There's evidence aplenty that investing in overseas markets is a very good way to improve the returns from a portfolio while actually reducing overall risk. What's more, evidence indicates that individual stock selection can outperform mutual funds and exchange traded funds (ETFs). It stands to reason, then, that investing in individual foreign equities could be a great way to boost returns and lower overall portfolio risk. If only it were that easy.
TUTORIAL: Exchange-Traded Funds
While there are indeed many good reasons to invest overseas, it is not nearly so easy as it sounds. In fact, investors face rather limited choices unless they are willing to take on larger risks and a longer investment timeframe. Let us consider, then, some of the least-accessible markets to U.S. investors.
Starting from Scratch
In terms of nominal GDP, Poland and the Czech Republic are the 20th and 45th largest economies, respectively, and both have been tapped many times in the past as attractive emerging markets within Europe. Yet, American investors have exactly zero choice when it comes to listed ADRs. That's right. There are zero listed ADRs hailing from Poland or the Czech Republic on U.S. exchanges. (For background on ADRs, see What Are Depositary Receipts?)
True, there are some unlisted shares (shares trading with a "Y" or "F" at the end of the ticker), but many of these are illiquid, and some brokers charge extra for these transactions. That leaves more conservative-minded investors with ETF options like Market Vectors Poland (Nasdaq:PLND) or the iShares Poland Index (Nasdaq:EPOL), but nothing for the Czech Republic.
Perhaps even more surprising is that Singapore has zero listed shares in the U.S. as well. Although there are some relatively liquid unlisted ADRs like those of DBS Group, Keppel and SingTel, as well as ETFs, it is surprising that a key financial center like Singapore has such little representation on U.S. exchanges.
Big Markets, Few Chances
Along similar lines, there is very poor representation from Turkey (1 ADR), Finland (1) and Indonesia (2) on major U.S. exchanges. These are very large economies - numbers 17, 36 and 18 in GDP terms, and Turkey and Indonesia are frequently hailed as among the most promising emerging markets. Yet, there is minimal representation on U.S. exchanges, and investors are forced to accept less liquidity to invest in companies like Koc Holdings or UPM-Kymmene.
There are country-specific ETFs here (and Indonesia actually has two), but the trouble with country-specific ETFs is that they are often heavily weighted toward natural resource and financial services companies, and not the sort of industrials and consumer goods companies that so often benefit from a rising standard of living within a country.
BRIC Leads the Way … Sort of
There are certainly a few exceptions to these dismal numbers. Looking at the BRIC countries, for instance, things get better. Russia has six listed companies on U.S. exchanges, India has 15 and Brazil has a whopping 34. China puts them all to shame, though, with 117 listed ADRs, to say nothing of the large number of "Chinese stocks" where the companies are technically and legally headquartered somewhere other than China. (To learn more, see Understanding BRIC Investments.)
TUTORIAL: Stock Basics
A Problem of Need Versus Want
Investors may wonder why there is so little representation from major foreign markets on U.S. exchanges.
To a large extent, it has to do with the cost-benefit analysis for the issuing company. To have a listed ADR, the company must comply with certain SEC regulations, must offer regular financial reports and must incur certain expenses. That is a headache that many leading global companies, including Germany's E.ON and France's AXA, have decided that they simply do not need. What's more, with institutional investors willing to buy shares on local exchanges, companies in countries like Turkey or Indonesia just don't see the need anymore for a U.S. listing, as they can raise the capital they need at home.
This should also persuade U.S. investors to be a bit more skeptical about the eagerness with which many Chinese companies approach the U.S. market. In many cases, these companies use reverse mergers to get a U.S. listing and to later raise capital through follow-on offerings. Why would a Chinese company that nobody has heard of want to list in the U.S. when a major Turkish company like Koc does not? Perhaps it has much to do with investor enthusiasm for anything China, and the reality that a good story can float a richly-priced share offering before reports of accounting irregularities and other problems come to light.
Make the Best of a Bad Situation
What's a U.S. investor to do? The best option may be to roll up one's sleeves and take the plunge with some liquid unlisted ADRs. As long as the shares routinely trade 10,000 or so a day, most regular investors can build a decent position without seeing the price move against them badly. That said, remember that these shares carry an above-average workload for the investor. It will be up to you to find information about the company, monitor press releases and so on, and it is not as easy as it is with listed names.
As time goes on, markets are becoming more integrated and accessible. Perhaps the day will come when an investor anywhere in the world can buy shares trading on any market. That is not the situation today, though. So investors looking to diversify into international investing need to make the best of the mutual funds, ETFs and ADRs (listed and otherwise) available today. (For additional reading, also see 5 Trendy Investment Ideas.)