In a world where international scope is accessible to all companies and cross border trade forms a large part of many business strategies, an increasing number of investors are looking overseas for investment opportunities.
Investing in international stocks not only presents the opportunity for greater returns on money invested, but also allows an investor to diversify his stock portfolio across geographic boundaries as well as industrial and business sectors.
Investing in the equities of international companies is not without risk, however. Most obvious is the associated exchange rate risk. When an investor buys the shares of a foreign company, he will do so with exposure to the currency of the country in which he is trading. For this reason, returns are subject to the variance in the exchange rate of the dollar against the foreign currency. For example, if an American investor buys shares in a UK company, and the value of Sterling against the dollar rises, then dollar returns will increase. But if the dollar rises against Sterling, then investment return will be decreased.
There is also risk associated with the foreign markets themselves, which may have less onerous reporting and trading rules and tax investment returns differently. Of course, it could also be far more difficult to conduct research into the fundamentals of an international company, making stock valuations harder.
Methods of investing
For those investors who want to broaden their investments and diversify into international stocks, there are several ways of doing so.
Firstly, many domestic US companies have a high and increasing exposure to foreign markets. They may have have bought other companies internationally, or expanded their businesses organically across countries and continents. So called multinational companies like McDonald’s and Coca-Cola make the majority of their earnings from their overseas operations. Whilst profits made abroad will be subject to exchange rate risk, this way of gaining exposure to international markets is seen as having the lowest inherent risk for the investor.
Perhaps the most common of investing internationally is by the purchase of American Depository Receipts (ADRs). These are certificates issued by a US bank that represent the shares of a foreign company. Though denominated in dollars, the price and any dividends paid are converted from the price of the underlying foreign shares. ADRs are available in a growing number of large international companies, such as BP and Royal Dutch Shell, and are listed on US exchanges. They are traded in exactly the same manner as the stock of US listed companies.
Some foreign companies have their shares listed on US exchanges. This means that they have complied with the reporting requirements of US company regulations, and as such the related research and information risk should be similar to that associated with investing in the shares of US companies.
For those investors who want an international exposure but don’t want to conduct their own research – perhaps not having the time or inclination to do so – there are many international mutual funds available. Such funds may invest in specific markets (countries), or in entire regions, such as Far East funds. They could be industry specific or generalized equity funds managing investments around the globe.
Whilst investing internationally through mutual funds has its benefits, they will, of course, be exposed to the risks associated with investing in international stocks. The investor will also be liable to pay management fees upon their fund value.
Finally, Exchange Traded Funds (ETFs) are available to today’s investor. These funds will invest directly into the foreign securities, with fund value dictated by the price of those underlying holdings. These holdings could include directly held foreign shares, ADRs, and futures and options on foreign companies and stock indices. Just like international mutual funds, ETFs to suit the international objectives of most investors are available, whether that is exposure to certain countries or regions.
Investing internationally is now within the reach of all investors, large or small. Such investments can be made in collective schemes such as mutual funds, or in single company shares either through ADRs or direct investment abroad.
Though many routes to investment are now competitively priced, buying the shares in foreign companies on a foreign stock exchange will require the services of a full service broker. This will be more expensive than buying shares in a domestically traded US company.
However, the shares of ETFs and ADRs, for example, can be traded on the US exchanges in the same way as trading domestic shares, and through execution only brokers if wanted. The costs of buying stock in this way are far cheaper than through a full service broker.
For those investors wanting to expand their stock portfolios into international markets, often the first way of doing so is through the purchase of units in a mutual fund. This is more advantageous for the smaller investor, though management fees will be detrimental to returns. However, mutual funds do offer the immediate diversification not possible through a single stock investment.
Whatever method of investment you select, be sure to conduct proper research and due diligence before committing your investment cash. The risks associated with investing in international stocks are greater than investing at home, and include not only exchange rate risk but also all the usual risks of domestic companies (competition, regulation, rising expenses, etc.).
Finally, when investing your money, particularly in foreign stocks, it is wise to always use the services of a reputable broker. There are many fraudsters that will sell you the world for a penny. Ensuring that your broker is properly licensed and regulated by the US authorities will ensure that you are not one of the unfortunate investors caught every day with no chance of recouping ‘invested’ funds.