Foreign Investment Opportunities
Today's investing opportunities are not bound by geography. If you're intrigued by the reports of emerging economies and booming growth in many nations around the world, you may well want to invest in some of them. You just have to know how to get started. There are six ways to invest in foreign growth that are available to any investor:
- American depository receipts (ADR)
- Global depository receipts (GDR)
- Direct investing
- Mutual funds
- Exchange-traded funds (ETF)
- Multinational corporations (MNC)
The Vagaries of Investing
For most investors, the main point of investing in foreign stocks is to diversify their portfolios by spreading the risk and to take a stake in the growth of other economies. Most financial experts and advisors consider foreign stocks to be a healthy addition to an investor’s portfolio. They recommend an allocation of 5% to 10% for conservative investors and up to a maximum of 25% for aggressive investors.
Like most things, international investing has its flip side. Measured in terms of volatility, foreign stocks, in general, are considered to be riskier. They tend to experience dramatic changes in market value and, in some cases, political risk can suddenly upend a nation's economy. Furthermore, it should be noted that many foreign markets are less regulated than those in the U.S., increasing the risk of manipulation or fraud.
Today's investors have extraordinary access to 24-hour global news, yet there also is a risk of inadequate information from a scene that is, often, thousands of miles away. This can limit the investor’s ability to interpret or understand events.
Finally, there is currency risk, stemming from changes in the exchange rate against the investor's home currency. Of course, currency moves both ways and the move can also be in the investor's favor.
If you're up for the degree of opportunity and risk of international investing, there are six ways to gain exposure to foreign growth.
1. American Depository Receipts (ADR)
American depository receipts (ADRs), are a convenient way to buy foreign stocks. Foreign companies use ADRs as an opportunity to establish a U.S. presence and sometimes to raise capital. The world’s largest IPO, Alibaba Group Holding Limited (BABA), is an example of a Chinese giant raising capital via an IPO and trading in the US as an ADR.
- Level 1 ADRs cannot be used to raise capital and are only traded over-the-counter (OTC).
- Level 2 and Level 3 ADRs are all listed on established stock exchanges like the NYSE or AMEX, but only Level 3 ADRs can be used to raise capital.
In order to equate its price in the home country and issuing country, each ADR represents the underlying shares in a ratio. For example, each Vodafone Group plc ADR (VOD) represents 10 ordinary shares (1:10 ratio), while Japan’s Sony Corporation has a 1:1 ratio (SNE). These companies are listed, traded, and settled just like US shares. That makes them a convenient way for the average investor to hold foreign stocks.
2. Global Depository Receipts (GDR)
A global depository receipt (GDR) is another type of depository receipts. In this case, a depository bank issues shares of foreign companies in international markets, typically in Europe, and makes them available to investors within and outside the U.S.
The London and Luxembourg Stock Exchanges are the most common locations for the listing of GDRs, but they have also been listed on exchanges in Singapore, Frankfurt, and Dubai. GDRs are mostly offered to institutional investors via private offerings.
3. Foreign Direct Investing
There are two ways for investors to buy foreign stocks directly. You can open a global account with a broker in your home country. Fidelity, E*TRADE, Charles Schwab, and Interactive Brokers all offer this service. The other is to open an account with a local broker in the target country. The Boom’s Trading Platform in Hong Kong or OCBC Securities in Singapore are among the brokers that offer services to foreign investors.
Going direct is not suited to the casual investor. The system is complicated, involving costs, tax implications, technical support needs, currency conversions, access to research, and more. In short, only active and serious investors should dive into this process.
Investors also need to be wary of fraudulent brokers who are not registered with the market regulator in the home country, such as the Securities and Exchange Commission (SEC) in the US.
4. Global Mutual Funds
Investors who are keen on exploring international markets without much hassle can opt to invest in international mutual funds. These funds are like any mutual funds in terms of the benefits they offer and how they work, except they hold a portfolio of foreign stocks rather than domestic stocks.
These funds come in a variety of flavors with something for everyone, from aggressive to conservative investors. They include global funds, international funds, region- or country-specific funds, and international index funds. Like other international investments, these funds tend to have higher costs than their domestic counterparts.
5. Exchange-Traded Funds (ETF)
International exchange-traded funds offer a convenient way for investors to access foreign markets. Picking the right exchange-traded funds (ETF) is easier for investors than constructing a portfolio of stocks by themselves.
While a single ETF can offer a way to invest globally, there are ETFs that offer more focused bets, such as on a particular country. There is also a wide range of international ETFs in categories such as market capitalization, geographical region, investment style, and sectors.
The prominent ETFs come from providers including iShares, SPDR, Vanguard, FlexShares, Schwab, Direxion, First Trust, Guggenheim, Invesco, WisdomTree, and Market Vectors, among others. Investors should research the costs, liquidity, fees, trading volume, taxation, and portfolio before buying an international ETF.
6. Multinational Corporations (MNC)
Investors who are not comfortable buying foreign stocks directly and are even wary of ADRs or mutual funds can seek out domestic companies that have a majority of their sales and revenue overseas.
The best-suited companies for this purpose are multinational corporations (MNC). For a US investor, that could be shares in Coca-Cola Company (KO) or the McDonald's Corporation (MCD), companies that increasingly generate most of their revenue from their global operations. This approach is a back door entry and does not provide true international diversification though it does give the investor a stake in international growth.
The Bottom Line
Knowledge about the political and economic conditions in the country that you're investing in is essential to understanding the factors that could affect your investment returns. As always, investors must focus on their investment objectives, costs, and prospective returns, balancing those factors with their risk tolerance.