opportunities today are not bound by geographical location. 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.
6 Paths to Global Growth
There are six ways to invest in foreign growth that are available to any
investor:
- American
depositary receipts (ADRs) - Global
depositary receipts (GDR) - Direct
investing - Mutual
funds - Exchange traded
funds (ETFs) - Multinational
corporations
The Ups and Downs
For most
investors, the main points of investing in foreign stocks are to diversify
their portfolios 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. In some cases, political risk
can suddenly upend a nation's economy and, 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 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 Depositary Receipts
(ADRs)
American
depositary receipts, or 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.
ADRs can
be sponsored or unsponsored and have several levels.
- Level 1
ADRs cannot be used to raise capital and are only traded over-the-counter. - 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, while Japan’s Sony Corporation has
a 1:1 ratio (SNE).
These
companies are listed, traded and settled just like US shares which makes them a
convenient way for the average investor to hold foreign stocks.
2) Global Depository Receipts
(GDRs)
A global
depository receipt or GDR is another type of depository receipt. 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.
Most GDRs
are denominated in U.S. dollars, although some use the euro or the British
pound. They are typically traded, cleared and settled in the same way as
domestic stocks.
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) 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, comparable to the Securities and Exchange
Commission (SEC) in the US.
4) Mutual Funds
Investors
who are keen on exploring the 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 types with something for everyone, from aggressive to
conservative investors. They include global funds, international funds,
regional 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
International
exchange-traded funds offer a convenient way for investors to access foreign
markets. Picking the right exchange-traded funds (ETFs) 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, PowerShares, 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
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 the purpose are multinational corporations (MNCs).
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 although it does give the investor a stake in international
growth.
In Summary
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 such investors need to focus on their investment
objectives, costs, and prospective returns and
balance those factors with their tolerance for risk.
Prableen Bajpai can be contacted at FinFix
