolio “pretty much since I began investing” because of two advantages it provides: the potential for diversification and the potential for higher returns outside of the U.S. So his use of the strategy even predates his founding of Kalorama in 2005.

Taube uses a “global diversified strategic asset allocation strategy,” in which he looks for the potential for higher returns. The fact that other countries are in different points of the economic cycle will drive returns, as will other parameters, such as “interest rates, exchange rates, the point of an economic cycle and the economic foundation of the country.”

“What is the focus of the country? [There are] different economic inputs or influences at different countries that will be different from [those in the] U.S., and the ultimate focus here is that you want to capture the returns of the best-performing markets,” Taube said.

But of course it’s not all about returns. Taube doesn’t favor any particular region or country, and in keeping with his globally diversified strategy he rebalances portfolios periodically. While his strategy is designed to capture those top performances, eventually those top performers have to be sold.

“[The strategy is to] buy based on what your target asset allocation is, and [then do] a periodic rebalancing, which essentially forces you to sell off some of the best-performing markets and buy those that are performing less well,” he said. Internationally he focuses on three different investment buckets: large-cap, small- and mid-cap considered together, and emerging markets.

Taube uses ETFs and mutual funds, “depending on the type of account, whether it’s a taxable account or a tax-deferred retirement account, and it also depends on market cap.” For taxable accounts, he uses ETFs exclusively across the board for all asset classes.

But for tax-deferred retirement accounts, “I use ETFs for tax efficiency purposes so I can control the capital gains taxable amount, because usually, if the ETF is managed correctly by the ETF provider, it should not generate capital gains, either short- or long-term capital gains.” That correct management is “a real bone of contention for some of them,” he said.

Also, looking at the tax-deferred account, “I take the market efficiency standpoint.” For large-cap, he uses an index ETF—something that’s tied to a benchmark and not actively managed. “There are esoteric strategies out there,” Taube said, “but I use index ETFs for a market efficiency, tax efficiency strategy.” Still within the retirement account, small, mid-cap and emerging markets investments would be actively managed, however. “If you’re able to find the manager who consistently outperforms, then he’s going to beat the benchmark.”

There are exceptions, however. He checks the Morningstar star ratings for indexed funds, considering that three stars are “average,” and said, “If I can buy an indexed ETF with a four-star rating, why bother trying to pick an active manager?”

Internationally, over long periods of time, he said, emerging markets and small caps have outperformed large caps.

Fixed income portfolios “generally mirror” equity portfolios, in terms of the overall percentage allocated to international investments. That depends on the client’s risk profile, generally running about 20–35% of the total allocation of the portfolio (either equity or fixed income), with more conservative portfolios running closer to 20% and more aggressive investors running higher.

Rather than being at different points on the economic cycle, as on the equity side, with investments on the fixed income side, countries are at different points on the interest rate cycle.

Taube educates his clients about his strategy, and although “the last two years have not rewarded investors who diversify,” his clients are mostly accepting of it. And he makes sure to let them know, too, that when there are returns on international investments and “the fund or ETF pays taxes in the foreign country, then you get a foreign tax credit for your pro rata share.” So clients need to claim the foreign tax credit on their returns: “Advisors should tell their clients, ‘You don’t want to pay anything more to the IRS than you have to.”