The global economy offers many opportunities that attract investors to participate in economies outside the U.S. that are growing and generating significant returns. Stock markets in other countries can often show greater growth, due in many cases to the speed with which emerging markets are advancing.
Two of the main reasons investors want to invest in international markets are diversification and growth. By diversifying, the risks of investments can be distributed among different companies and markets overseas, where the economies are different from that in the U.S. And there may be opportunities to participate in more rapid growth in certain foreign economies, especially in emerging markets.
How can a private investor in the U.S. access this opportunity to invest outside the country? There are different ways, including mutual funds that offer options for investing outside the country, exchange traded funds that are indexed to foreign markets, ADRs (American Depository Receipts), shares of foreign companies that are traded on U.S. stock exchanges, and direct investments in the stock markets in other countries.
Mutual Funds
Many of the mutual funds available in the U.S. offer opportunities to invest in emerging markets, international equity, and other categories, with a complete portfolio of international stocks and bonds. These funds offer diversification, are managed by professional fund managers, and are less risky. They do not offer the personalization that you could have with your own portfolio of stocks you select yourself, but they offer the chance to participate in foreign stock exchanges without carrying all the risk involved in buying and selling individually.
There are funds that are specifically focused on a certain region, such as Latin America, Europe, or Asia, and others that are diversified, with investments in various parts of the world. There are also different types of funds according to the size of the companies they invest in, their market capitalization, and their potential growth.
You could consult with your stock broker for more information, or with the manager of your 401(k) plan, if applicable. Or you could do some research on the Internet, in practically all the principal financial and investing sites, such as Yahoo Finance, Google Finance, MSN Money, CNN Money, Forbes, TheStreet.com and Business Week, among many others, and in the websites of all the online brokers.
ETF's - Exchange Traded Funds
ETFs are similar to mutual funds in that they are baskets of stocks, which means you can diversity with just one purchase. But unlike mutual funds, ETF's are traded on the stock exchanges and can be bought and sold throughout the trading day, just like stocks.
These funds are managed passively - they follow some type of index, which could be a single country, a region, a certain segment of the market, or some other index or parameter, such as future prices or price to book value ratios.
One of the advantages of ETFs is their low cost. Annual management fees are minimal. And generally you don't need a large amount to start investing in an ETF. But you have to pay commissions when you buy and sell shares in an ETF.
With an ETF, an investor is buying and selling shares in the fund. The investments the fund makes are determined based on its purpose, which is the index it follows. So ETFs do not offer the investor the possibility of personalizing a stock portfolio. Nevertheless, there is a great variety of international ETFs you can choose from in order to participate in the type of foreign investments that interest you. For more information on the range of funds, you can consult your broker, or search the Internet in the same types of sites previously mentioned for mutual funds.
ADR's
ADRs (American Depositary Receipts) are certificates that basically enable the investor to participate in shares of a specific foreign company. Therefore, ADRs provide the opportunity to select the specific shares you want to invest in, as opposed to a mutual fund or ETF, which are baskets of stocks. ADRs are quoted on the New York Stock Exchange and on the NASDAQ. They can be distinguished by the "ADR" indicated after their name.
In the case of ADRs, a U.S. bank purchases a large block of shares of a foreign company and sells the shares in packages on U.S. stock exchanges. The foreign companies generally have to present reports and adhere to SEC (Securities and Exchange Commission) standards.
ADRs can be purchased, held, and sold as if they were shares in companies based in the U.S. They are traded in U.S. dollars so there is no need for a foreign exchange transaction. Despite being traded on U.S. stock exchanges, the prices of ADRs tend to reflect prices in their country of origin.
International Stocks Traded on U.S. Exchanges
In addition to ADRs, there are some foreign stocks that are traded directly in U.S. markets. These companies have met the requirements to be quoted on the New York Stock Exchange or the NASDAQ. For example, shares of many Canadian companies are quoted on exchanges in Canada and also on exchanges in the U.S. There are also large companies from various parts of the world that have their shares listed on a U.S. exchange, or in the over-the-counter market. Shares in these companies can be purchased the same way as shares in U.S. companies.
Multinational Companies in the U.S.
Some would say that you can gain exposure to international markets by investing in shares of U.S. companies that operate internationally. Many of the large U.S. companies generate part, or even most of their income overseas. Others would say that the returns that appear in the U.S. stock exchange indices already reflect these companies' earnings in foreign markets.
But there are U.S. companies that have all, or nearly all their operations in markets in other countries, and this could be an option for investors who want to participate in the increases in value that these operations generate. Research is needed to determine where different companies operate, in order to determine if they would be the type of investment you are interested in making.
Buy Directly
When you are an investor in the U.S., buying stocks directly on a foreign stock exchange can be more difficult that buying stocks on a U.S. exchange. First you have to consult your broker to see whether they offer the service of buying stocks on foreign exchanges. In order to offer this service, the brokerage firm in the U.S. has to work with an affiliated company, or with a bank or other broker in the country in which you want to buy and sell stocks. This bank or broker in the other country effectively makes the market for buying and selling stocks by being prepared at all times to accept buy and sell orders. For that, it sets firm ask and bid prices, with a spread, or margin built in to protect itself from the risks.
Another alternative would be to contact a brokerage firm in the country in which you want to buy and sell stocks and open an account with them. In this case, it would be advisable to ask your broker in the U.S. if they can recommend a brokerage firm in the country in which you are interested in opening an account.
Opening an account can be difficult in many countries and impossible in others. It depends on the current capital market regulations in each country, specifically the norms that regulate foreign investments.
Risks and Returns
The advantage of investing in shares of foreign companies is that it combines the aspects of globalization, diversification, and the chance to earn significant returns. You can seek out the best companies and therefore the best opportunities all over the world. Diversification serves to distribute risks. There is not always a correlation between movements in the values of stocks of companies in the U.S. and those overseas. And, you can look for the markets that are growing the fastest and generating the greatest returns.
Along with the opportunities, there are risks associated with investments overseas. It can be difficult to find accurate and timely information on foreign companies. Foreign governments can have different regulations regarding the information that companies must make available to the public, and the accounting principles that companies use in the preparation and presentation of their financial statements can be different. This can complicate a comparative analysis with companies in the U.S.
The regulations in different countries can affect your investments and the accounts you open in the country. For example, there may be restrictions on transfers of funds from your account in that country to your account in the U.S., or there could be a tax imposed on withdrawals of funds from the country.
Variations in the exchange rate of the foreign currency can affect the return a U.S. investor obtains. For example, if you purchase stocks in Japan and the value of the yen rises compared to the U.S. dollar between the time you buy the shares and the time you sell them, your return will be greater. But on the other hand, if the value of the yen falls in comparison with the U.S. dollar, your return will be lower.
There may be country risk, which relates to political, social and economic stability in the country. Also, inflation is a condition that can have a severe adverse effect on the economy of a foreign country and therefore on your investment in companies in that country. And, the volume of transactions on a foreign exchange can affect the variations in quoted prices. When there is relatively low volume, variations can be larger and more sudden.
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